Chinese take-privates: End of a US affair?

By Matt Roberts, Maples Group
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2020 will be a year to remember as covid-19 and the associated economic disruption have put many businesses in liquidation or under immense strain like never before. As a result, a number of Chinese-operated Cayman Islands public companies listed on major securities exchanges such as the New York Stock Exchange (NYSE) and the NASDAQ have experienced volatility in the prices of their publicly traded securities.

Couple this volatility with ongoing regulatory developments in the US, such as the US Senate recently putting forward the Holding Foreign Companies Accountable Act in May 2020 and the NASDAQ proposing new “Restricted Market” Listing Rules involving increased audit and reporting requirements, these potential changes could materially and negatively impact Chinese-operated Cayman Islands companies listed on NYSE and NASDAQ.

Matt Roberts
Maples Group
Partner and Head of Corporate, Asia

Presently most relevant companies appear to be closely watching and monitoring developments. Some companies may consider a secondary (dual) listing closer to home on the Hong Kong Stock Exchange such as Alibaba and more recently, JD.com. However, in certain instances, the founders and management of public companies may consider a privatization or “take-private” deal, whereby the company is taken private by becoming a private Cayman Islands company and, as a result, delists from these US securities exchanges.

Since 2010, over 50 Chinese public companies have been privatized and delisted from US securities exchanges.

Privatization process

Typically, on these deals, the founders and management may partner with private equity firms and institutional investors, usually with the support of financing institutions such as the investment arms of major Chinese and Western banks, to provide a proposal to the relevant company’s shareholders and holders of publicly traded securities such as American Depositary Receipts (ADRs), whereby such shares/ADRs will be cancelled in exchange for cash, with the bidders becoming the owners of the delisted private company. Given the interests of the founders and management, a special committee comprising disinterested members of the company’s board is formed to negotiate the deal with the bidder group on an arm’s length basis.

Cayman mergers

These transactions are generally structured through a Cayman Islands merger under the statutory merger regime of the Cayman Islands Companies Law, which provides a mechanism whereby the publicly listed Cayman Islands company merges with another Cayman Islands company specially incorporated for this purpose (often referred to as a “merger sub”), to act as a subsidiary of a holding company that is wholly owned by the bidders. Once the merger is completed, the Cayman Islands company and the merger sub become the same legal entity with the former deemed to survive and the latter killed off.

The effect is that the bidders’ holding company ends up as the sole shareholder of the surviving Cayman Islands company, which continues to hold all of the assets and liabilities of the once listed public company business.

Once the company is private, the founders and management can seek to position the business to generate further value and to implement strategies to potentially monetize their investment with a material uplift at a later date, perhaps via a future listing in China, where the value of the business (and the potential returns) may be significantly greater, or through a potential future M&A buyout or trade sale.

Dissenting shareholders

If the deal is approved by a special resolution (usually 66.66%) of the company’s shareholders voting at a shareholder meeting, then the transaction will go ahead and shareholders who disagree with the terms of the deal cannot block the deal from proceeding.

However, the Cayman Islands merger regime permits shareholders who dissent from a merger and who wish to challenge the price being offered for their shares to undergo a compulsory negotiation process with the company to agree a fair value for their shares. If the company and the dissenting shareholders are unable to agree on the fair value within a prescribed timeframe, the dissenting shareholders can apply to the Cayman Islands Court seeking a determination of the fair value of their shares.

This is a significant area of litigation in the Cayman Islands with the Cayman Islands Court hearing a number of cases relating to fair value with varying valuation methodologies being adopted to determine fair value.

These cases include Re Integra Group [2016] 1 CILR 192, in the Matter of Shanda Games Limited (FSD 14 of 2016, 25 April 2017 unrep), in the Matter of Qunar Cayman Islands Ltd, 2019 (1) CILR 611 and in the Matter of Nord Anglia Education, 2018 (1) CILR 164. In each of these cases, the Cayman Islands Court determined that the fair value payable to the dissenting shareholders was higher than the price offered in the privatization deal, although the amount of “premium” awarded by the court has varied considerably from case to case.

Schemes of arrangement

An alternative method under the Cayman Islands Companies Law that does not include the dissenting shareholder regime is a scheme of arrangement, which effectively is a court supervised M&A process. The advantage of a scheme over a merger transaction is that the former does not allow dissenting shareholders to litigate about the consideration offered for their shares.

This method can provide certainty in that respect, however, the downside is that interested parties, such as the bidder and its affiliates, are not able to vote in favour of the scheme (unlike Cayman Islands mergers), which requires a majority in number and 75% of the shareholders present and voting in favour of the deal to get it over the line, which can potentially be quite difficult to obtain (depending on the shareholder spread of the company involved).

Certainly, at present, it appears that most companies are still willing to proceed with the merger route for take-private deals and we expect to see a trend of more take-private transactions in the short to medium term although the longer term outlook in this post-covid-19 era is still uncertain.

Matt Roberts is a partner and Head of Corporate, Asia at Maples Group. He can be contacted on +852 3690 7405, +852 6013 7108 or by email at matt.roberts@maples.com