Coming Home – Overview Of Going Private Transactions Of U.S.-Listed Chinese Companies
Since the early 1990s, the U.S. stock exchanges have long been home to many prominent Chinese companies as they tried to attract a wide spectrum of investors and enhance their global profile. However, waves of the reverse trend – of those U.S.-listed Chinese companies going private with the ultimate goal of relisting in China – have come and gone in the past 10 years, with this year representing the most recent and perhaps ultimate wave as Chinese companies abandon what they see as a very unwelcoming U.S. market.
While the traditional reasons that public companies choose to delist are still relevant for U.S.-listed Chinese companies’ decision to go private (such as reduced compliance costs and burdens, better focus on the company’s long-term development goals, and more control over the company’s shareholder base), growing political and trade tensions between China and the United States, heightened regulatory scrutiny of U.S.‑listed Chinese companies by U.S. regulators, and potential high trading multiples upon relisting in China appear to be the key drivers for the recent wave.
These going private transactions can present attractive investment opportunities for PE houses as the controlling shareholders/management of many U.S.-listed Chinese companies with great prospects and solid fundamentals feel pressure to take their companies out of the U.S. market and require partners with cash and corporate finance expertise to do so.
In this article, we will elaborate on the following topics:
1. A Typical Going Private Transaction: What is a typical going private transaction of a U.S.-listed Chinese company?
2. Key Players and Their Roles: What are the key players’ roles, objectives, and strategic considerations?
3. Key Procedural Steps and Indicative Timeline: What is the approximate timetable setting forth the key procedural steps from submission of a going private proposal?
4. Key Strategic Considerations: Such as Buyer Consortium, Special Committee, Deal Certainty, Schedule 13E-3 and the SEC Review
5. Conclusion: What to look ahead for?
1. A TYPICAL GOING PRIVATE TRANSACTION
“Going private” generally refers to a transaction where a publicly traded company is delisted and ceases to be publicly traded. A majority of U.S.-listed Chinese companies are incorporated in the Cayman Islands. Although going private transactions for Cayman Islands incorporated companies can be accomplished through a tender offer and squeeze out or a scheme of arrangement, these transaction structures involve higher shareholder approval thresholds and, in the case of a scheme of arrangement, supervision by the Cayman court. As a result, the vast majority of going private transactions of U.S.-listed Chinese companies have been completed through a cash-out merger pursuant to the merger provisions in the Cayman Companies Law. In a cash-out merger, the buyer consortium and the target enter into a negotiated merger agreement, pursuant to which at the effective time of the merger, all outstanding shares of the target, other than shares held by the buyer consortium and the rollover shareholders, are converted into cash, and the target becomes 100% owned by the buyer consortium and the rollover shareholders. In most going private transactions of U.S.-listed Chinese companies, management or controlling shareholders of the target will either join the buyer consortium or roll over their shares.
We limit our discussions in the context of a typical going private transaction of a U.S.-listed Chinese company incorporated in the Caymans Islands, i.e. a cash-out merger where the buyer consortium is comprised of PE sponsors and management of target will roll over their shares.
2. KEY PLAYERS AND THEIR ROLES
It is important to note that, while the buyer consortium and the target stand on different sides of the deal, they need to understand each other’s roles, objectives, and strategic considerations in order to successfully negotiate the deal. Once a merger agreement is signed, the buyer consortium and the target need to work closely in preparing SEC filings, in particular, the Schedule 13E-3 to be jointly filed by the buyer consortium members and the target.
The consortium members will sign a consortium agreement to address ownership percentages and capital contributions, expense sharing arrangements, appointment of legal and financial advisors, commitment period of the consortium members to work exclusively through the consortium, post-privatization governance of the target, exit events, and indemnities for breach by the consortium members. One recent PE-sponsored going private transaction is the cash-out merger of 58.com Inc. (NYSE: WUBA), China’s largest online classifieds marketplace. The definitive merger agreement was signed on June 15, 2020. Warburg Pincus, General Atlantic, and Ocean Link Partners teamed up with 58.com founder Jinbo Yao in forming the buyer consortium.
