By Tom Cane
The Mergermarket Group
23 May 2016 | 21:05 UTC
- Heng Ren normally seeks richer valuation in campaigns
- Lobbying effort underway for ADR holders to have ability to petition courts
Chinese stocks listed in the US offer a “special situations Nirvana” even as the country’s regulators scrutinize backdoor listings used to bring these companies back home, says Peter Halesworth, founder of Heng Ren Investments.
The Boston, Massachusetts-based activist fund was established in 2013 to focus on bottom up research of small and mid-cap US-listed Chinese stocks, convinced of the arbitrage opportunity in what had long been a “moribund” area of the market.
“Because it [the Chinese ADR universe] is neglected and inefficient, there’s a convergence between deep value and these sectors that are the future,” says Halesworth.
The fund has favored e-commerce, healthcare, consumer and transportation stocks, which can be bought at “deep value in the US universe because they’re orphan,” he adds. Whereas a company’s shares may be trading at 40x-50x earnings in China’s A-share market, in the US a comparable stock could be trading at price-to-earnings ratio closer to 10x, with some companies trading as low as 2-3x earnings.
This valuation misalignment has sparked a wave of going-privates in the ADR universe in the last few years, as controlling shareholders push through deals at lower valuations, only to relist in China, often via a backdoor listing, and achieve a much richer valuation in Shanghai or Shenzhen.
For example, Focus Media (SZ:002027) was taken private after a December 2012 offer that gave it an implied equity value of USD 3.6bn and is now trading in Shenzhen with a market capitalization of CNY 125.592bn (USD 19.3bn), after a backdoor listing via Hedy Holding in 2015.
A buyout offer for Giant Interactive in March 2014, meanwhile, gave it an IEV of USD 2.89bn. After a backdoor listing via Chongqing New Century Cruise (SZ:002558), it now trades in Shenzhen, with a market capitalization of CNY 66.327bn (USD 10.2bn)
The wave of going-privates at perceived low-ball offer prices has also irked minority shareholders in the ADRs. US-listed Chinese companies tend to be registered in the Cayman Islands or the British Virgin Islands, meaning holders of their ADRs lack the same rights as holders of US equities, including appraisal rights.
Because many of the companies in its portfolio have been targeted for buyouts, some of Heng Ren’s most notable campaigns have been waged to secure a richer valuation.
Last April, the fund challenged an initial USD 5.37 per share bid fromJiayuan.com shareholder Vast Profit, issuing a “fight letter” to the board of China’s largest online dating platform outlining that its full and fair value was USD 11.74 a share. The buyer, which owned a 21% stake, subsequently raised its offer by 34% to USD 7.20.
Jiayuan.com then received further bids. Vast Profit, which had acquired its shares shortly before lodging its initial offer, fell out of the running after failing to come up with proof of financing. In December Baihe Network, a smaller Chinese rival, came up with the winning bid of USD 7.56 a share. The deal closed on 15 May.
Two of its other investments, Sinovac Biotech (NASDAQ:SVA) and China Nepstar Chain Drug Store (NYSE:NPD), are in the midst of their own going-private processes.
The fund is also invested in Kingold Jewelry (NASDAQ:KGJI), which it last year issued with a series of operational and corporate governance recommendations to enhance shareholder value, including the hiring of a corporate advisor, which the company did. The company’s board also formed a Shareholder Value Committee.
This strategy is more illustrative of Heng Ren’s core approach, which is to step into the void left by the companies' lack of analyst and advisory coverage on Wall Street and use its research to provide operational and corporate governance recommendations to companies that are “adrift.”
“They’re small companies in China and it’s a challenge to be a public company period,” he adds. “They’re trying to be public in a mature market, which is a daunting task.”
Heng Ren, whose first launch was the Haiwai Huaren (Overseas Chinese) Fund, is eyeing USD 100m in assets-under-management, Halesworth said.
Halesworth has over two decades of investment experience, mainly in Asia, and was previously a journalist, having set up Dow Jones’ Indonesia bureau in 1994. Heng Ren also has three analysts.
Fighting for protection
Heng Ren has also been a vocal critic of the wave of Chinese buyouts and is actively lobbying for change. Last month it published a white paper urging regulators to afford greater recourse to holders of Chinese ADRs targeted by buyouts.
“US stock markets have become corporate governance havens for foreign companies that take coercive actions after raising investor funds from US markets,” the report said.
The fund would ultimately like to see holders of ADRs given the ability to petition the courts in the case of a lowball offer, the report said.
The paper noted that of 38 Chinese management buyouts in 2015 worth USD 44.4bn, the average premium offered was 20.6% compared to 28.4% in US M&A transactions, with many offers coming below the price of a target’s IPO. Of these, the average offer came 54% below the IPO price. Of these 32 stocks, the companies' total assets had increased 9x and cash on hand 6x
While Heng Ren fights for protection for ADR holders, China’s regulators are also closely scrutinizing the wave of buyouts.
Earlier this month, the China Securities Regulatory Commission (CSRC) said it was conducting an “in-depth study” of Chinese companies delisting in the US and relisting on the A-share market.
The backdoor listings wave continued Monday when Chinese courier company SF Holding (Group) said it had signed an asset-swap agreement with Maanshan Dingtai Rare Earth (SHE:002352), which would be the biggest backdoor listing since Focus Media.
“They’re seeing it from the market integrity angle,” says Halesworth, who expects CSRC scrutiny to put an end to the “speculation” that has seen Chinese companies coming back to the A-share market via a reverse merger with a listed shell company.
“There will still be buyouts, they’ll just be done in a different fashion,” he says. “The fast track route will be lost for the time being but the government still wants to encourage technology and healthcare companies to come back to China.”
Looking ahead, if Chinese regulatory scrutiny results in a more stable, credible path back to China for companies listed overseas, some of the larger e-commerce companies listed in the US could be encouraged to move back, Halesworth points out.
The two biggest Chinese ADRs are Alibaba (NYSE: BABA), which has a market capitalization of USD 194.7bn, and Baidu (NASDAQ:BIDU), with a market capitalization of USD 58.79bn.
The IPO pipeline remains populated, with Didi Chuxing, Uber’s Chinese rival, reported to be planning a US listing in 2017, though the company responded by saying it is not currently planning a listing.