Trading in Yongye's (NASDAQ:YONG) common stock was halted while the company was on its way to going private. Yongye is currently being scrutinized by regulators while the trading remains halted. There are signs that Yongye is robust and may be able to survive the halt. There is also fear because so many previous and recent halts of Chinese reverse takeovers ended delisting. If trading in the stock resumes, Yongye will go private. If it gets delisted, the going private will break up. The belief of the writer is that for the interests of investors, NASDAQ will not delist the company and the going private will finally prevail. Below I will explain this in more detail and show you an example of NASDAQ facilitating a buyout. At the end, I will also explain why Yongye may survive the halt without regard to the buyout.
The delay of filing was not the true reason for the halting
On Friday, March 15, 2013, after the market closing, Yongye filed a notification of late filing of its annual report with the SEC. On Monday, March 18, 2013, upon the market opening, NASDAQ halted trading in the company's common stock. Two days later, Yongye apprised the public of the following:
On Tuesday, March 19, 2013, Yongye received a written request from NASDAQ for additional information relating to the Company's delay in filing the Form 10-K, the collection of accounts receivable as of year-end 2012, the current state of the Company's auditors' audit of the financial statements to be included in the Company's Form 10-K for the year ended December 31, 2012, and the status of the Company's proposed 'going private' transaction.
Apparently, the halt seemed to be because of the delay of filing. But after the filing of the annual report on April 1, 2013, the halt was not lifted. Nearly two months after the filing, the halt is still ongoing. What is the trouble Yongye is having?
The true reasons are much more serious
If you read the article "Yongye When A Halt Is Just A Start", you should be able to find the answer. The author revealed:
the auditor was notified late last year of 1) recent on-the-ground evidence related to lack of production activity in Yongye's facilities during the peak season, and 2) an issue with Yongye's 2010 coal mine purchase transaction.
If the person knew to notify the auditor, why wouldn't he know to notify NASDAQ and the SEC? We can reasonably assume that NASDAQ was notified of the same package of information possibly around the same time or earlier. Then we can understand that the true reason for the halt is that NASDAQ is currently investigating Yongye on the accusations made by the person et al.
Delisting is probable but …
In the last few years, quite a few shocking frauds committed by Chinese reverse takeovers were uncovered, followed by delistings one after another. Chinese reverse takeovers have become notorious. One can imagine the sentiment at NASDAQ with regard to these companies. Suspicion, distrust and tough stance might currently be part of the context. Yongye might be having a hard time dealing with NASDAQ. The proofs that have convinced KPMG China might fail to convince NASDAQ. NASDAQ might be requesting additional information in addition to more information and proofs that support proofs. In the end, Yongye might have provided all it is able to provide and NASDAQ might still not be fully satisfied. What will happen next?
Delisting is probable in general but less probable in the case of Yongye because it has an ongoing and seemingly serious going private offer.
Going private may alter a decision to delist
To understand why a going private offer may alter NASDAQ's decision to delist a company, let's first check the purpose of delisting.
On the FAQ page of the site of NASDAQ Listing Center, we can read the following:
What is the effect of a regulatory trading halt?
… While NASDAQ recognizes that a trading halt can disadvantage existing investors, NASDAQ's primary regulatory responsibility is to prospective investors.
This explanation should also apply to delisting if you agree. We understand now that it's for protecting prospective investors that NASDAQ has to sacrifice existing investors (shareholders). But if a company goes private, no more prospective investors will be victimized and the reason for sacrificing shareholders no longer exists. So, why not let the going private go through and saving the shareholders? This is even better than letting the stock trade on the pink sheets because the risk for prospective investors will persist there even though NASDAQ is no longer responsible for that. It's an optimal solution for all investors that NASDAQ can't ignore.
Yongye's going private case seems to be credible
On October 15, 2012, Yongye received a going private proposal at $6.60 per share from Mr. Zishen Wu, the Company's Chairman and Chief Executive Officer, Full Alliance, MSPEA and Abax. In the following days, a special committee was formed and legal counsel and financial advisor were retained. On December 28, 2012, Yongye received a loan of $99 million from China Development Bank (CDB) in connection with the proposed transaction and a debt commitment letter from CDB for a debt financing of up to $232 million to fund a portion of the proposed transaction. On the same day, Abax issued a financing commitment letter to provide a mezzanine debt of $35 million, as part of its total proposed financing of $50 million to partially fund the transaction. Investors were awaiting the definitive agreement. So might NASDAQ.