Management of the target may have a conflict of interest if they join the buyer consortium or roll over some or all of their equity interests into the new private company upon closing of the going private transaction. While not legally required, where management are potentially interested, it is prudent for the target board to appoint a special committee of independent and disinterested directors to evaluate the going private proposal in order to provide assurance that a corporate decision has not been coerced or unduly influenced by directors who have an existing or potential interest in the deal. The special committee is typically formed as soon as the target board receives a going private proposal, and the special committee should be empowered with real bargaining powers to negotiate the proposed transaction on behalf of the target board, consider alternative transactions, and recommend the target board to approve or disapprove the proposed transaction. The special committee should retain its own independent legal counsel and financial advisor to advise the special committee in connection with the proposed transaction. The special committee and its advisors will have access to management, financial projections and other non-public information of the target. The target board will approve or disapprove the proposed transaction based on the special committee’s recommendation.
Financial Advisor to the Special Committee and Fairness Opinion
Once appointed by the special committee, the financial advisor to the special committee will conduct financial due diligence on the target to set preliminary valuation goal and assist the special committee in conducting a market check and evaluating whether to accept the going private proposal. The financial advisor will prepare and deliver a fairness opinion to the special committee regarding the fairness of the purchase price of the proposed transaction (from the view of the public shareholders). The special committee uses the fairness opinion to evaluate the fairness of the purchase price offered in the proposed transaction, and to support its decision in pursuing or rejecting the proposed transaction. Importantly, to minimize the risk of a merger being challenged on a fair value basis, the special committee should carefully consider the scope of investigation undertaken by the financial advisor, the documents and information provided to the financial advisor and the assumptions adopted as part of the fairness opinion, as these can be points of contention in post-merger fair value disputes in the Cayman Islands.
3. KEY PROCEDURAL STEPS AND INDICATIVE TIMELINE
While it is difficult to predict the specific timeline of any particular transaction, below is an approximate timetable setting forth the key procedural steps from submission of a going private proposal by the buyer consortium to the closing of such transaction (with some steps potentially happening simultaneously). Note that the buyer consortium may spend a few months or longer to evaluate the target and market conditions and to form the buyer consortium, prior to its submission of a going private proposal.
|Key Procedural Steps||Timeline|
|The buyer consortium submits a going private proposal to the target board||Day 1|
|The target issues a press release announcing receipt of the going private proposal||Day 1-2|
|The target board forms a special committee||Day 2-5|
|The special committee appoints its independent legal counsel and financial advisor||Day 6-15|
|The buyer consortium (and its legal and financial advisors) conducts due diligence on the target||Day 6-65|
|The financial advisor to the special committee conducts financial due diligence on the target and reports to the special committee its preliminary views on valuation of the target||Day 15-75|
|The special committee conducts a market check to evaluate alternative transactions||Day 20-80|
|The buyer consortium (and its advisors) and the special committee (and its advisors) negotiate the purchase price, the terms of the merger agreement, and other transaction related documents||Day 20-99|
|Members of the buyer consortium negotiate the consortium related agreements (e.g., interim investor agreement, rollover agreement, support agreement, limited guarantee, and equity commitment letter) and new Cayman merger subsidiary is incorporated by the buyer consortium||Day 65-99|
|Financial advisor to the special committee delivers the fairness opinion to the special committee, the special committee approves the proposed transaction and recommends the target board to approve the proposed transaction, and the target board approves the proposed transaction||Day 100|
|The buyer consortium and the target sign the merger agreement and other transaction related agreements||Day 100|
|Members of the buyer consortium sign the consortium related agreements||Day 100|
|The parties prepare Schedule 13E-3 and proxy statement||Day 101-120|
|The buyer consortium and its debt financing sources finalize debt financing documentation (if needed)||Day 101-140|
|The parties obtain regulatory approvals (if needed) and secured creditor consents (if the target has any secured creditors)||Day 101-210|
|File and clear Schedule 13E-3 with the SEC (the SEC may have several rounds of comments)||Day 120-180|
|The target mails proxy statement to the shareholders, and holds an extraordinary shareholders’ meeting||Day 181-220|
|Plan of merger registered by the Cayman Registrar, fund and close||Day 220-230|
4. KEY STRATEGIC CONSIDERATIONS
- Planning and due diligence of the target
At the preliminary stage, the buyer consortium should conduct thorough analysis of the target and its shareholder base, including reviewing the SEC filings and other public materials to see how much of the target is owned by its management or controlling shareholders, and reviewing the target’s constitutional documents to confirm shareholder approval requirements for the merger, special voting rights, anti-takeover provisions, and requirements for a shareholder to call an extraordinary shareholders’ meeting. Note that if the buyer consortium plans to acquire shares of the target in the open market, there are certain disclosure obligations under Section 13(d) of the U.S. Exchange Act — e.g., any buyer that purchases 5% or more of shares of a public company or changes its previously disclosed “intent” with respect to its holding of the target shares needs to file a new, or update an existing, Schedule 13D or Schedule 13G.
