An Epic Saga Comes to an End
On Saturday morning Harbin Electric (HRBN) shareholders overwhelmingly voted in favor of the management buyout, representing the culmination of a process that had dragged on for almost a year while the credibility of both the deal and Harbin's fundamentals were often questioned by short sellers and longs alike. The deal is now expected to close in the week ahead, mirroring the timeline observed in China Security & Surveillance's management buyout which was also funded by China Development Bank (CDB) and closed in September, 2 days after receiving shareholder approval.
On Saturday, approximately 90.6% of the outstanding shares of Harbin Electric and approximately 84.2% of the unaffiliated shares of Harbin Electric were voted in favor thereby satisfying the majority of unaffiliated stockholders voting requirement set forth in the Merger Agreement. Only 0.1% of Harbin Electric's shares were voted against the approval of the Merger Agreement, indicating the $24 share price was deemed adequate given the lack of dissension.
The process had its beginnings in July of 2010 when Harbin's Chairman and largest shareholder, Tianfu Yang was introduced to Baring Private Equity to discuss a potential management buyout. Following these discussions, Yang and Baring decided to pursue the buyout and formulated a $24/share proposal which they provided to the board on October 10th.
After receiving the proposal, Harbin's board formed a special committee to consider the proposal and began to select advisors. On November 12th, Baring withdrew from the deal, bringing into question whether or not Yang would be able to proceed with the buyout with or without another partner. From November to January, Yang sought various financial and strategic partners for the buyout.
In the course of the process a number of proposals were received including a formal proposal to acquire Harbin for $24/share. As the buyout selection process continued through April, Abax emerged as Yang's preferred partner and it became clear that any buyer consortium would have to include Abax. Accordingly, several other potential bidders dropped out of the process. On April 19th, Harbin's special committee received a proposal from Yang and Abax to acquire the shares of company they did not already own for $24/share.
On June 9th, Yang and Abax received a loan commitment from CDB to finance the buyout. Shortly thereafter on June 19th, the Special committee voted in favor of the Yang/Abax proposal and executed the merger agreement. Following the execution of the merger agreement, over the course of the next few months Harbin continued to work towards the shareholder vote and ultimate closing.
Despite the progress and the advancement of the proxy filings with the SEC, Harbin shares continued to be challenged by doubts created by accounting irregularities and other accusations right up until the very last days. Few of these issues were ever resolved or addressed but ultimately they appear to have been irrelevant. Notably, Citron Research (one of the more outspoken bears, which I suspect become a "closet" long by the end) recently bowed out with one last quasi-jab that appears to be an attempt to save face. Nevertheless, it still stands to be seen whether any of these accusations are true, but with the deal closing in this coming week it appears that we will likely never know.
It is important to note that Harbin partially consists of several former State Owned Enterprises (SOEs) and Tianfu Yang is very well connected with the government, suggesting that even if Harbin was engaged in suspect accounting policies Yang's connections would allow Yang to influence a policy bank like CDB to support his prerogative and essentially buy back the SOEs originally sold to Harbin. One last point of note - has anyone seen an Executive VP of Investor Relations receive a $2+ million termination package? Is this a generous pat on the back for all the headaches I'm sure she dealt with or potentially some form of hush money... not sure I'll care once $24 has been paid.
Implications for the US Listed Chinese Sector
With an apparent victory for the longs in Harbin, you have to wonder how this will affect both sentiment and short selling strategies within the space. It is becoming increasingly apparent that the merits of the short side of the trade are diminishing rapidly, especially for the stronger names that are working to regain credibility. It appears that not performing adequate due diligence, not fully understanding the aspects of a situation (relationships, agendas, etc) and relying on questionable sources in making investment decisions can prove dangerous to your financial health and perhaps only increasingly so.
It is apparent that there are numerous US listed Chinese companies that are either outright frauds or maintain suspect accounting policies and there have been plenty of opportunities to make money on them, but not all are fraudulent and at some point the risk/reward will shift to the other side, as the entire space is currently mispriced relative to fundamentals due to the overwhelming short interest. It seemed in the past year there has been a limited risk and high return investment to bet against any small Chinese company traded in the US, however this was a somewhat self-fulfilling prophecy as heavy shorting crushed illiquid names across the board.
The key to this trade is credibility and transparency and sentiment towards the space. As sentiment improves, most likely driven by the attractive returns achieved in certain names (many have already made a killing in CFSG, CSR, HRBN, SPRD, SINA, YONG, etc) one would expect valuations to improve providing great returns, which will only be enhanced by the sector wide short squeeze that may occur. The bottom line is there are plenty of great Chinese companies that have been discarded in a "baby with the bathwater" manner, if you will. Investing in these names will continue to result in very attractive returns as some already have.
Harbin's buyout may just be the event that turns the tide given that greed is a powerful force and there is plenty of money to be made. As returns shift to the long side from the short side, it is best to be early to the party. There are plenty of great plays out there and I will follow up with some of my better ideas. For now, have a look at another Abax management buyout play - Fushi Copperweld (FSIN), which reports earnings Thursday morning and may provide an update on the buyout. See my Fushi Copperweld Article for more details.