Snowman acquisition case shines light on PE divestment model

By Li Yonggang, Concord & Partners
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Private equity (PE) investment has been developing for many years in China. From the outset, where it was known by few, to the national PE craze arising after the introduction of second boards, those foreign products that came drifting from foreign shores, such as VC (venture capital), PE (private equity), LPs (limited partnerships) and GPs (general partnerships) have become high-frequency terms often on the lips of people everywhere. However, changes in the PE divestment model seem very rare, with IPOs (initial public offerings) consistently occupying an absolute leading position, even becoming the sole divestment method in the eyes of some.

Except for projects in the real estate sector, such divestment models as mergers and acquisitions (M&A) and liquidation have never been a primary option of investors. The reason is simple; during the crazy years when IPO price to earnings (P/E) ratios kept hitting ever higher highs, divestment by IPO was without a doubt the best means to realise investment returns.

李永刚 Li Yonggang 共和律师事务所 合伙人 Partner Concord & Partners
Li Yonggang
Concord & Partners

Divestment difficulties

The precondition to the foregoing option has been facing more and more challenges in the last year or so. Due to the backlog in A-share IPOs, the frequent denunciations of the offer review system and numerous other reasons, the China Securities Regulatory Commission (CSRC) has, since 2012, gradually reduced the pace of A-share IPO reviews and made them more stringent, leading to a temporary halt to offerings. On 7 June 2013, the CSRC published the Opinions on Further Promoting Reform of the New Share Offering System (Draft for Comment), seeking public comment.

On 23 August 2013, a CSRC spokesperson indicated that the draft opinions were being improved and would be issued and implemented at the appropriate time. However, it has been reported that the draft opinions have run into opposition at a higher level for failing to make fundamental changes. From the effects of this, there is little hope that the gates will be opened for IPOs this year.

There is little doubt that this is bearish news for PE investors, not only messing up their timetables, but more importantly making it impossible for them to complete their divestments at their predetermined times, and realise their returns. Accordingly, since last year, some PE investors have gradually turned to divestment through M&A in an effort to obtain cash returns within a relatively short period of time.

However, there is a limit to the cash in the market, and the total volume of M&A transactions cannot grow without limit, so it is not an easy matter for many PE investors who wish to find an appropriate M&A divestment opportunity. Opting for an acquisition by a foreign investor is also an option, but there are numerous restrictions in the foreign investment sector that directly affect the feasibility and effectiveness of acquisitions by foreign investors.

New approach

The scheme to offer shares and pay cash to purchase assets and raise ancillary funds, disclosed by Fujian Snowman on 30 August 2013, provided the entire PE sector with a new divestment approach. According to the documents disclosed by Snowman, the company will purchase the multi-PE invested Changzhou Jingxue Freezing Equipment Company in three steps: 1) purchase 75% of the equity in Jingxue held by Jingxue Investment, TBP Ice Age, Guosen H&S, Tongde Investment, Hongbang Investment and Goldsun Venture Capital by means of a share offer; 2) make a private offer to not more than 10 other specific investors to raise ancillary funds not exceeding RMB149 million (US$24 million); and 3) use the cash proceeds to purchase the remaining 25% of the equity in Jingxue held by Jingxue Investment and Changrun Shiye. By way of this arrangement, certain PE investors in Jingxue will transfer their shares in Jingxue to Snowman, and receive listed and tradable shares of Snowman. They can then achieve divestment by selling the shares of the listed company.

Two birds with one stone

From the investment perspective, as Snowman will become the parent of Jingxue after completion of the transaction, Jingxue’s business performance will continue to reflect upon Snowman, and its original shareholders as shareholders of Snowman will be able to continue to benefit from the growth in Jingxue’s profits. From the divestment perspective, the original investors in Jingxue come to hold tradable shares of a listed company, and once the lockup period expires they can freely transfer such shares, thus permitting them to avoid the long time required for the IPO method and the divestment risks that it entails due to numerous factors of uncertainty.

The prompt returns that the investors in Jingxue will derive from the above-mentioned transaction may not reach the return levels obtained during the time of the high IPO P/E ratios, but the transaction accords the investors options: they remain indirect investors in Jingxue, and as such, they not only can continue to enjoy the benefits deriving from the growth in that company, but they also have the option to freely put up the listed company’s shares for sale once the lockup period expires. For PE investors, such options are conducive to efficient decision-making in responding to changes in market and other external conditions, e.g. changes in CSRC policies. Compared to the usual M&A divestment model, this kind of arrangement does not represent a one-off deal, but to a certain extent retains the dual possibility of continuing to hold onto an investment or selling and divesting. Accordingly, for many PE investors it is a way of having their cake and eating it, too.

Some illumination

In the current situation, where IPOs have been suspended, the illumination that the Snowman acquisition scheme has provided will undoubtedly assist PE investors and relevant intermediary firms in their thinking and exploration of more multi-faceted divestment methods that suit their own circumstances and requirements. Only in this way can innovation continue and changes in the market environment be adapted to, thus satisfying the needs of market development and allowing limited resources to be invested in sectors required by the market, and so maximising investment returns.

Li Yonggang is a partner at Concord & Partners in Beijing



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