- Organizing the bid
It is ideal for the buyer consortium to reach an agreement on the terms of the consortium agreement as early as possible. A signed term sheet would be sufficient for this purpose and the execution of the actual consortium agreement may be deferred to when the parties are ready to execute the definitive agreement. The buyer consortium should preliminarily agree on the purchase price and sources of financing before it submits a non-binding proposal to the target board. The proposal will be publicly disclosed by the target, and is therefore best kept short.
Going private transactions are often funded with equity commitments from the consortium members, and sometimes debt financing from commercial banks. Financing arrangements should be discussed and confirmed as early as practicable in the deal process. The special committee needs to see a debt commitment letter to get comfortable that the required financing will be available before it approves the proposed transaction.
- Fairness of the price
The special committee has a fiduciary duty to secure the best value reasonably available for the public shareholders or, in the absence of this, disapprove the offer. To ensure the proposal from the buyer consortium is fair to the public shareholders, the special committee should consider conducting a proactive market check to seek competing bids prior to signing the deal with the buyer consortium (or retain a post-signing “go-shop” right), vigorously negotiate with the buyer consortium on the possibility of purchase price increase, and carefully consider whether the target can create more value for the public shareholders in the near term without going private.
- Fairness of the process
The special committee should establish a robust process to evaluate the going private proposal and vigorously negotiate the terms of the merger agreement, so as to serve the best interests of the public shareholders. The members of the special committee should actively participate in meetings, carefully evaluate information and advice presented to them, and maintain a good record of its work (such as minutes of the special committee meetings as well as negotiations and decision-making processes leading up to the approval of the proposed transaction) in order to help demonstrate the independence, diligence, and deliberations of the special committee. Additional procedural safeguards include conducting a pre-signing market check, retaining a post-signing “go-shop” right, negotiating a fiduciary out provision in the merger agreement to allow the board to terminate the merger agreement for a superior proposal or upon an “intervening event,” and negotiating approval of the transaction by a majority of the minority shareholders as a closing condition. Note that in practice not all procedural safeguards can be adopted, in particular, “go-shop” and approval by a majority of the minority shareholders remain minority positions in recent transactions.
Deal certainty is very important to both the buyer consortium and the target, and at the same time, both the buyer consortium and the target want to keep the option to back out of the deal under certain circumstances. From the buyer consortium’s perspective, it wants to retain a financing out for its own benefit, and in the meantime, to limit the target’s right to terminate the merger agreement and accept a competing bid. From the target’s perspective, it needs to be able to accept a superior proposal to maximize value for the public shareholders, and in the meantime, to limit any financing out of the buyer consortium. The following provisions relevant to deal protection are often heavily negotiated in the merger agreement as the parties try to allocate the associated risks.