Have you noticed that between the time NASDAQ was notified of the accusations and the time of halting, NASDAQ seemed to have waited? For what? The annual report of course. But that might not be sufficient for NASDAQ to wait. It's probable that NASDAQ was also awaiting the going private transaction, the definitive agreement which looked imminent after the filings on financing at the end of last year. NASDAQ was probably monitoring the process and evaluating the credibility of the going private offer. In the above-mentioned request for additional information, NASDAQ indeed requested information relating to the status of the Company's proposed going private transaction. If a definitive agreement had been reached in that period, NASDAQ might have left the stock trading without interrupting it. Alas, the parties in the transaction missed the time.
Despite the halt, the going private offer is still alive. Yongye reiterated on May 10, 2013:
On April 1, 2013, the Buyer Parties confirmed to the Special Committee that they remain interested in pursuing the proposed going private transaction set forth in their proposal.
The financing and the commitment of financing from CDB remain in place.
We would like to inform you that Abax remains interested in pursuing the proposed going private transaction …
Abax continues to be focused on this transaction and will re-engage in the going private transaction as soon as the trading suspension is lifted.
It seems that the parties were awaiting the annual report to decide on the definitive agreement. When the annual report was finally out, the halt on trading effectively blocked the going private, which NASDAQ might not have thought of when it had halted the trading. It seems highly probable that we would have seen the definitive agreement if there weren't the halt.
Going private needs the listing and trading
For the going private to succeed, keeping the listing and resuming the trading are essential. Abax stipulated in its SC 13D/A filing of April 16, 2013:
The obligation of Abax HK to provide the Mezzanine Debt Financing is subject to a number of conditions, including without limitation … the resumption of trading of the Issuer's common stock on the Nasdaq Global Select Market.
This condition may be general for all the buyer parties. The good reputation of a company is an important intangible asset that is an integral part of the acquisition and if that asset is gone, buyer parties may simply walk away.
Often, a bank reaches an amicable settlement with its clients without being ruled guilty by the court. NASDAQ may do similar things to the court, keep the listing and facilitate the happening of the going private. After all, once the risk for prospective investors is discarded, it is shareholders' interests that are what it is all about.
The SEC and NASDAQ facilitated the buyout of Harbin Electric
Do you still remember Harbin Electric International (NASDAQ:HRBN)?
On June 16, 2011, the then non-binding going private offer of taking the company private for $24 per share came under heavy fire from Citron Research. In its article "Harbin Electric: Loan Fraud and the Docs to Prove It", Citron Research called the offer a sham and called on the SEC to halt the stock.
The accusations sounded so serious and the proofs looked so strong that suddenly, the going private offer disappeared in the eyes of the investors and panicked investors sent the stock to an intraday low of $5. The stock closed the roller coaster of the day at $6.98, down 51%. But only two business days later, the definitive agreement was out.
In the following months, Harbin Electric continued to be under fire from short sellers of all sides. Below are just two examples.
On September 15, 2011, in its article "GeoTeam Corroborates AlfredLittle.com Findings On Harbin And Deer", The GeoTeam wrote:
According to A*L's due diligence, in the case of HRBN, the $38 million purchase price was approximately $18 million higher than the highest price quoted by the official in charge of the land use sales in the local development zone.
Just one week later, on September 23, 2011, The GeoTeam published another article and sounded desperate:
HRBN has made material misrepresentations to the SEC, the NASDAQ and to China Development Bank. The size and nature of these material misrepresentations is now too big and too public to be ignored by the SEC, the NASDAQ or China Development Bank. There now exists a very real basis for the NASDAQ to halt/delist the stock and for CDB to walk away from the financing.
Despite all those accusations and appeals to the regulatory authorities, the SEC and NASDAQ didn't come out and halt the stock. Around that period, quite a few Chinese reverse takeovers were halted and delisted. But the authorities didn't halt Harbin Electric. On October 29, 2011, approximately 84.2% of the unaffiliated shares of Harbin Electric were voted in favor of the buyout. The next business day, the merger was completed.
