Tag Archives: NKBP

Exited NKBP and SHP

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Quick update to let you know that I sold out of China Nuokang Bio-Pharmaceutical (NKBP) and ShangPharma (SHP). The first transaction is almost complete, and the spread between the buyout price and the market price is just a few cents anymore. The finish for the SHP deal on the other hand is just as far away as when I initiated my position, but at the same time a large part of the spread is already gone. I made an 8.1% return on NKBP in a bit less than three months time, and a 1.8% return on the SHP position in a bit more than a week. I prefer to buy a position and stick with it until the deal is finished, but I wanted to exit some positions to manage my risk exposure since I did initiate multiple new positions recently.

Disclosure

No position in NKBP and SHP anymore

ShangPharma (SHP) going private

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ShangPharma announced at the end of December that it has reached a definitive merger agreement for a going private transaction. The company intents to pay shareholders $9.00 per ADS (minus a 0.05$ ADS cancellation fee) and expects to close the transaction in the first half of 2013. With the shares currently trading around $8.57 a successful transaction would generate a 4.4% return. This is certainly above average, but is it also above average risky?

Going private transactions in China

I wrote a few paragraphs about this subject in my post on Nuokang, and I’m not going to repeat that. One interesting thing to note is that all going private transactions mentioned in that post have been completed successfully with the exception of Nuokang itself, but that’s not a surprise since this was the only deal that was scheduled to be completed in the first quarter of 2013. So far the Nuokang deal also seems to be progressing as planned, and I expect it to close this month shortly after the extraordinary general meeting of shareholders on January 15. Even the Fushi Copperweld (FSIN) deal closed last year.

ShangPharma Corporation

The obvious question to ask when looking at something Chinese is, “is it a fraud?”. The most important check is in my opinion looking at the history of debt offerings, equity and insider sales. If you want to defraud investors you need to sell them something first.

ShangPharma went public (prospectus) at the end of 2010. The company sold 3.2M ADSs at $15, raising $44.6M after fees and insiders sold 2.6M shares for a $36M payday. Before the IPO directors and executive officers owned 74.9% of the company, and after the IPO this percentage dropped to 55.8%. Since then there were no big changes in the ownership structure: today directors and executive officers as a group own 55.5% of the company. The company never issued debt, and last year both the company and the CEO bought back stock. So while the IPO created a nice payday there isn’t a pattern of insiders trying to sell whatever they can to outsiders suckers.

Related party transactions (or other significant transactions) also deserve to be examined. Because once you have raised cash from shareholders you need a little bit of creativity to let it disappear. With most of the cash that was raised in the IPO still on the balance sheet there doesn’t seem to be a big problem in this area. I would have liked to have seen a bit less related party transactions though: I would guess that ~10% of revenue is paid to suppliers that are related to the CEO.

One thing that is good to see is that the financials aren’t great. If the numbers aren’t real, why would you report declining income and declining margins? At the same time the numbers are still good enough that you would think that the buyers are getting a good deal at the offering price. That’s of course also important: you want that the buyers are motivated to complete the deal, otherwise you risk that they find an excuse to walk away.

So ShangPharma passes my “is it real” smell test, but that’s not the only thing that could stand in the way of a successful transaction: most notably financing and shareholder approval could be an issue. Based on the proxy statement released by the company those two risks seems to be quite small. The buyer group does have financing available, and they also have enough voting power to approve the deal. The buyer group controls 66.9% of the outstanding shares while 66.7% of votes are required to approve the transaction.

Conclusion

The possible return of this merger arbitrage deal is limited, but I think the same can be said about the related risks. I don’t think the deal is significantly more risky than the average deal, yet at the same time the market is offering a significant above average return. That sounds like a good combination to me. Making a 4.4% return in three months time isn’t bad.

Disclosure

Long SHP & NKBP

Nuokang (NKBP) going private

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While the going private transaction of China Mass Media hasn’t yet completed (it is progressing as planned) another Chinese company announced that it reached a definitive agreement for a going private transaction last week. The CEO of China Nuokang Bio-Pharmaceutical is offering $5.80 in cash ($5.75 effectively after a $0.05 ADS cancellation fee). The deal is expected to close in the first quarter of 2013, and with the stock currently around $5.30 a successful transaction could offer an ~8.3% absolute return and an IRR of ~19.4% (assuming a close on the last day of the quarter).

My view on going private transactions in China in general

Everybody is these days aware of the risks related to investing in Chinese companies, and that is exactly the reason why I’m interested in this corner of the market (see also my investment in DSWL). With all US listed Chinese companies trading at depressed valuations you have to figure that there are some real companies out there that are trading significantly below fair value. And given the scale and sophistication of the fraud there are just a few parties in a position to capitalize on the opportunity. The exception are of course insiders: they know perfectly well that they are buying, so you would expect that the management of legitimate companies will try to take their company private if they are in a position to do so.

I think that this is exactly what we are seeing today. Besides the large number of Chinese companies that went to zero there are also a decent number that already went private, or are in the process of going private. Besides the subject of this post and China Mass Media you currently also have:

  • Yucheng Technologies
  • Fushi Copperweld
  • Winner Medical Group
  • Pansoft
  • China Transinfo Technology Corp
  • Gushan Environmental Energy

These deals trade in general at a above average spread compared to merger deals in the rest of the world, and the question is of course if this is correctly pricing in a higher risk or if investors are simply burned by their experience in investing in China.