Under the “go-shop,” the target would be permitted to solicit a superior offer for a period of time following signing of the merger agreement. With respect to a superior offer, the buyer consortium may ask for matching rights. “Go-shop” is not the prevailing practice for going private transactions of U.S.‑listed Chinese companies. If the target has conducted a pre-signing market check, a “go-shop” does not have much value to the target. In addition, if the buyer consortium holds a sufficient number of shares in the target, it can block a competing bid when it comes to shareholders approval, thereby making it difficult for the target to attract any competing bids; and where the buyer consortium includes the management or controlling shareholders, there is a very low prospect of a third-party bidder being willing to offer an improved price, given the inherent difficulties of operating a business with China‑based operations without the support of the management team, the members of which are often key for internal relationships in China.
- Approval by “majority of the minority”
The special committee may require that the proposed transaction be subject to the approval by shareholders holding a majority of the shares not owned by shareholders affiliated with the buyer consortium. This requirement effectively means that the shares owned by the buyer consortium and the rollover shareholders will not be counted in determining whether the proposed transaction is approved, even if the buyer consortium otherwise holds a sufficient number of shares to approve the proposed transaction. The buyer consortium often considers approval by a “majority of the minority” to be a deal breaker because it leads to significant uncertainty and reduces their leverage. The special committee would often consider a price increase or other provisions favorable to the target as a trade-off.
- Specific performance lite
As noted above, the buyer consortium wants to keep the flexibility of backing out of the deal upon failure to obtain financing, and the target, on the contrary, wants to limit financing out of the buyer consortium. To allocate the risks and get both sides comfortable, specific performance lite has been widely adopted for past going private transactions. Under the construct of specific performance lite, the target would be able to force the buyer consortium to close if the debt financing is available and all the other closing conditions are satisfied.
- Break-up fees and reverse break-up fees
Break-up fees and reverse break-up fees are cash penalties for backing out of the deal. On the buyer consortium side, it will pay the target a reverse break-up fee if it is unable to close (unless in the situation where the target can enforce the specific performance lite provision to force closing when the debt financing is available). On the target side, it will pay the buyer consortium a break-up fee if the target is unable to close – e.g., if the target accepts a superior offer. The amount of the reverse break-up fee is usually higher than the amount of the break-up fee.
Schedule 13E-3 and the SEC Review
The vast majority of the going-private transactions of U.S.-listed Chinese companies in the past decade involved management or existing controlling shareholders of the target. Rule 13e-3 of the U.S. Exchange Act imposes stringent disclosure requirements on these management buyouts to regulate the perceived conflicts of interest (e.g., rollover of their equities by management may result in management receiving material benefits not available to public shareholders). These additional disclosure requirements are reflected in the Schedule 13E-3 filed with the SEC. Among others, Rule 13e-3 requires disclosure of information relating to:
- Purposes and effects of the transaction, as well as alternatives to accomplish the stated purposes and effects, if any;
- Identity and background of the members of the buyer consortium, and their relationship with the target;
- Post-acquisition plans of the buyer consortium for the target as well as its business;
- Source and amount of funds used in the transaction;
- Background and history of the going private transaction, including events leading up to the signing of the merger agreement and negotiations among the parties;
- A statement that the special committee believes that the transaction is fair to the public shareholders as well as any fact supporting such belief;
- Summaries of the main transaction documents including the merger agreement;
- Fairness opinion of the financial advisor to the special committee; and
- Pro forma data regarding the effect of the transaction.
Schedule 13E-3 will include the proxy statement used to solicit target shareholder approval for the transaction, and must be filed prior to the beginning of the process of soliciting target shareholder approval. As Rule 13e-3 was designed to protect minority shareholders, the disclosure regarding the fairness of the transaction is likely to receive close scrutiny from the SEC and the SEC comment process may take up to a few months.
Chinese companies continue to play an important role in global capital markets. As the U.S. stock market becomes less welcoming and attractive to these companies and in the meantime, China is carrying out securities listing reforms to encourage listing in China, including on China’s equivalent of NASDAQ, the one-year old STAR market, we could be witnessing the start of a very major wave of going private transactions of U.S.-listed Chinese companies, similar to the one during the years 2014-2016. If played right, delisting from the U.S. stock market may mark the beginning of a new era of growth for these companies and bring value to all parties involved.