Previously we have discussed approval procedures for scenarios where participation of state-owned shareholders in the restructurings of listed companies results in change of their equity in the listed companies. The authors will focus on the procedures for cases where financial state-owned enterprises (SOEs) take part in material asset restructurings of listed companies.
It is not uncommon that a financial SOE acquires a stake in a target as a strategic investor, as an initial step leading to the subsequent participation in a material asset restructuring of a listed company. The ultimate purpose of the action plan is not to take control of, or obtain the power to direct, management activities of the target, but to acquire shares in the listed company through the restructuring.
Therefore, in addition to statutes concerning state-owned assets and restructurings of listed companies including the Company Law, the Securities Law, the Measures for the Administration of Material Asset Restructurings of Listed Companies (amended in 2016), and the Law on State-Owned Assets of Enterprises, these restructurings are also governed by the Circular on Further Clarifying Asset Management Issues Relating to Direct Equity Investment by Financial State-owned Enterprises (the circular) of the Ministry of Finance.
“Direct equity investment” is defined under the circular as a financial investment activity whereby a financial SOE, in accordance with the Company Law and/or any other laws and regulations concerning industry regulation, acquires any equity of a non-public company with capital of its own, or from any other lawful sources other than for the purpose of holding the equity for a long term, or taking control over the company. A financial SOE that makes any direct equity investment must ensure that there are effective exit routes in place.
According to the circular, an arrangement of a financial SOE that comprises equity investment in a target as a strategic investor, and subsequent participation in a material asset restructuring of a listed company, involves approval procedures especially at the two points of time as further discussed below:
1. Approval procedures upon direct equity investment by the financial SOE. In connection with the direct equity investment, the financial SOE must prepare an investment analysis report based on the due diligence findings, industry analysis, financial analysis and valuation or assessment results, and undergo an investment decision-making process in accordance with its articles of association, management agreement or any similar internal documents.
It should be noted that to ensure a prudent and reasonable valuation result, the financial SOE should choose from internationally accepted valuation approaches – which include the book value approach, replacement cost approach, market comparison approach, discounted cash flow approach and multiples approach – one or more that suit the specific conditions of the target.
Taking into account cost-effectiveness and efficiency, the financial SOE may decide at its sole discretion whether to use an external professional service provider for the valuation process. It must ensure that internal filing procedures are completed for the valuation results. A baseline price for the target, to be used as reference in the investment decision making process, has to be fixed with reference to the valuation or assessment results.
To sum up, a financial SOE may decide at its sole discretion whether to use a professional service provider for the valuation process of an equity investment. Unless otherwise decided by the financial SOE, only internal filing procedures need to be completed in relation to the valuation result. In other words, filing with the SASAC (State-owned Assets Supervision and Administration Commission) or competent SASAC office is not mandatory.
2. Approval procedures upon exiting the financial SOE from the direct equity investment. The financial SOE should ensure that there are effective exit routes for offloading its direct equity investment. The main options include initial public offering (IPO), M&A and restructuring, transfer by agreement, and equity repurchase. Where the exit is enabled through transfer at the price and on the terms and conditions as agreed in the investment agreement, or through equity repurchase, the decision making process must be performed by shareholders’ meeting (or general meeting, as the case may be), board of directors or any other appropriate internal function of the financial SOE in accordance with its articles of association, and equity transfer procedures must be completed accordingly. Equity transfer through any other means must be subject to regulations concerning the administration of state-owned financial assets.
Therefore, a sufficient number of effective exit routes should be in place so that the financial SOE will have greater flexibility in choosing the approval procedures that work best for it, and being better able to develop an estimated restructuring timetable based on its expectations. But it is noteworthy that listed companies generally use asset valuation agencies to value targets when implementing any material asset restructurings. In practice, the internal policies of a financial SOE may restrict it from completing filing procedures directly with the valuation result provided by the asset valuation agency. Instead, it may need to work out the valuation of the transferred equity independently and perform valuation approval/filing procedures accordingly.
Besides, in connection with valuation of a target with two or more state-owned shareholders, they may arrange for the largest state-owned shareholder to complete approval or filing procedures on their behalf on the strength of their equity holding proof, or for one of them to complete these procedures if they are holding the same percentage of shares.
In general, valuation filing procedures as well as the SASAC’s approval procedures must be duly completed for a state-owned shareholder’s involvement in restructuring of a listed company, whether it is a participation that results in change of the shareholder’s equity in the listed company, or an acquisition of shares as a new shareholder by a financial SOE. However, the state-owned shareholder should be careful that it is following the right approval procedures, because procedures vary depending on the transaction scheme or structure for the restructuring of the listed company.
Du Lili is a partner and Zhao Yuanyuan is a trainee at Grandway Law Offices