Since the early 1990s, a large number of well-known Chinese companies have been listed in the United States to enhance their global image, and the US stock market has become a haven for many Chinese stocks. However, China concept stocks have been privatized indirectly in the past decade, and the ultimate goal is to return to China and relist. This year, as Chinese companies abandon the US market that they think is no longer friendly, the wave of privatization of Chinese concept stocks has resurfaced.

The traditional reasons why listed companies choose to delist are also applicable to the privatization of Chinese concept stocks (for example: reducing compliance costs and burdens, committing to the company's long-term development, and simplifying the company's shareholder structure, etc.). However, in addition to the above-mentioned traditional reasons, the main driving force of this wave of privatization comes from the increasingly tense Sino-US political and trade relations, the increasingly stringent regulatory review of China concept stocks by US regulators, and the re-listing of China concept stocks in China. Potentially high valuation.

Many Chinese concept stocks with bright prospects and good fundamentals are under pressure to withdraw from the US market, and they need partners with capital and financing expertise to help them achieve this goal. Therefore, the privatization of Chinese concept stocks provides very attractive investment opportunities for private equity institutions.

In this article, we will address the following topics:

1. Typical privatization transaction : What is the typical privatization transaction of China Concept Stock?

2. Main participants and their roles : What are the roles, goals and strategic considerations of the main participants?

3. Main procedural steps and reference timetable : What is the approximate timetable for the main procedural steps from the submission of the privatization proposal?

4. Main strategic considerations : for example: the strategic considerations of the buyer consortium, the strategic considerations of the special committee, the importance of transaction certainty to the parties to the transaction, and the impact of the 13E-3 form and the US Securities and Exchange Commission review on the transaction.

5. Conclusion : Future prospects.

1. Typical privatization transaction

"Private transaction" generally refers to a transaction in which a listed company delists and its shares are no longer publicly traded. Most U.S. listed entities of Chinese concept stocks are incorporated in the Cayman Islands. Although the privatization of a company established in the Cayman Islands can be accomplished through tender offer or arrangement by agreement, the threshold for shareholder approval involved in these transaction structures is higher, and if privatization by agreement arrangement is adopted, it will be subject to the Cayman court. Supervision. Therefore, most of the privatization transactions of Chinese concept stocks have been completed through cash mergers in accordance with the "Cayman Companies Law." In a cash merger, the buyer’s consortium and the target company sign a merger agreement, according to which, upon completion of the merger, all of the target company’s outstanding shares (except those held by the buyer’s consortium and rollover shareholders) will be It is cancelled and exchanged for cash consideration, so that the target company is 100% held by the buyer consortium and upturned shareholders. In most privatization transactions of Chinese concept stocks, the target company’s management or controlling shareholder will join the buyer’s consortium or upturn its shares.

Our discussion in this article is limited to the typical privatization transaction of Chinese concept stocks, namely: the target company is established in the Cayman Islands, the buyer consortium is composed of private equity promoters, and the target company’s management upturns its shares.

2. Main participants and their roles

It is worth noting that although the buyer consortium and the target company have different positions in the transaction, if they want to successfully complete the privatization transaction, they must understand each other's roles, goals and strategic considerations. Once the merger agreement is signed, the buyer consortium and the target company need to work closely together to prepare the documents to be filed with the US Securities and Exchange Commission, especially the 13E-3 form jointly submitted by the buyer consortium and the target company.

Buyer consortium

Consortium members need to sign a consortium agreement to stipulate ownership and capital contribution ratio, cost-sharing arrangements, legal and financial advisers’ employment, exclusivity period (that is, consortium members’ exclusive commitments to only conduct proposed transactions through the consortium), and the governance structure after the target company’s privatization , Consortium members’ withdrawal arrangements and compensation for breach of contract. Taking a recent privatization transaction initiated by private equity as an example, 58.com Inc. (NYSE: WUBA), China's largest online classified information mall, intends to privatize through a cash merger. The final merger agreement was signed on June 15, 2020. The buyer consortium is formed by Warburg Pincus, General Atlantic and Ocean Link Partners, together with 58.com founder Yao Jinbo.

