After keeping the market on tenterhooks by suspending share trading for four days pending an announcement (in accordance with stock market regulations), Shenzhen-listed Chinese bottling firm Zhuhai Zhongfu recently announced that it would be selling a controlling stake to a foreign strategic investor in the form of CVC Asia.
One might have expected such news to be greeted with something less than jubilation in a country where the common characteristic of foreign private equity-led takeover attempts appears to be a period of torment at the hands of the authorities followed by reluctant compromise or outright failure. Anyone familiar with The Carlyle Group's tortuous negotiations at Xugong Construction (where a planned 85 percent interest was initially reduced to 50 percent and is currently down to 45 percent) will know how messy things can get.
So what happened when trading in Zhuhai Zhongfu stock resumed? Investors scrambled to buy it up, pushing the company's share price to its daily ceiling over three consecutive days. According to the China Daily, “the low-profile company overnight found itself a focus of the market”. The deal couldn't have received a more impressive sign of approval had traders carried a CVC representative shoulder high across the Shenzhen trading floor amid scenes of cheering and backslapping.
It wasn't just professional investors hailing the deal. Company founder and president Huang Lefu was also celebrating, having sold a major stake in the business he founded in 1982 while retaining a six percent interest. For those who might assume that private equity has a long way to go to win the battle for hearts and minds in China, it is informative to note that Lefu, aged 65, had stated prior to the CVC sale: “I want to introduce strategic investors to let the company step on to a higher stage.” He also succeeded in keeping the company in the family: his son Huang Chaohui is reported to be taking the reins as general manager under CVC's stewardship.
One lesson from these events is that in China, as anywhere else, money talks. It has been widely reported that CVC is paying 1.65 billion yuan ($214 million) for its controlling stake, a price that represents three times the target's book value and a 21 percent premium over its closing price prior to the announcement.
An ‘industry insider’ told China Business Weekly that “CVC has strong confidence in the company's solid fundamentals and that is the key reason for it to bid such a high price”. As a major supplier of polyethylene terephthalate (PET) bottles to Coca Cola and Pepsi Cola in China for over two decades, Zhuhai Zhongfu has been able to ride on the back of a soft drinks boom in the country. Its cash flows also look secure given that it recently signed a ten-year contract with Coca Cola. In 2006, the firm's net profits increased 50 percent.
But aside from the high price paid, there was another notable feature of the deal. There has been much focus on China's recently published (and subsequently revised) M&A rules, which, as a result of their considerable length and vagueness, have done much to muddy the waters for foreign investors seeking access to the Chinese market. Attention has mainly been on the more restrictive aspects of the rules, such as the broad category of assets that seem to fall into the ‘strategic interests’ bucket perceived to be in need of safeguard against foreign predators. Carlyle's approach at Xugong fell foul of this when construction machinery was – somewhat bizarrely some might say – interpreted as being of strategic importance.
What is more frequently overlooked is that the rules also, in a number of ways, seek to open up the Chinese market to foreign investment. Nor should this come as a surprise: China is, in fact, obligated to take such measures through its membership of the World Trade Organisation (WTO). CVC Asia's investment in Zhuhai Zhongfu is the first to take advantage of a beneficial piece of reform in the rules allowing foreign investors to take strategic stakes in tradable A shares of a Chinese listed company.
Contrary to popular perception, control deals are possible in China. You just need the regulations to be working with you rather than against you.