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Xinyuan Real Estate Co., Ltd. Message Board

  • hmmm26 hmmm26 Oct 15, 2012 8:02 PM Flag

    What Is a "Going Private" Transaction?

    There's been a lot of discussion about XIN potentially "going private," and rightly so, but let's take a step back so everybody understands what we're talking about.

    I. What is a "Going Private" Transaction?

    Don't let the terminology throw you: "going private" just means that a company is being purchased by a buyer's group that includes the company's CEO.

    Going private is normally good news for shareholders because to accomplish it, the buyers group needs to purchase ALL of the shares of the company: yours, mine, your grandmother's, everybody's.

    To do that, the buyers group needs to win a supermajority yes vote -- often 3/4 or 4/5 of the shares outstanding -- in favor of accepting their price offer.

    That's a whole lot of yes votes, so to get there, buyers have to offer a price higher than the current market price of the shares. How much higher differs radically deal to deal, but if you want to ballpark it, a decent guess might be 20% to 40% over market (although earlier this year, YOKU paid a 120% premium to buy TUDO).

    Using 30% as our guess, that would put a XIN offer at about $3.50 per share.

    II. Here's Where It Gets Complicated.

    If you've understood everything so far, pat yourself on the back because you understand going private transactions better than 90% of all investors.

    Nobody would blame you for not reading further.

    III. Why The Story Gets Ickier: Jurisdictional Problems Unique to China Stocks.

    US law is the best in the world at protecting the interests of minority shareholders during a corporate takeover (i.e., your interests, if XIN went private) . Unfortunately, US investors haven't had much success getting Chinese courts to enforce US judgments in China.

    That means the deterrents to a China stock CEO's misbehavior are mostly paper tigers: "Prison? Only if I'm stupid enough to set foot in your country again. Have fun waiting for me to do that. My assets? Help yourself to all the assets I left in the US. If you're lucky, they'll cover lunch."

    Unlike any other M&A event, in a going private transaction the CEO's interests and the shareholders' interests don't align. As sellers, shareholders want the highest price possible; as a buyer, the CEO wants the lowest.

    Therefore, unpunishable CEO mischief can have really bad effects:

    1. CEO can disregard the interests of minority shareholders.

    For example, in a normal situation, Share Repurchase is a legitimate alternative to Dividends. The main difference is that Dividends realize company value and distribute it to shareholders immediately, whereas Share Repurchase retains that value inside the company for the future ("pay me now" versus "pay me later").

    But what if there is no later? If a CEO knows he's going to be part of a buyers' group, then Share Repurchase becomes an excellent way to use company money to reduce the amount of shares outstanding, a number also known as the amount of shares left for the buyers group to purchase. Sure, the value is retained for future owners, but those future owners won't include you.

    It's not an accident that ZSTN did a Share Repurchase about two seconds before it went kamikaze.

    2. Going Kamikaze.

    This is a new outgrowth from #1, and represents a whole new risk for US shareholders in "going private" transactions, a way that humps shareholders out of any buyout premium and most likely leaves them with losses.

    ZSTN and CMED(Q) were the first stocks to do this, starting about a year ago. The idea is to use the CEO's position and influence to intentionally tank the public perception of the company, thereby lowering the share price and allowing the vast majority of the float to be purchased by the buyers' group ON THE OPEN MARKET, where there's no need for any price premium. For ZSTN and CMED, the buyers' groups were made up of the companies' CEO's and a previously unknown investment group called AER.

    To keep the share price low despite the hand over fist buying by AER, the CEO's of ZSTN and CMED both took the following, price depressing actions: they delayed reporting quarterly results, then broke SEC rules outright by ceasing to report them entirely. They picked fights with their Auditors, causing the Auditors to resign and to renounce their Opinions for previous years. They both stopped paying and eventually defaulted on their debt. They both refused to cooperate with the SEC on the non reporting question which caused trading halts followed by outright de-registrations. Then they both refused to cooperate with OTC Markets, causing their Pink Sheets re-listing to be on the lowest tier, "Buyer Beware," which features an honest to god skull and crossbones next to its quotes.

    While all of this was happening, both CEO's intensified the panic by refusing to give shareholders any information about what was happening to their companies or why.

    Naturally, any stock going through even a couple of those steps would immediately drop to zero, but here the buyer's group maintained price levels it set without regard to the actual value of the stock. That's a process that's still ongoing today, but we know from SEC filings the buyer's group definitely now owns 95% of ZSTN, and the numbers are probably similar for CMEDQ.

    That means they've managed to get very close to taking both companies private by paying an average price per share cost that's LESS than the market prices of the two companies a year ago.

    In my opinion, XIN is an excellent candidate for the Going Kamikaze option, better even than ZSTN and CMED themselves. Like the rest of the China stocks world, I imagine XIN's management is watching to see how the SEC responds to ZSTN and CMED and whether any punishments it doles out will be effective or not.

    3. Insufficient Offers.

    US shareholders only own the top level of any China stocks' corporate structure, a company which is always without any assets or revenues. As such, the true decision to accept a going private offer is made at the Operating Company level in China, under Chinese law, where we have no votes. This is the primary drawback to the FIE/VIE ownership structure, the evil stepsister of a normal ADR.

    For reasons passing understanding, this option seems to be less liked by rogue CEO's than the others.

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