Private equity firms dealing in take privates on Chinese companies are facing increased execution risks, with due diligence costs spiralling.
Speakers at IFLR's Asia M&A forum in Hong Kong today described the practical problems associated with de-listing Chinese targets.
The biggest concern was due diligence. Vanessa Koo, managing director at Barclays Capital said that private equity firms are often forced into hiring private investigators to properly assess the target companies.
"From an execution perspective, the time and resources required to do a Chinese take private has grown hugely," she said. "Firms regularly spend over $10 million in due diligence costs alone."
Of all Chinese companies going private one would think that the vast majority are doing so due to depressed valuations and in some cases with irritation at being unfairly tarred with the same brush as those companies who have become embroiled in accounting scandals, said Mark Lehmkuhler, partner at Davis Polk & Wardwell.
"But some companies will actually have been cooking the books, engaging in accounting fraud and improper disclosure that are seeking to exit the public markets before being found out," he said.
"The risk, however small, that you are dealing with this latter category is what places a very high premium on the need to conduct extremely thorough and effective due diligence."
Lehmkuhler also touched on the interaction between the due diligence investigation by the deal professionals and the online reporting and commentary made by short sellers and internet-based securities analysts.
He said that having highly motivated people trying to uncover accounting irregularities and other problems concerning the target as you are simultaneously undertaking due diligence could be very useful. "In the best case scenario, these efforts can complement and extend our own work," he added.
However, there is the possibility that they could be spreading disinformation and false allegations in an effort to profit from a collapse of the share price and the abandonment of the deal, Lehmkuhler added.
Since all claims need to be carefully looked into, where there is no underlying substance this can lead to wild goose chases and waste precious time and limited resources available for due diligence.
In terms of financing, because of the difficulties offshore lenders have in underwriting acquisition financing for operating assets that are onshore in China, domestic PRC banks are a natural source of senior debt financing for these transactions.
They will bring to the table their own internal approval procedures, documentation preferences and the like, which in many cases differ from those of a typical Western bank that provides LBO financing, and sponsors and targets must take these into account well in advance, said Lehmkuhler.
Richard Yee, general counsel at Abax Global Capital, explained that investment firms can navigate through issues of potential fraud that have become prevalent in these deals. "Firms should acquire a deep understanding of a potential investment company from multiple perspectives and from objective sources," he said.
Yee added that this can include verifying assets, cash flows and profit and growth margins from both the company's perspective and third party sources.