Special committee

If the target company’s management joins the buyer’s consortium or transfers part or all of its equity to a private company that survives the completion of the privatization transaction, a conflict of interest will arise due to the inconsistency of its interests with the public shareholders. Although the Cayman law does not provide for it, if there is a possibility of a conflict of interest among management, the board of directors of the target company should designate a special committee composed of independent and non-conflict-of-interest directors to evaluate the privatization proposal to ensure the privatization of the target company The decision was not made by directors who have an interest in the transaction, nor was it improperly influenced by these directors. Generally, the target company will set up a special committee as soon as possible after receiving the privatization proposal, and the special committee should be given independent bargaining power and decision-making power. It can negotiate the proposed transaction on behalf of the target company’s board of directors, consider the feasibility of other transactions, and recommend the target The company's board of directors approves or rejects the proposed transaction. The special committee should hire independent legal advisers and financial advisers to advise the special committee on the proposed transaction. The special committee and its advisers should have access to the target company’s management, financial forecasts and other non-public information. The target company’s board of directors shall approve or reject the proposed transaction based on the recommendations of the special committee.

Special Committee Financial Advisor and Fairness Opinion

The financial adviser of the special committee should conduct financial due diligence on the target company, set the target company's preliminary valuation benchmark, assist the special committee in market research, and evaluate whether to accept the privatization proposal. The financial adviser should write and submit a fairness opinion to the special committee on the fairness of the proposed transaction consideration (from the perspective of public shareholders). The special committee may decide to proceed or reject the proposed transaction based on the assessment of the fairness of the proposed transaction consideration based on the fairness opinion. It is very important that the special committee should carefully consider the scope of the financial advisor’s due diligence, the documents and information reviewed by the financial advisor, and the valuation method used in the fairness opinion, because these issues may be based on the completion of the privatization transaction. Issues in shareholder lawsuits triggered by the fair value of transactions.

3. Main procedural steps and reference timetable

Although the timetable for each specific transaction is different, we provide a rough timetable here, listing the main procedural steps from the buyer’s consortium’s submission of the privatization proposal to the completion of the transaction (some steps may be carried out at the same time) ). Please note that before submitting a privatization proposal, it may take several months or more for the buyer consortium to evaluate the target company and market conditions and form a buyer consortium.

4. Main strategic considerations

Buyer consortium

• Transaction preparation and due diligence on the target company
  At the initial stage, the buyer consortium should conduct a comprehensive analysis of the target company and its shareholder structure, including reviewing the information filed with the US Securities and Exchange Commission and other public materials to understand the target company’s management or holdings Shareholders own the proportion of equity in the target company and review the target company’s articles of association documents to confirm the merger’s required shareholder approval, special voting rights, reverse takeover clauses, and requirements for convening an extraordinary general meeting. Please note that if the buyer’s consortium plans to acquire shares in the target company on the open market, the buyer’s consortium has an obligation to disclose under Section 13(d) of the Securities Exchange Act of 1934 in the United States-for example, any individual or entity For a listed company with 5% or more shares, or to change its previously disclosed "intention" regarding holding shares in the target company, it is necessary to submit a new 13D or 13G form, or update an existing 13D or 13G form.
• The quotation
  buyer consortium should reach an agreement on the terms of the consortium agreement as soon as possible. To this end, it is sufficient to sign a list of terms of the agreement, and the final consortium agreement can be signed before the final privatization merger agreement is signed. Before submitting a non-binding privatization proposal to the target company’s board of directors, the buyer’s consortium should preliminarily agree on the consideration and financing arrangements. The privatization proposal should be as short as possible, because the target company usually publicly discloses the privatization proposal received.
• Funds for financing
  privatization transactions generally come from cash contributions from consortium members and debt financing from commercial banks. The buyer’s consortium should discuss and confirm financing arrangements as early as possible in the transaction process. Before approving the proposed transaction, the special committee needs to see the debt undertaking from the debt financier of the buyer’s consortium to ensure that the proposed transaction can obtain the required financial support.

