Download Where`s The Exit? New Opportunities In China For PE

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Where’s The Exit? New Opportunities In China For PE Firms
Law360, New York (July 24, 2015, 9:39 AM ET) -It has long been a well-established exit route in developed markets
for a private equity firm to sell its interest in a portfolio company to a
listed company in exchange for shares in that listed company. Until
recently, this was not a route that was used by acquirers that are
listed on the local Chinese stock exchanges, and with more than
2,700 companies listed on such stock exchanges (each a “listco”), this
has effectively shut out a financing route for many potential
acquirers. A key reason for this relates to the weaker capital markets
in China, which meant that this was not necessarily an attractive
route for private equity sponsors. However, with a deepening of
China’s A-share market, this has become a more attractive route,
although it has been unclear how, on account of regulatory
constraints, this could be achieved for foreign sellers. A recent
transaction has thrown interesting light on this issue.
The Issue
Dean Collins
The key issue for a foreign owner of shares that might be acquired by
a Chinese listed company is that there are significant hurdles that apply to a foreigner who wishes to
acquire shares in a listco. It was not at all clear whether the same restrictions that would apply to a cash
purchaser of A-shares would apply to someone who is receiving such shares in return for equity.
Generally speaking, it is possible for foreign investors to invest into a listco through one of two
regulatory schemes. First, China has developed the Qualified Foreign Institutional Investor (QFII)
program, which is designed for investors that wish to trade listed shares, and which, amongst other
things, permits acquisitions of 10 percent or less of a listco’s shares. Second, there are rules allowing a
strategic investor to make investments into a listco pursuant to the Administration of Strategic
Investment in Listed Companies by Foreign Investors (“Strategic Investment Measures”) provided that it
is acquiring more than 10 percent of the listco’s shares. However, high qualification requirements, long
lockup periods and a cumbersome approval process are impediments to the popularity of both of these
schemes among foreign private equity funds.
For example, applicants under the QFII program are subject to a minimum assets under management
threshold of $500 million of securities assets (the authorities generally require these assets to be
publicly traded securities) in its most recent accounting year, and any investment under the Strategic
Investment Measures are subject to approval of both the China Ministry of Commerce (MOFCOM) and
the China Securities Regulatory Commission (CSRC), and require a 10 percent minimum shareholding
threshold and, of particular concern to a private equity firm, a three-year lockup period.
However, a recent development has suggested that neither of these two routes needs to be adhered to
if, following a share-for-share exchange, the foreign private equity fund holds less than 10 percent of the
shares of the listco.
The Blue Gold/Kaile Transaction
In April 2015, Blue Gold Ltd., a Hong Kong company and the investment arm of a private equity fund,
together with various other companies, proposed to sell Shanghai Fanzhuo Ltd., a privately owned
company, to Hubei Kaile Technology Co. Ltd., a company listed on the Shanghai Stock Exchange, in
exchange for newly issued shares in Kaile. Following completion of the transaction, Blue Gold would
hold 3.04 percent of the publicly listed shares in Kaile.
Public documents relating to the transaction revealed that Kaile twice sought clarification from
MOFCOM as to whether this transaction was possible and/or required any approvals from MOFCOM. On
both occasions, MOFCOM stated that no such approval was required. Treading carefully, Kaile also
sought out a clarification from its “local MOFCOM,” the Hubei Provincial Department of Commerce,
which declined authority over the matter on the basis that the shareholding percentage would be below
10 percent following the completion of the transaction, informing Kaile that it should seek approval
from CSRC. CSRC approved the transaction.
Conclusion
The initial conclusion is that a share-for-share exchange that results in a private equity seller owning less
than 10 percent of the listco falls outside of the ambit of the Strategic Investment Measures, and is
possible even if the seller does not have a QFII license. MOFCOM has in practice adopted a flexible
approach to regulate a foreign investor’s purchase of listed shares. In addition to providing private
equity firms with a new exit route, this precedent could potentially open up an additional route for
private equity firms to make private equity-style investments into public equity securities (i.e. PIPEs), a
route that has been hitherto restricted to investments in 10 percent or more of the listco.
However, there remain a number of unanswered questions. The target acquired by Kaile was a Chinese
company and the foreign private equity firm would have needed to have obtained MOFCOM approval at
the time of its initial investment into that company. Some commentators have surmised that this was
the basis upon which MOFCOM felt they did not need to approve the transaction. It is not clear whether
this is the case, and by extension, it opens up an interesting question as to whether the share-for-share
exchange would work if the listco was acquiring a foreign company where no such approval would have
been obtained. With many Chinese companies building their operations abroad through acquisitions,
this would open up very interesting possibilities for expansion.
Another question relates to whether MOFCOM would take a similar approach if a syndicate of foreign
private equity investors were to individually receive less than 10 percent of the shares in a listco but
collectively hold more than 10 percent. The wording of the various approvals would suggest that this
would be permissible, but each approval was provided in the context of a transaction where this
scenario did not arise.
We are aware that there are a number of similar transactions being pursued in the market at present,
and further insights will no doubt be gained in due course. For now, private equity firms that have
invested into Chinese companies can, at the very least, take comfort that an additional exit route
appears to be available to them.
—By Dean Collins, Karl Gao and Hailin Cui, Dechert LLP
Dean Collins is a partner in Dechert's Singapore office. He is a former in-house lawyer at Actis Capital, a
London-based private equity firm, where he oversaw the spinout of Actis from CDC Capital Partners and
established a number of emerging markets funds.
Karl Gao is an associate in Singapore and Hailin Cui is an associate in Beijing.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its
clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general
information purposes and is not intended to be and should not be taken as legal advice.
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