THE BIG SQUEEZE
Despite their notoriety, privatizations live on. Still, the outcome of any bid to buy out minority shareholders can be uncertain - or unsettling.
By Chris Leahy

It sounds simple enough, if you're a bearish majority shareholder facing a battered economy: stock up the larder by taking the company private while prices are low. So goes the thinking. And so goes the latest round of privatization attempts in Hong Kong and Singapore. Disillusioned with depressed equity values earlier this year, controlling shareholders in a large number of listed companies have launched efforts to buy out their minorities, often at heavily discounted prices.

But these privatization bids - dubbed squeeze-outs - are controversial at the best of times and the latest have met with a very mixed reception. Several have suffered ignominious defeat at the hands of increasingly militant minorities who have questioned the real motives behind such moves. Others have been knocked sideways by damning reports from independent financial advisers. And yet others, with an apparently fine ethical and equitable pedigree, have fallen at the last hurdle.

Take Singapore government-backed SembCorp Industries (SCI). Low Sin Leng, group chief operating officer, could be forgiven for wondering just what is required for a successful privatization. When SCI launched an offer to buy out the minorities from Singapore-listed subsidiary, SembCorp Marine, everything, in strict Singaporean fashion, was done by the book. It was, by common consent, full and fair.

"We thought we put a very reasonable deal on the table," says Leng. "It was a significant premium to the share price before the announcement. When we launched the offer, the price moved at or around the offer price, which suggested strong support for our proposal. Unfortunately," she sighs, "two holders declined the offer."

Even David Gerald of Securities Investors Association (Singapore) (SIAS), the scourge of many Singapore squeeze-outs, believed SCI produced the goods. "We supported SembCorp Marine," he says. "We thought the price was right; we had no objections." From an association that has voiced an in-principle objection to privatizations, that is praise indeed.

SCI's bid ultimately failed at the hands of just two institutional shareholders together holding around 7 percent of SembCorp Marine. "Something like 99 percent of shareholders by number approved the deal," says one source close to the deal, "but just two large minority shareholders blocked it."

Tough School

SCI's travails highlight just one reason why it has become so difficult recently to conclude successful buy-outs. Regulations in Hong Kong and Singapore require proposed privatizations to pass two key hurdles: a vote in favor from at least 75 percent by value of the minority shares and not more than 10 percent of the minorities voting against. In many companies where the minority shares total say, just 30 percent, a single recalcitrant shareholder with a 3 percent stake can single handedly dump a deal. That is a high bar for success by any reckoning.

Henderson Land knows all about the voting issues. A leading Hong Kong property company, Henderson sought to privatize investment holding subsidiary, Henderson Investment, late last year. Pitched at a 28 percent discount to adjusted net assets, the deal failed narrowly; it passed the first vote with 85 percent approval but failed at the second hurdle when just 58 holders with 14 percent demurred.

"A majority of the independent shareholders were celebrating their payout at the meeting," says Martin Sabine, managing director of Somerley, a leading Hong Kong independent financial adviser (IFA). "They thought the deal had gone through but they'd forgotten about the second vote!"

Henderson's failed bid to squeeze the minorities from Henderson Investment is just one of a spate of privatization attempts that have hit the buffers in Hong Kong and Singapore within the last 12 months. Some attempts have proved to be controversial and have raised the hackles of both minority shareholders as well as pressure groups, including the redoubtable David Webb, thorn in the side of many Hong Kong boards. "Privatizations are very opportunistic," he says, "with record low interest rates and a depressed equity market: it's a cyclical phenomenon."

Todd Marin, managing director and head of mergers and acquisitions Asia Pacific at JPMorgan Securities, agrees, but has a very different agenda. His corporate finance team has been combing the market for possible privatization targets to pitch. "We've taken a look at a lot of potential squeeze-outs," says Marin. "We've gone to talk to major companies: the economics are very compelling. I think there'll be some more deals."

JPMorgan last year advised a management buy-out vehicle, Crown Central Assets, in a complex transaction that amounted to an effective privatization of NatSteel, another Singapore government-linked corporation. Having won the deal fair and square in an exhaustive tender, Crown Central Asset's deal was brushed aside when NatSteel became the subject of a frenzied bidding war at the hands of two of the Singapore market's leading tycoons, Ong Beng Seng and Oei Hong Leong. Having effectively put NatSteel in play, management was left to rue what might have been as the company was eventually sold for a price just 4.7 percent higher than Crown Asset's highest implied offer. It was certainly frustrating for JPMorgan's Marin. "We won it [NatSteel] in an auction - we were the highest bidder," he says, "and then others came in and jumped the deal."