Special committee

• 
  The fiduciary duty assumed by the Special Committee on Price Fairness requires it to allow public shareholders to obtain the maximum value that can be reasonably obtained in the privatization transaction, otherwise the privatization proposal should be rejected. To ensure that the privatization proposal of the buyer consortium has price fairness to public shareholders, the special committee should consider proactively conducting market surveys before signing the merger agreement with the buyer consortium and seeking competitive third-party bids (or reserve the " Actively compare prices), and actively negotiate with the buyer’s consortium on raising the consideration, and carefully measure whether the target company can create more value for public shareholders in the short term without privatization.
• The procedural fairness
  special committee should develop a sound evaluation procedure for privatization proposals, actively negotiate the terms of the merger agreement, and seek the best interests for public shareholders. The members of the special committee shall actively participate in the meetings of the special committee, carefully evaluate the information and suggestions submitted by their legal advisers and financial advisers, and keep good work records (such as the minutes of the special committee meetings, as well as all major matters and processes of the negotiation and decision-making of the proposed transaction ) In order to prove the independence, diligence and transaction review of the special committee. Other procedural fairness safeguards include conducting market research before signing the merger agreement, reserving the right to "proactively compare prices" after signing the merger agreement, and agreeing on exit clauses based on fiduciary duties so that the board of directors can receive better transaction proposals or "intervention events" "("Intervening events"), the merger agreement was terminated, and a majority of minority shareholders approved the transaction as a delivery condition. Please note that in practice, not all procedural fairness safeguards can be adopted. In particular, the practice of "active price comparison" and approval by more than half of minority shareholders is still a minority in recent transactions.
• Active price comparison (" go-shop ")
  Active price comparison rights allow the target company to seek better privatization proposals within a period of time after the signing of the merger agreement. The buyer's consortium can follow up on these better privatization proposals and raise their prices. Active price comparison is not part of the mainstream practice of privatization of Chinese concept stocks. If the target company has conducted a market survey before signing the merger agreement, the active price comparison right is of little practical significance to the target company. In addition, if the buyer’s consortium holds sufficient shares in the target company, it can vote against other privatization transactions when the target company’s shareholders approve other privatization transactions, making it difficult for the target company to attract competitive third-party buyer offers. If the buyer’s consortium contains management or controlling shareholders, third-party buyers are usually unwilling to spend time quoting, because in China, management members are particularly important to the internal governance of a company. Without the support of the management team, it means it is difficult to operate the business in China , Thus making any privatization proposal meaningless.
• The approval by “majority of the minority”
  special committee may consider requiring the proposed transaction to be approved by a majority shareholder of a non-buyer consortium related party. This requirement actually means that whether the proposed transaction can be approved by shareholders is not affected by the shares owned by the buyer consortium and upturned shareholders (even if the buyer consortium holds sufficient equity to approve the proposed transaction). The buyer’s consortium usually cannot accept the approval of the majority of minority shareholders because it brings great uncertainty to the transaction and reduces the buyer’s consortium’s advantage in the proposed transaction. In view of the above considerations, the special committee will generally require the buyer consortium to increase the consideration or accept other terms that are beneficial to the target company, thereby waiving the requirement that the proposed transaction requires the approval of a majority of minority shareholders.
• Lightweight version of the enforcement clause ( specific performance lite )
  > As mentioned above, when the buyer consortium fails to obtain debt financing, it will hope to have room to withdraw from the transaction. On the contrary, the target company hopes to avoid the failure of the transaction due to the inability of the buyer consortium to obtain debt financing. In order to balance risks and achieve a win-win situation, the lightweight enforcement clause has been widely used in past privatization transactions. Under the framework of the lightweight version of the enforcement clause, once the buyer consortium obtains debt financing and all other delivery conditions have been met, the target company will have the right to require the buyer consortium to complete the transaction.
• Break-up fees and reverse break-up fees ( break-up fees and reverse break-up fees )
  are cash penalties imposed when exiting the transaction. If the buyer consortium fails to deliver, it must pay the target company a reverse break-up fee (unless the target company has the right to require the buyer consortium to deliver according to the lightweight version of the enforcement clause). If the target company fails to deliver (if the target company accepts a better privatization proposal), it must pay a break-up fee to the buyer's consortium. The reverse breakup fee is usually higher than the breakup fee.