One thing to consider is that undertaking a going private transaction does not accomplish much if you are running a fraudulent company. You can’t complete it, and starting the process and then not completing it doesn’t do you any good either. There are of course always some angles to consider: you can manipulate the stock price and gain through illegal insider trading, or maybe you could transfer money out of the company using a break-up fee. But I think that in most cases something like that would be an unnecessary complex and inefficient way to commit fraud. So I would say that logically a going private proposal from a Chinese company should indicate that management is motivated to complete the transaction.

I wouldn’t blindly buy the above basket. A going private proposal is a good hint that the company is real and that management wants to complete the transaction, but I would want to see that there are no major red flags in the financials (especially w.r.t. issuing debt, raising equity or insiders selling shares). Besides a management that is motivated to complete the transaction, you also want to see that they have the financing to get the deal done. Shareholder approval could also be a roadblock, and last but not least: you do want a sufficient expected return.

China Nuokang Bio-Pharmaceutical

Enough chitchat: time to take a deeper look at Nuokang. The company went public at the end of 2009 (prospectus) and describes itself as follows:

China Nuokang Bio-Pharmaceutical Inc. is a leading, fully integrated, profitable biopharmaceutical company focused on researching, developing, manufacturing and marketing hematological and cardiovascular products.  We sell a portfolio of fourteen products, which includes principal products Baquting®, a flagship hemocoagulase, and Aiduo®, a cardiovascular stress imaging agent. Our product pipeline includes product candidates under development in hematological, cardiovascular and cerebrovascular disease diagnosis, treatment and prevention.

Developed in-house and launched in 2001, Baquting, our flagship product, is China’s leading hemocoagulase for the treatment or prevention of bleeding. Through September 30, 2009, we had sold an aggregate of over 38 million units of Baquting to our end-customer base of over 2,400 hospitals across China.

The short public history of the company makes a fraud evaluation harder. Positive is that insiders haven’t sold a share since the public offering (literally!). The CEO, Baizhong Xue, owned 94,508,704 shares after the IPO (representing 60.02% of all shares) and he owns the same number today (now representing 61.2%). Neil Nanpeng Shen, a board member and managing partner of Sequoia Capital China, has controlled 20.1M shares since the IPO representing another 12.77% of shares. As a group insiders own 74.6% of the company today. Another positive sign is that the IPO wasn’t used to cash out insiders, but to raise cash for the business. The CEO sold less than one percent of his shares in the IPO.

The debt side of the story also looks good. The amount of short term debt on the books has decreased the last years and the amount of long term debt has been almost non-existent. Unfortunately the company has never paid out a dividend (I like to see that: it’s an unfakeable cash flow back to shareholders). That said: I don’t think there is a pattern here that indicates that management is trying to get rich by raising money.

Related party transactions are another specific area of concern because these offer the potential for unfair deals at the expense of shareholders. Nuokang seems squeaky clean here, in the latest 20-F only the following was reported:

Transactions with Mr. Baizhong Xue

From time to time, Mr. Baizhong Xue, our chairman and chief executive officer, has extended loans to us and paid business-related expenses on our behalf. We from time to time make advances in respect of business-related expenses incurred by Mr. Xue on our behalf. As of December 31, 2009, 2010 and 2011 amounts due to Mr. Xue were nil, nil and nil, respectively.

Loans and Guarantees

In March 2009, Dengzhou Credit Union extended to us a short-term loan of RMB3.0 million at the interest rate of 7.7%. In September 2009, Industrial Bank Co., Ltd. and China Merchants Bank extended to us short-term loans of RMB60.0 million and RMB15.0 million, respectively, each at an interest rate of 6.372%. While these loans were secured by certain of our property, plant and equipment or land use rights, Mr. Baizhong Xue, our chairman and chief executive officer, also provided guarantees for all these loans. As of December 31, 2011, these loans have all been repaid.

So don’t see any major red flags here w.r.t. fraud, and it seems very logical that a company that is already majority owned by the CEO is going private. If the 13E3 filing can be trusted the CEO does have the necessary financing to take the company private (he needs ~$44M). Don’t think shareholder approval is going to be a problem either: as far as I can tell there is no majority of the minority provision. Nuokang Bio-Pharmaceutical is, just as China Mass Media, domiciled in the Cayman Islands, and only two-thirds of the shares need to vote in favor of the transaction. With Mr. Xue owning 61.2% that doesn’t seem to be a difficult threshold…

Pursuant to the merger agreement, Anglo China and Britain Ukan, companies controlled by Mr. Xue, agreed to vote all of the Shares beneficially owned by them in favor of the authorization and approval of the merger agreement, the Cayman Plan of Merger and the transactions contemplated thereby (including the merger). Mr. Xue beneficially owns approximately 61.2% of the total outstanding Shares.

Conclusion

Investing in China is not without risks, but in this case I think I’m getting paid well for taking the risk. I don’t see anything in China Nuokang Bio-Pharmaceutical history that raises a big red flag, and there also doesn’t seem to be a whole lot that can stop the transaction from going through. Combine that with a wide spread between the offer price and the market price and you have, what looks to me, a nice opportunity.

Disclosure

Author is long China Nuokang Bio-Pharmaceutical