Garry Lester, a vice president at JPMorgan who worked on the transaction, is philosophical about the result. "Crown was the successful bidder in the auction, it was the highest and cleanest bid," he says, "but as can happen, others came in and bid higher. The [Crown] MBO effectively put NatSteel in play and shareholders were the net beneficiaries."

Opportunity Knocks

Indeed, what makes the NatSteel deal so different to other squeeze-outs is that management did not control NatSteel and that allowed other competing bids to up the ante and create a genuine auction, which clearly benefited all shareholders. In most privatizations, shareholders are a minority and feel the squeeze from the controlling families. The only viable buyer for the minority shares, family-controlled shareholders have been accused of exploiting depressed share values over the last year to launch opportunistic bids at knock down valuations.

"There have been examples of deals that have been opportunistic in Singapore," says Glenn Porritt, director, global corporate finance at ANZ Investment Bank in Singapore and a market leader in IFA work. "By the time most deals have gone public, you would expect that a lot of work on pricing and value has been done to ensure the deal succeeds."

That may be true for most privatizations, but in the case of one of Hong Kong's most controversial squeeze-out attempts, that did not happen. In April this year, during the height of the Sars outbreak and the nadir of the local market, Kerry Holdings, the holding company for Malaysia's Kuok family interests, bid to privatize its property investment arm, Kerry Properties, and pitched the offer at an optimistic 47 percent discount to the underlying value of the assets and a premium of just 9.5 percent to a much deflated share price. According to one investment-banking source, Kerry management did not disclose the proposed terms to potential IFA candidates before electing to appoint investment bank NM Rothschild & Sons (Hong Kong).

"They [Kerry Holdings management] were flying blind," says the source. "They didn't disclose the terms. It was an unusual situation, with the background of Sars. I can understand where they were coming from, but the valuation was in April at the bottom of the market and, effectively, they would have been getting a double discount."

Kerry Holdings is probably regretting not being more forthcoming with their proposed terms. For once Rothschild had learned the price and produced its opinion letter, a workmanlike piece of corporate finance analysis according to many, they advised shareholders to reject the deal as neither fair nor reasonable. Negative opinions are rare indeed in squeeze-outs where the IFA is often appointed indirectly by the company seeking to privatize. As Webb says: "The independent board committee may ultimately pick the candidate, but they'll be presented with a shortlist who'll be expected to give a favorable opinion."

Just why Kerry chose not to pursue standard practice and check the opinion ahead of launching its bid is unclear. Equally strange in light of the difficult voting requirements, is the fact that despite knowing just one minority shareholder, Capital Group, had a de facto veto over the deal. Kerry and its advisers, HSBC, apparently did not tie up this vote before it upped its offer by a dollar a share. "It's a bit of a puzzle," admits Somerley's Sabine. "I'd always assumed that when the price went up, they'd secured the vote [they needed], but that wasn't the case."

HSBC and Rothschild declined to comment on the specific aspects of the transaction, which is hardly surprising. According to one source, Rothschild's opinion was not well received by HSBC or Kerry Holdings and there were significant differences of opinion between the two bankers over valuations and comparables. Rothschild also took issue apparently over the stipulated reasons for the proposed privatization, including the lack of liquidity and the company's inability to raise capital. Rothschild noted in its opinion that the average trading volume of Kerry Properties' shares was within the range of comparable companies. Furthermore, as one source noted: "PCCW managed to raise US$400 million just before the vote. If PCCW could raise money in this market, then Kerry Properties certainly could." Executives from Kerry Holdings did not return calls to comment for this article.

Chew Fook Aun, CFO of Kerry Properties was reticent about the merits of the transaction. "I was in the position of being the target," he explains. "I wasn't privy to the pricing process. Shareholders have exercised their right to vote. It's not something that I'm at liberty to comment further on."

Feeling the Squeeze

Kerry's deal was not the only squeeze-out to receive the thumbs down from an IFA. In January, Lai Sun Development, a heavily indebted Hong Kong-listed property company, launched a bid to privatize its subsidiary, eSun Holdings, a media business, at an eye-popping 91 percent discount to asset value, yet a 31 percent premium to the then share price. CFO of Lai Sun, Keith Wu, is unashamedly candid about the deal.

"We tried to hit the window when the shares were trading at a very low price so that we could offer a 20 or 30 percent premium to the minorities. Lai Sun was in a difficult financial position," he explains, "our resources to privatize eSun were very limited."