• The purpose and effect of the transaction, and alternatives (if any) to achieve those purposes and effects;
• The identity and background of the members of the buyer’s consortium, and their relationship with the target company;
• What post-acquisition plans does the buyer consortium have regarding the target company and its business;
• The source and amount of funds used in the transaction;
• The background and history of the privatization transaction, including the events that occurred before the signing of the merger agreement and the negotiation between the parties;
• A statement by the Special Committee that it believes that the privatization transaction is fair to public shareholders, supported by facts;
• Overview of major transaction documents, including merger agreements;
• The fairness opinion of the financial adviser of the special committee; and
• Simulated financial data of the target company after the transaction is completed.

Transaction certainty

Transaction certainty is particularly important for both the buyer consortium and the target company. At the same time, both the buyer consortium and the target company hope to have a choice to withdraw from the transaction under specific circumstances. The buyer’s consortium hopes to have room for exit when debt financing cannot be obtained, and also hopes to restrict the target company’s right to accept a better privatization proposal and thus terminate the merger agreement. The target company hopes to have the right to accept a better privatization proposal to benefit public shareholders, and also hopes to avoid the buyer consortium from terminating the transaction because it cannot obtain debt financing. When both parties negotiate a merger agreement, they will strive to balance the relevant risks. Therefore, the following terms related to the certainty of the transaction are often the focus of negotiation between the two parties.

Form 13E-3 and the US Securities and Exchange Commission review

In the past decade, most of the privatization transactions of Chinese concept stocks involved the management or controlling shareholders of the target company. Article 13e-3 of the Securities Exchange Act of 1934 in the United States imposes strict disclosure requirements on such management’s participation in acquisitions to supervise conflicts of interest (for example, when the management turns over the equity, it may gain public shareholders’ Significant interests). The parties involved in the transaction must submit Form 13E-3 that meets the disclosure requirements to the US Securities and Exchange Commission. The information required to be disclosed in Article 13e-3 includes:

The attachment to Form 13E-3 includes a voting statement used to solicit shareholders of the target company to approve the transaction, and it must be submitted to the US Securities and Exchange Commission for review before seeking approval from the target company’s shareholders. Since Article 13e-3 is designed to protect the rights and interests of minority shareholders, the US Securities and Exchange Commission is likely to scrutinize disclosures regarding the fairness of privatization transactions, and the review process may take several months.

5 Conclusion

Chinese companies have always held important positions in the global capital market. Given that the U.S. stock market’s attitude towards Chinese companies is becoming increasingly resistant and its attractiveness is declining, and China is currently undergoing securities listing reforms to encourage companies to list in China (including the Shanghai Stock Exchange’s Science and Technology Innovation Board on the first anniversary of the opening of the market), U.S. stocks May begin to privatize aggressively. If Chinese companies can make a correct layout when they delist from the U.S. stock market, it is expected to start a new chapter in company growth and bring a win-win situation for all parties involved.

* Special thanks to David Bulley , Private Equity / Venture Investment / M&A Partner of Appleby Law Firm, for his valuable comments on this article.

The information provided in this article does not constitute legal advice. For further explanation, please refer to the terms/statements linked below. Any information related to the People's Republic of China (hereinafter referred to as "China") is not intended and should not be regarded as constituting an opinion, determination or proof regarding the application of Chinese law. We are not permitted to engage in Chinese legal affairs.

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