Podcast: Dissent Involving Cayman Incorporated Chinese Companies Taken Private From U.S. Exchanges

Chinese ADRs and Dissent 

Anette Johnson, associated editor for Dealreporter based in Hong Kong, joins Julie-Anna Needham to discuss dissent involving Cayman incorporated Chinese companies that are being taken private from U.S. exchanges. Dealcast is presented by Mergermarket and SS&C Intralinks.'

In this podcast, you’ll hear about:

• Why Chinese companies are incorporated in the Cayman Islands.
• How the trend to incorporate in the Cayman Islands has reversed.
• How will the legal battles impact Chinese companies who list ADRs in the U.S. via a Cayman incorporated company.

Transcript

[MUSIC PLAYING] JULIE-ANNA NEEDHAM: Welcome to Dealcast, the weekly M&A podcast presented to you by Mergermarket and SS&C Intralinks. I'm Julie-Anna Needham. In this episode, we're looking at dissent involving Cayman incorporated Chinese companies that are being taken private from U.S. exchanges. Joining me is Anette Jonsson, Associate Editor for Dealreporter, based in Hong Kong. Hi, Anette.

ANETTE JONSSON: Hello.

JULIE-ANNA NEEDHAM: So starting off quite broadly, can you explain why these Chinese companies are incorporated in the Cayman Islands in the first place?

ANETTE JONSSON: Yes, historically, Chinese companies that wanted to tap foreign investors had to be incorporated outside of China, because China didn't allow them to have any foreign shareholders if they were based back home. So many of those chose to incorporate in the Cayman Islands, and some of them listed in Hong Kong, others listed in the U.S.

There was a lot of those that we saw a trend since the early 2000s of companies going that way. Since the global financial crisis though, we've seen a bit of an opposite trend, partly because China has relaxed its requirements for companies that can be listed at home. They've also invited companies to return to the domestic market. At the same time, many of these companies have been unhappy with the valuations they've been getting in the U.S. for various reasons.

So since, I would say, 2015, we had a massive explosion in these take-privates. And we've been tracking them quite closely since then. What happened basically was that the buyer groups, often the founding fathers of the company, often still the chairman, or the CEO, or both, often also still the controlling shareholder of the company, even though it had been listed for sometimes 10 years. They teamed up with other long-term shareholders, sometimes private equity firms, sometimes they went it alone, made offers to buy out these companies.

And because these companies are listed in the Cayman Islands, which have fairly relaxed rules towards corporate governance, or the corporate governance rules are focused more on companies than on shareholders to many extents, it was possible for these founders to use their controlling stakes, their controlling votes to push these deals through the EGMs without much opposition from minority shareholders.

They could do this because they need 2/3 of the votes to push the deals through the EGM, and the buyer groups themselves are allowed to vote, even though they are the ones buying out the company. So that meant that they would sometimes -- they were perceived to take advantage of this by offering what was often referred to as lowball prices.

To give an indication of what kind of money we're talking about, as of August last year, Dealreporter had tracked 26 completed take privates. And they had a combined implied equity value of about $21.6 billion. Now, since then, 10 of those companies -- this is as of August last year, 10 of those companies had subsequently relisted either in domestic China, in the domestic Chinese market or in Hong Kong, and where they were trading at a combined equity value of $164 billion.

Now, remember, they were taken private at just under $22 billion. They were worth $164 billion by August. And these are just the 26 companies that have been successfully completed their take private since 2015.

JULIE-ANNA NEEDHAM: So, Annette, can you just give us a brief idea of how this dissent works with the minority shareholders used in the Cayman courts?

ANETTE JONSSON: Yes, so what happens is that the only way minority shareholders, who are essentially given no right to vote at the EGM, they have a right to vote but the controlling shareholder can push the deal through. They can choose to seek a fair value appraisal by the Cayman court. And we have seen the majority of the 26 deals that have gone through so far have, in fact, gone down that route.

JULIE-ANNA NEEDHAM: And can you just talk us through one of the more recent situations with Sina. What's happening with that?

ANETTE JONSSON: So Sina is interesting because the deal was voted through at the EGM. But the buyer group had set a maximum dissent condition of 10%, which means that if more than 10% of the share capital dissented, the buyer group would have the right to walk away from the deal.

Now, the reason why they would set a dissent condition is that otherwise, the dissent could be massive, they could have half the share capital seeking a fair value ruling in the Caymans, and the cost of the take-private might balloon. So they're setting this as a level that would give them the rights.

With Sina, there was a 10% dissent condition. But in actual fact, 35.9% of the share capital did actually indicate that they would dissent. Right now the buyer group is trying to negotiate with some of these dissenters and try to make them back off, so that in return for a slight premium above the offer price.

This is still an ongoing case. We don't know whether it's going to go through. But we expect that it will because we've only seen two other similar cases in the past where the dissent condition was exceeded. And on both occasions, the buyer groups managed to get the dissent down to a level where they were comfortable to proceed.

JULIE-ANNA NEEDHAM: The take-private of 58.com is another situation that's facing dissent from minorities. What is happening with that, and why is that one significant?

