Private practice

An old Chinese saying states that the wheel of fortune is ever turning, and this is certainly true for many ­Chinese companies listed in the US.

A little over a year ago Chinese companies such as Youku.com and E-Commerce China Dangdang were the darlings of the US market after achieving staggering performance in their New York IPOs. A mere six months later a spate of accounting fraud allegations questioning several Chinese companies’ financial practises have dealt a major blow to the valuations and reputations of all US-listed Chinese companies. In 2011 no fewer than 20 companies, mostly those that went public through ­reverse mergers with a public shell, were forced to suspend trading and delist by the stock exchanges for ­violating regulations.

While things are still looking gloomy, some companies’ fortunes have taken another turn that will most likely be for the better. The management of Nasdaq-listed Shanda Interactive Entertainment, Funtalk China Holdings and New York Stock Exchange-listed China ­Security & Surveillance Technology, among several others, have decided to delist voluntarily through management buyouts (MBOs).

More than a dozen of such take-private transactions were announced or completed in 2011, supplying a ­vibrant flow of deal activity for ­leading US law firms. Shearman & Sterling and Skadden are enjoying the lion’s share of this market, having been involved in 10 and nine transactions respectively.

The two firms often meet across the deals table. In the $2.3bn (£1.5bn) take-private transaction of Shanda, for example, Shearman is advising the buyer and Skadden is acting for JPMorgan, the financial adviser to the buyer and the sponsor of the transaction. The deal is expected to close in the first quarter of 2012.

The average total legal costs and expenses of taking a mid-cap US-listed company private is estimated at $5m or more, usually exceeding the cost of an IPO of a similar ­company. In the Shanda deal, in ­addition to Shearman and Skadden, seven other law firms have also been engaged.

In terms of deal count, a group of elite firms consisting of Davis Polk & Wardwell, Latham & Watkins, ­O’Melveny & Myers, Simpson Thacher & Bartlett and Weil Gotshal & Manges are not too far behind Shearman and Skadden. Lower down the pecking order a dozen other US firms have also scooped roles in one or two such deals so far.

It is only natural for US firms to dominate the instructions for go-­private transactions of US-listed ­Chinese companies. However, a ­couple of magic circle firms have made appearances, aiding their long-term bank clients. Clifford Chance, led by Hong Kong partners Matthew Truman and Neeraj Budhwani, acted on the Shanda deal for JPMorgan, while Allen & Overy, fielding Hong Kong partner Walter Son, won the role for HSBC and ­Citigroup Global Markets Asia, which served as the underwriter of the debt facilities for China Fire & ­Securities Group.

Adversity and opportunity

The global capital markets and M&A landscape had its share of volatile times in 2011, but for certain US law firms, particularly those with strong China M&A and private equity practices, the adverse situations have created new demands for legal services.

Skadden Beijing partner Peter Huang co-headed the firm’s transaction teams in all nine China-related deals alongside Hong Kong-based senior M&A partner Michael Gisser.

Huang says: “The inability to raise additional capital by the Chinese ­issuers due to depressed prices and lack of liquidity in the US markets, coupled with the high cost of maintaining public company status in the US and the increased risk exposure to short sellers’ attacks, have prompted them to consider going private and delisting.”

Skadden has carved a niche for ­itself representing the management and buyer groups in Chinese companies’ take-private transactions. In six out of the nine transactions the firm has been buy-side counsel.

“We think we’ll continue to see new deals in 2012 and we know ­several companies’ management are thinking of going private. This type of transaction has become a meaningful part of our M&A work out of China,” Huang reveals.

One of the fundamental reasons behind the emerging wave of going private and delisting among small-cap and medium-cap Chinese issuers is the undervaluation of their share prices. That said, the low valuations have been seen as providing good ­investment opportunities by an ­increasing number of private equity firms and strategic investors. Almost half of the MBOs of US-listed Chinese companies are backed by private ­equity groups.

Weil Hong Kong managing partner Akiko Mikumo has advised on three transactions so far, including the ­ongoing deal of Fushi Copperweld. On the Fushi deal she is representing private equity house Abax Global Capital in its joint bid to take the ­company private. TPG Growth Asia, represented by Ropes & Gray, is ­another private equity fund backing this deal.

“The low valuation of many ­Chinese businesses listed in the US presents great opportunities for ­private equity funds to invest in good Chinese companies at relatively low prices,” says Akiko. “We expect to be involved in a few more deals this year. Taking listed companies private is a long-established practice, but transactions involving Chinese ­issuers have opened an exciting new space for this practice. It’s part of a natural development cycle for a listed company to go private, but in the context of Chinese companies it took us by surprise because it ­happened so fast. Just 18 months ago there was still an incredible US IPO and listing boom among Chinese companies. Now the market’s turned on a dime.”

Davis Polk is another active adviser in this area, mostly representing ­private equity investors. The firm was instructed by Abax on the Harbin Electric deal, with Hong Kong-based Mark Lehmkuhler as lead partner.

“Lots of private equity funds are keen on making such investment in the challenging climate. But they’re also worried about companies ­making accounting frauds – among several key matters they’ve put significant emphasis on due diligence issues,” says Lehmkuhler.

Pulling power in the East

While challenges in the US market are the obvious driving force for the go-private phenomenon, what is happening in China and Hong Kong is an equally important contributing factor.

“Companies listed in Hong Kong and Shanghai generally enjoy higher market valuations than those of their competitors listed in the US. The ­valuation diversity is very relevant to the wave of delistings in the US,” says Gregory Puff, a partner in Shearman’s Hong Kong office. “If there was no alternative for companies to raise funds elsewhere, few would consider delisting from the US.”

Puff noted that in some circumstances companies have delisted in     the US with the full intention of relisting in Hong Kong or China.

“Although there hasn’t been any proof in the market yet, I believe the next two years will see some of the relisting considerations starting to materialise,” he says.

Many lawyers disagree with the market’s general perception that the regulatory frameworks in Hong Kong and China governing public companies are less strict than in the US.

“Thresholds for listing on the main boards in Hong Kong and China are higher than in the US, although the US has more stringent disclosure ­requirements,” says Jonathan Zhou, a Shanghai-based partner at Fangda & Partners, who recently acted as the China counsel for Bain Capital ­Partners on its MBO of China Fire & Security Group.

“Some companies that are listed in the US won’t be ­eligible for listing here.”

In addition to higher valuations, the management in Chinese companies have increasingly come to ­realise that certain companies are better appreciated closer to home, where investors usually have a better understanding of their businesses.

“I see the go-private move as a fairly understandable reaction to the basic business proposition. A great part of the transactions are a result of­ well-considered and prudent ­business decisions, responding to the current business and capital environment,” says Pillsbury China head Tom Shoesmith, who recently acted as company counsel on the go-­private transaction and delisting of China Security & Surveillance Technology.

But will this delisting trend lead to a dearth of future IPOs of Chinese companies in the US?

“There’s a continued emphasis on Hong Kong and Shanghai in the global capital markets,” says Puff. “That’s been true for a while. ­Companies will be more interested in listing in this part of the world ­without a doubt. But I don’t think US capital markets lawyers in Hong Kong will pack up and go home. There’ll still be some listings in New York, ­particularly in the healthcare, internet, banking and some traditional ­industries.”

In the context of all the changes in the market, perhaps the influx of US firms entering into Greater China and launching Hong Kong law ­capabilities in 2011 could be a step in the right direction.