For chosen IFA, Somerley, the deal just did not stack up for minorities, although managing director Martin Sabine is sympathetic. "The price was understandable," he says, "I could see why they couldn't raise much money. But the discount to net assets was so large that from any IFA's point of view it would be very difficult to say it was fair and reasonable."

Lai Sun's desire to privatize eSun was not motivated by philanthropy alone however. Behind the deal was a cute attempt to eliminate a huge inter-company loan due from Lai Sun of some HK$1.5 billion (approximately US$192 million). If Lai Sun had succeeded at squeezing out the minorities at the offer price, it would be able to consolidate eSun's books and thereby write off the loan. Keith Wu is unapologetic again. "The deal would have enabled us to eliminate the inter-company debt," he admits, "and that would have helped Lai Sun's restructuring - that would have been very neat."

For Sabine, the loan itself was problematic. The major asset on the books of eSun, Somerley took a robust view of its likely value, which enhanced the asset backing and correspondingly, increased the offer discount, reducing its attraction to minorities. He claims Somerley just could not see its way to issuing the fairness opinion, despite some obvious benefits. "Even though it was at a huge discount," he says, "the shares had traded nowhere near the offer price. And here was 28 cents on the table, free and clear."

"Of course we were surprised by Somerley's negative opinion," says Wu. "We questioned how they'd valued eSun's media assets [as well as the loan]." Perhaps inevitably, the deal was rejected.

"I'm not surprised the privatization failed," adds Wu, "to be honest, once Somerley had given a negative opinion, we had to respect that." But he is magnanimous in defeat. "It's good that minorities are willing to stand up for themselves."

Getting Away With It

With minority shareholders increasingly stamping their feet and voting requirements already setting tough targets, it may be surprising that minorities do occasionally agree to be squeezed out and take the cash on the table. Shanghai Industrial Holdings, a Hong Kong-listed "Red Chip", recently concluded a successful privatization of subsidiary, SIIC Medical Science and Technology Group, a pharmaceutical and healthcare business. The first GEM-listed company to be privatized, the SIIC offer was pitched at a respectable 15 percent premium to the underlying share price. According to Michael Li, director at BNP Paribas Peregrine, who advised Shanghai Industrial on the deal, the squeeze-out sailed through. "It was a no-brainer,' he says. "We even got comments from the Chinese press that we were too generous! Virtually all of the property company deals were priced below book: our deal was a premium to everything."

While the SIIC deal appeared straightforward, the same cannot be said of this year's only other successful squeeze-out in Hong Kong, COFCO (Hong Kong)'s privatization of Top Glory International Holdings, a Hong Kong and China property and hotel business. While Kerry's opportunistic squeeze-out was left high and dry by minorities on gripes over the paltry sum offered, Top Glory's deal breezed past minorities at almost the same time and on almost identical terms (a 45 percent discount to assets against Kerry's 47 percent). What might have made the difference was that while Kerry's deal was mortally wounded by Rothschild's negative opinion, Top Glory's IFA, Somerley, opined that the terms of COFCO's offer passed muster. Not everyone, however, was convinced.

"I don't have time to fight all the battles," says David Webb. "The Top Glory circular came out at the same time as Kerry. The IFA looked at the same list of comparables as Rothschild and reached the opposite conclusion. One bent over backwards to give [the company] a fairness opinion, the other did it objectively." "The announcements were side by side in the Hong Kong Economic Times," says BNP Paribas Peregrine's Li, "one said yes, the other said no. Strange!"

Not according to Florence Fan, vice president at Citigroup Global Markets Asia, who jointly advised COFCO on the deal. "The rationale and reasons for privatizing were very clear," she says. "The price we offered was a historical high and the shares had suffered from poor liquidity. Minority shareholders saw that if they didn't grab this opportunity, the share price would go back to pre-deal levels."

Somerley's Sabine, who provided the fairness opinion, maintains that the Top Glory and Kerry deals are very different. "On the face of it, the discounts were very similar," he admits, "but Kerry Properties has very substantial Hong Kong properties: it's very different to Top Glory. The bulk of their [Top Glory] portfolio is in the PRC in some fairly secondary locations."

At the heart of the discrepancy between the two diametrically opposed recommendations, is the list of comparable transactions that each IFA used when trying to benchmark their respective deals. So-called precedent transactions, the numbers from these comparables are crunched interminably by earnest investment banking associates until some sort of consensus benchmark emerges. Like most statistics, however, the numbers can be easily manipulated to produce dramatically different results. In the case of the Kerry transaction, Rothschild chose to omit two heavily discounted squeeze-outs, the effect being to increase the apparent discount of Kerry Holdings' offer. By including these same two precedents in its analysis, Somerley increased the discount benchmark and thereby narrowed the apparent discount of Top Glory's proposal.