ANETTE JONSSON: Well, 58.com is interesting and significant because of the sheer volume of the dissent. The implied equity value of the take-private itself was $8.4 billion. But the company faced almost $2 billion of dissent.

Now, this was possible because 58.com did not have a maximum dissent clause. Therefore, there was nothing to suggest that irrespective of how many shareholders dissented, there was no threat that the buyer group would walk away from the deal. They would have no right to do so. And lots of investors piled into dissent. In addition to the hedge funds that had started this trend back in 2015 and 2016, we were seeing on 58.com a massive number of long-term and long-only shareholders, including pension funds, getting involved.

JULIE-ANNA NEEDHAM: Yeah, I was going to ask that. What kind of funds are driving the dissent. So it is mainly hedge funds that are driving it with some of the long-only investors getting involved when it's an easy process?

ANETTE JONSSON: Yeah, it started off with one hedge fund dissenting a very small amount of money at 1.46% of the share capital on the first such situation to actually go to court, Shanda Games. But after that ruling, which came in May 2017, and they came in court determined that the fair value of Shanda Games, at the time of the 2015 take-private, should have been 135% higher than the actual price the minorities were paid.

After that ruling, everyone got their eyes opened and realized that this might be of interest. This led to a bunch of other hedge funds, primarily Asia-based to begin with, and getting involved. And later it spilled over into U.S. and some European hedge funds. And in the past couple of years, we've seen more and more long-only and long-term investors jumping on this bandwagon as well.

Mind you, not all long-only investors can take part in this, because there are statues may say that they can't hold unlisted or illiquid shares. And of course, this whole dissent process takes place after the company has been delisted. And therefore, many of those are forced to sell their shares to these hedge funds who can then take the situation into the courts.

JULIE-ANNA NEEDHAM: And how will the legal battles impact Chinese companies who list ADRs in the U.S. via a Cayman incorporated company? We touched on it a bit earlier, and you said that a lot of them are not looking to list there anymore. But I'm guessing this will deter them even further.

ANETTE JONSSON: Well, it's actually not true that they're not listing there anymore. We're actually, at the same time as we're seeing this take-private trend go on, we are still seeing a number of Chinese companies listing in the US. So there is a dual trend, if you wish.

I think we were all hoping, or the hedge funds and the long-onlies that were watching this process, we're all hoping that the Cayman court rulings were going to serve as a deterrent for buyer groups to offer low ball prices. They would start off offering a higher price to begin with. But essentially, if you look at what the investors themselves say and the dissent, we continue to see that has not quite happened. We are continuing to see buyer groups take advantage of their high voting rights to push through these deals.

JULIE-ANNA NEEDHAM: Looking at a bit more detail on another recent development, the legal challenge against the Changyou.com transaction. Can you explain what the situation is there, and how minority shareholders are getting on in their legal battle?

ANETTE JONSSON: Yeah, Changyou is interesting because it is done not as most of the other take privates as a long-form merger. It is done as a short-form merger. And that has developed and become more common as the buyer groups found a bit of a loophole, if you wish.

While you had dissent rights under section 238 of the Companies Law for long-form mergers, which is how most deals are done. If the buyer group already controls more than 90% of the votes, they have the option of doing a short-form merger instead. And some lawyers have been arguing that the Cayman law did not give dissent rights on these shortfall mergers. The reason was, very briefly, that they don't require a shareholder vote. There is no EGM. And as a result of that, the EGM, which is used as a starting point for dissent, since that didn't exist then, so dissent couldn't exist.

Now, as more and more companies tried to fit into this mold to do these short four mergers, lawyers were starting to talk to investors about potentially challenging that way of looking at the Cayman company's law. And in June last year, a group of shareholders filed a petition in the Cayman Islands, basically arguing that they should still have a right to dissent these short-form mergers, including Changyou.com, because they are no less deserving of a right to fair value just because the company controlling shareholder owns more than 90% of the vote or controls more than 90% of the vote.

Now, the ruling on that, there was a two-day hearing in the Caymans in November. The ruling came out in late January. And basically, the judge sided almost entirely with the petitioners and ruled that yes, they should have a right to dissent Changyou.com and short-form mergers in general.

So this is very significant. Now, we anticipate that this will be appealed by the company. And we expect that it's going to be a drawn-out process. But essentially, the loophole that allowed some buyer groups with large amounts of voting rights, to begin with, to get around the dissent has effectively been closed if this ruling is upheld.

JULIE-ANNA NEEDHAM: Great. We will have to leave it there, Anette. It's really interesting. Thank you very much.

ANETTE JONSSON: Thank you.

JULIE-ANNA NEEDHAM: That was Anette Jonsson speaking to me Julie-Anna Needham. Thank you for listening to this week's episode of Dealcast, presented by Mergermarket and SS&C Intralinks. Please rate, review, and subscribe to the podcast. You can find us on Apple Podcasts, Spotify, or look out for your Mergermarket news alert. For more information, check out our show notes. Join us again next week for another episode.