Coming Home – Overview of Going Private Transactions of U.S.-Listed Chinese Companies
MoFo PE Briefing Room
Coming Home – Overview of Going Private Transactions of U.S.-Listed Chinese Companies
MoFo PE Briefing Room
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?
“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.
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.
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.
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
The buyer consortium submits a going private proposal to the target board
The target issues a press release announcing receipt of the going private proposal
The target board forms a special committee
The special committee appoints its independent legal counsel and financial advisor
The buyer consortium (and its legal and financial advisors) conducts due diligence on the target
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
The special committee conducts a market check to evaluate alternative transactions
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
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
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
The buyer consortium and the target sign the merger agreement and other transaction related agreements
Members of the buyer consortium sign the consortium related agreements
The parties prepare Schedule 13E-3 and proxy statement
The buyer consortium and its debt financing sources finalize debt financing documentation (if needed)
The parties obtain regulatory approvals (if needed) and secured creditor consents (if the target has any secured creditors)
File and clear Schedule 13E-3 with the SEC (the SEC may have several rounds of comments)
The target mails proxy statement to the shareholders, and holds an extraordinary shareholders’ meeting
Plan of merger registered by the Cayman Registrar, fund and close
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.
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:
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.
*We would like to extend our sincere appreciation to David Bulley, PE / VC / M&A Partner of Appleby, for his great contribution to this article.