Neither IFA is necessarily wrong and each will justify its reasons for acting in the way it did. What is clear is that with a negative IFA opinion, it is hard to see squeeze-outs getting the nod from minority shareholders, and this explains why so much pressure is exerted on advisers to provide the desired opinion and why negative opinions are so rare.

In another attempted privatization earlier this year, Hong Kong's South China Industries attempted to squeeze out the minorities from its Singapore-listed subsidiary, Wah Shing International Holdings, a toy manufacturer. In a carefully worded recommendation, IFA, PricewaterhouseCoopers Corporate Finance, maintained that the deal "does not fully reflect the underlying value of the shares", but nevertheless advised shareholders to "avail themselves of the opportunityÉto exit their investment," based on a number of factors detailed in the circular. Notwithstanding the advice, the deal, with its offer price, pitched at a 77 percent discount to assets, caused an uproar in the Lion City. "They tried to privatize it at a very high discount to NAV," says ANZ's Glenn Porritt, "which led to a lot of unhappiness at the EGM."

David Gerald of SIAS was incensed by the proposal. "We objected to the deal very strongly," he says. "Even the IFA said that they did not agree with the valuation, but they agreed with the privatization." Gerald recommended his members vote the deal down, which they duly did. "Now the share price is above the buy-out price," says Gerald defiantly.

Give Us a Squeeze

With all of the difficulties faced by controlling shareholders in recent squeeze-out attempts, it would be pertinent to ask why any are still bothering to try. There are several proposed privatizations awaiting approval and some in the pipeline. According to Kelvin Chau, director at Rothschild, and the adviser responsible for the negative IFA opinion on the Kerry deal, some of these deals may never see the light of day. "I know a couple of deals put on the back burner because of this [the Kerry deal]," he says. "Some of these deals are having a hard time getting an opinion."

Yet, despite the mixed reception these deals often receive, Glenn Porritt of ANZ Investment Bank still believes that they can be worthwhile. "If you look at a company with no analyst coverage, a languishing share price and illiquid volume, [a privatization] can be good for minorities," he says. "They're not going to get a third-party offer. This gives them the chance to get out at a reasonable premium to the market price." The key to success, according to Porritt, is homework. "It's down to fairness and making sure the deal stacks up. If you're serious about privatizing, you need to try and figure out what is fair and what your shareholders will accept."

That might sound obvious, but given the recent failures of many proposals, it begs the question as to how opportunistic some controlling shareholders really are. "There's always a price that they're [the majority holders] prepared to pay," says Rothschild's Chau, "and that's OK if they can get away with it."

David Webb agrees. "It's not necessarily a bad thing; it's a free market. Controlling shareholders are entitled to try to privatize at big discounts and minorities are entitled to say no." There is sound reasoning behind Webb's relaxed stance towards these deals. "When the largest shareholder in the company offers to buy all of the shares," he says, "it's a very bullish sign."

"The best statement you can make about the value of your company," says Rothschild's Chau, "is to make an offer for it. It's like a line in the sand and provides a psychological value."

Certainly, in the case of Henderson Investment, Kerry Properties, SembCorp Marine and even tiny Wah Shing, since the abortive squeeze-outs, after an initial dip in value, each share price has climbed to a level from just above to well above its buy-out value, having previously languished well below. It is a point not lost on management. "All property stocks trade at a discount," says Kerry Properties' Chew, "so all property stocks are undervalued. In that sense, the [Kerry Holdings] offer has helped us."

SCI's Low is of a similar view. "It was a shame that the deal didn't go through," she says, "but we put a reasonable price on the table and that has demonstrated the true value of SembCorp Marine."

While eSun's share price has not enjoyed quite the revival of others, Lai Sun's Keith Wu remains adamant that the attempt to privatize eSun was the right decision. "In hindsight, we don't regret attempting to privatize," he says. "Previously, minorities were scared that they might miss the boat if they didn't accept an offer. We have a lot more transparency these days. People are daring to say that even if I disagree with the privatization, I can appreciate that the shares are undervalued. That's a sign of a maturing market."

Despite all of the strong words, perhaps minorities do not mind a little squeeze from their controlling shareholders after all.

Chris Leahy is a contributing editor at CFO Asia.