A princely scandal

Much has been written about China’s “princelings” – the sons and daughters of senior politicians – and their high-profile roles at some of China’s most prominent private equity firms.

The topic was thrust into the headlines again in October when a scandal, which had its roots in a pre-IPO play, forced New Horizon Capital, the private equity firm co-founded by the most princely princeling of them all – Wen Yunsong, son of Chinese Premier Wen Jiabao – into the spotlight.

The drama began in mid-October when the Listing Committee of the Hong Kong Stock Exchange (HKEx) released interim guidelines on pre-IPO investments. The move, said a source close to the listing committee, was aimed specifically at the private equity industry and intended to stem the tide of GPs which have been seen coming into pre-IPO plays at a late stage and on heavily discounted terms.

In its statement, the HKEx Listing Committee said it had seen two recent cases in which the “pre-IPO investment agreements were signed on the date of submission of the listing application forms with settlement taking place later and close to the Listing Committee hearing date” and prices were at a “deep discount to the IPO price”.

In both cases, it added, the committee decided the investments went against the principle that all shareholders must be treated “fairly and equally” and decided the investments should either be withdrawn or else that the company should have its listing delayed to ensure “pre-IPO investors would be exposed to risks significantly different from those assumed by investors investing at the IPO stage”.

NEW HORIZON AND SIHUAN PHARMACEUTICALS

New Horizon came into the picture when it was discovered that one of the two cases cited was Sihuan Pharmaceuticals Holding Group, which raised $741 million when it listed on the HKEx in late October.

In July this year – when the company had already begun the IPO process – Sihuan agreed to sell a 9 percent stake to Beijing-headquartered New Horizon Capital. New Horizon paid a total of RMB540 million ($81.3 million; €57.7 million) for the holding, or RMB12.766 per share.

After investigation from the HKEx, the investment, which completed in August, was unwound in early October. However, it was not only the fact the deal was pulled up short by the regulators that caused the Hong Kong media to hone in on the deal, but also the fact Sihuan returned New Horizon 160 percent of its capital – a premium of 60 percent for a two-month investment for no obvious reason.

The resulting media outcry led New Horizon to publish a statement in several Hong Kong newspapers. In it, the firm said the investment in Sihuan was “completely lawful and did not violate any rules of the HKEx”. The firm said it had been discussing the investment with Sihuan’s management and controlling shareholders since the beginning of this year and that Sihuan itself was unaware of HKEx’s new guidelines on pre-IPO investments when the agreement was signed.

New Horizon pointed out in its statement that Sihuan could have pushed back its listing date making its investment a valid pre-IPO play under the new HKEx stipulations. However, the private equity firm stated that Sihuan’s management did not want to do this and therefore agreed to buy the shares back at 160 percent of the original cost.

Finally, at the end of the statement, the firm announced that the younger Wen, commonly known as Winston Wen, had left “last year” and was currently employed by a unit of China Aerospace Science & Technology Corporation.

End of story? Not really, as New Horizon’s statement raised more questions than it answered.

It did not explain why Sihuan’s management felt a highly unusual 60 percent premium was justified in these circumstances. Neither did the statement mention that New Horizon had at least one other option to make its investment valid. According to the source close to the HKEx listing committee, the firm could have chosen to stay invested on the condition its holding remain subject to a six-month lock-up post-IPO.

On Winston Wen, the statement did not clarify the reasons for his departure, its exact timing or the nature of his current employment. Neither did it mention whether Wen was a key man on any of the firm’s four funds and how the gap left by his departure was being filled.

The statement also seemed to contradict previous New Horizon statements. According to a report in The Wall Street Journal, the firm confirmed to the newspaper as late as January this year that Wen was still employed there.

The questions raised about New Horizon will, however, have to go unanswered for now, as the firm declined to comment beyond its statement when approached by PEI Asia.

POLITICAL DISCONNECT

As for the broader question raised again by the New Horizon episode about whether a private equity firm is the right place for a princeling, the answer increasingly seems to be ‘no’.

As one fund of funds manager puts it: “When you have a firm founded and managed by someone politically connected, unless they are extra careful to behave in a very overtly clean and above-board way, people will assume there are issues of political incest and influence at play.”

There may also, of course, be unwanted repercussions for the politician.

The Financial Times quoted sources “close to the younger Wen” as saying he had resigned in order to reduce the risk of scandal for his father, who is leading the country through political reform. The sources reportedly added though that Wen still has money invested in New Horizon and would “continue to be involved behind the scenes”.

“Winston has been under a lot of pressure; his father has been making a lot of waves with his strong public statements recently and it doesn’t look good if his son is on the side making lots of money,” a source told the newspaper.

As the fund of funds manager concluded: “In the case of the princelings, it’s beginning to be seen that playing in finance is a little too sensitive.”