It turned out to be the best solution for shareholders without prejudice to the interests of prospective investors. The SEC and NASDAQ did the right thing.
Note that Abax was one of the buyers and CDB was the main financier, as with Yongye's buyout.
Yongye's alleged acquisition fraud seems to be a legitimate transaction
One of the accusations against Yongye is about the acquisition of a permit for the rights to explore, develop and produce mineral resources in a certain area of Wuchuan County for $35 million. It is said that "Those rights were acquired by Yongye in 2011 for only about $10,000." This is similar to the above-mentioned accusation brought out by Citron Research and The GeoTeam against Harbin Electric. Harbin Electric denied the allegation:
Harbin Electric confirms that the land purchase was done in full compliance with various relevant Chinese government entities and notes this transaction structure is a common practice in China.
Note that the purchase of the land by Harbin Electric wasn't an issue for CDB and Abax in the going private.
Yongye made its acquisition of and the payment for the permit in 2010. The transaction was booked in the 2010 annual report. KPMG China signed off the Form 10-K on March 14, 2011. On May 31, 2011, "after extensive due diligence", MSPEA agreed to make a $50 million equity investment in Yongye. It's easy to see from the timing that the 2010 annual report must have been the main focus of the "extensive due diligence". The $35 million acquisition of the permit, because of its magnitude, must have been reviewed with extensive due diligence. It seems technically difficult from common sense to bribe Mr. Homer Sun of MSPEA at the moment of the acquisition in 2010 or at the time of the $50 million equity investment in May 2011. If it had been the case, with the high media exposure of the allegations, Mr. Sun's boss would have had enough time to take actions against him. The reality is Mr. Sun seems to be still comfortable in his positions.
KPMG China has 13 offices around China with about 9,000 professionals. Yongye is headquartered in Beijing. The fact that the KPMG office that has been auditing Yongye is the KPMG office of Hong Kong and not the KPMG office of Beijing seems to reflect the efforts of KPMG China to prevent corruption. It should be more difficult for Yongye to corrupt the office of Hong Kong than to corrupt the office of Beijing. Moreover, the notification of frauds seems to have been addressed to the headquarters of KPMG China in Beijing. If the office of Hong Kong had been corrupted by Yongye, the headquarters, being alerted, would have been able to uncover it and take actions. The reality is that we didn't see any such actions, the office of Hong Kong continued the auditing as usual and the notification didn't trigger any changes in the booking of the acquisition. There's more. The fact that Yongye had to delay the filing of the 10-K for reasons of accounts receivable and allowance is a further sign that the KPMG office of Hong Kong is not corrupted by Yongye. All these are very positive signs that lend credibility to the annual reports and support the idea that the acquisition is legitimate.
For their parts, CDB and Abax must have had a due look at the acquisition for some time. Both had a similar experience with Harbin Electric. Neither CDB nor Abax seems to have seen problems in the acquisition.
It's more likely that the short sellers have missed some advanced lessons on doing business in China.
Yongye may survive the halt without regard to the buyout
Yongye's 2010 annual report was actually double-audited by KPMG and MSPEA.
Yongye's 2012 annual report may actually have been double-audited by KPMG and Abax.
In its SC 13D/A filing of April 1, 2013, Abax stipulated:
The obligation of Abax HK to provide the Mezzanine Debt Financing is subject to a number of conditions, including without limitation, Abax HK's completion of its review of and satisfaction in all respect with the audited financial statements of the Company for the fiscal year ended December 31, 2012 …
From common business sense, it's highly probable that when Abax formally wrote to Full Alliance International one month and half later on May 15, 2013 that it would "re-engage in the going private transaction as soon as the trading suspension is lifted", it might have completed the review with a positive conclusion.
Neither MSPEA nor Abax can be expected to have been easy-going in the audit.
Yongye's annual reports may be reliable on all significant material aspects.
The going private eliminates the eventual risk to prospective investors and protects and benefits existing investors. The proposal seems to be serious and credible. NASDAQ may resume the trading and let the going private go through.