China Housing & Land Development (NASDAQ:CHLN) announced a few days ago that the board had approved a 1 for 50,000 reverse stock split with the intention of going private. Fractional holders will be paid $1.75 per pre-reverse split share. Based on closing price on August 26 of $1.67 that offers 4% on up to 49,999 shares. I expect the deal to close within 3 months, possibly sooner (more on that later).
Whenever I see these going private deals - which have been very popular for Chinese companies recently - I look at five factors: 1) What is the spread? 2) Is the financing certain? 3) How likely are shareholders to agree? 4) How quickly will the deal get done? and 5) What is the downside? Are there other concerns, hurdles, or impediments to the deal?
China Housing & Land Development is a residential developer focusing on fast growing cities in western China and affordable housing for middle class families. The majority of its customers are first time home buyers and first time up-graders. The company started in Xi'an in 1999 and is one of the largest private residential developers in the region having developed over 1.5 million square meters of residential projects. The majority of the company's apartments range in size from 70 square meters to 120 square meters; with such sizes considered to be a stable market section of the residential real estate market in western China. The typical residential project is approximately 100,000 square meters in size and consists of multiple high-rise, middle-rise and low-rise buildings as well as a community center, commercial units, educational facilities and other auxiliary facilities. In addition, the company provides property management services to its developments. (from Q2 10-Q)
The price here is $1.75 per share. The company lists directly on NASDAQ as a Nevada registered holding company, so there are no ADR fees to consider. Prices since filing have been in the $1.65 to $1.70 range. That gives a 3-6% profit.
The short version of the funding situation is: CHLN has $7 million on hand to cover just under $10 million in expected deal costs, and - I suspect - will probably cover the difference using an existing program for borrowing from employees (primarily management).
The longer version is that the financing of China Housing & Land Development is a fascinating read all by itself. The company has a gross debt of $300 million compared to assets of $600 million. However, the company has cash securing some of the debt, resulting in net debt of $208m, or 1.67 times equity. That debt comes from four sources: local Chinese bank mortgages, Hong Kong and Singapore bank lending, loans from executives, and loans from an executive's spouse's hotel company.
Local PRC banks fund mortgages on the property development, as one would expect. Interest rates on these are slightly above 6%. However, foreign exchange controls prevent the company from using cash on hand (~$100 million as of June 30) to pay overseas counter-parties. Thus the company has engaged in significant borrowing from banks and investors in Hong Kong and Singapore secured by cash in China. These loans cost around LIBOR + 2.5% on about $130 million in total debt.
The company also borrows directly from employees. These loans total only $3 million, but pay an astronomical 15%. Finally, they have borrowed about $20 million from Xi'an Xinxing Days Hotel & Suites and pay 20%(!) on those funds. Additionally, the Days Hotel is used extensively for corporate purposes (meetings, meals, travel, etc). Using a hotel as a bank seems strange until we read that the Days Hotel is 37% owned by the spouse of one of the company executives.
The upshot is that while management is clearly using unsecured loans to transfer money into their pockets, they also have broad and reliable access to credit. In fact, based on past terms I suspect that management would be thrilled to loan to the company to take it private. The company will have no difficulty in finding the funding.
Compared to many of the recent Chinese go-private deals, China Housing & Land Development has a relatively low insider ownership at ~20%. The next largest holder is Pope Asset Management at ~10%*. Non-institutional owners account for at least 55%. My experience has been that small block holders mostly vote to take the cash. CHLN stock prices are way way down over the last few years. They have also just posted a very bad quarter - revenues down 23% YoY and a loss of 0.20 per share compared to a profit of 0.17 a year ago. The PRE-14A also mentions oversupply in the Chinese property market. I suspect that most shareholders will be happy to get off this ride.
* There is a discrepancy between the PRE-14A filing from CHLN on August 26 which says Pope Asset Management has 10% of the shares and the August 14 13-F filing from Pope Asset Management which states a 16% ownership. I use the more recent company filing, but have no way to reconcile the difference. Maybe Pope Asset Management sold a couple million shares in two weeks, or maybe there is an error.
Management is obviously in a hurry to get this done. The transaction history starts in May of this year, which means they brought it from idea to definitive offer in three months. Moreover, the entire special committee process lasted less than two months. Additionally, they filed the first proxy and 13E3 the next day. Clearly they are on the ball for regulations and are well prepared to move very quickly. I suspect that they will keep the turn around times on proxies very short and schedule a vote as soon as possible.
Why is management in such a hurry? The stock price took a big dive in May and June providing an excellent opportunity for anyone not worried about the company's future performance. Management have been significant market buyers in June. This near an all time low for the price, so clearly management wants to get a deal done quickly.
I look to Focus Media (NASDAQ:FMCN), AsiaInfo (NASDAQ:ASIA) and Seven Days (NYSE:SVN) - three Chinese go-privates in the last eighteen months - to see how long this might take. Focus and AsiaInfo took some time from announcement to closing, but only 4 months after the preliminary proxy to closing. Both took two months from the first definitive proxy to closing. Seven Days took four months from the first go-private filing to closing. DGT Holdings (OTCPK:DGTC) went private through a reverse split last year and took three months to close.
Based on these, I think that closing in three months is very likely. Since the first DEF13 has been filed, even just two months is probable.
A downside occurs only if the deal doesn't go through. WSP Holdings (NYSE:WH) was a great example of a deal which couldn't succeed regardless of the votes. WSP's deal was blocked by violations of debt covenants. The time it took to bring out the deal was a big warning sign. CHLN was very explicit that they are current on all debt contracts and have access to more credit. There are no regulatory requirements or other impediments to closing the deal.
Should shareholders vote against the deal, the pre-announcement price was about $1.55, representing a 6% loss. Of course the property market and CHLN's financial performance could continue to deteriorate and produce further losses. However the financial projections in the proxy indicate a near-term return to profitability. The management eagerness to acquire shares also suggests that downside is limited. Lastly, the deal price is already at the very bottom of the range recommended in the fairness analysis, which should limit downside.
Circumstances have provided China Housing & Land Development with an opportunity to go private they won't miss. The current stock price is very low, making the acquisition price favorable for the company. Due to existing related party borrowing habits funding is certain (and probably means the company is less valuable to shareholders than to management). Despite the low price, many shareholders are likely to be ready to exit the risks of the Chinese property market. Management is showing considerable interest in closing quickly. In summary this going-private is very likely to close and close soon with 3-6% spread currently on the table.
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