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Hedge funds are demanding China buyers pay more in M&A deals

For years, Chinese executives pulled off multibillion-dollar buyouts of their public companies with little pushback from investors. Now, they are facing a backlash from hedge funds demanding better payouts.

[HONG KONG] For years, Chinese executives pulled off multibillion-dollar buyouts of their public companies with little pushback from investors. Now, they are facing a backlash from hedge funds demanding better payouts.

One pioneer has been Maso Capital, which has disputed the valuations of at least six transactions since 2015 claiming insiders at Chinese firms underpaid when taking them private.

In April, the Hong Kong-based hedge fund had its first victory when a Cayman Islands court awarded it 2.35 times the price paid for shares of Shanda Games in the developer's 2015 buyout.

Shanda Games has appealed that ruling, but other investors including PAG Absolute Returns and Senrigan Capital Group have jumped on the bandwagon, disputing the valuations of other deals involving companies domiciled in the Cayman Islands. The new bout of activism marks a fresh challenge for corporate chiefs, who face pressure to pay more to avoid protracted legal battles after buying out their companies.

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In the transactions that Maso is challenging "clearly there are asymmetries or inefficiencies from an information perspective between what we believe is fair value and what the company knows is fair value," co-chief investment officer Sohit Khurana, 44, said in an interview. "The two are very clearly different."

Catch Up

Maso was founded in 2012 by Manoj Jain and Mr Khurana, who are both alumni of Och-Ziff Capital Management Group. The hedge fund is challenging deals including Qihoo 360 Technology's US$9.3 billion management buyout in 2016 and a take-private of Qunar Cayman Islands by Ocean Management earlier this year valuing the online travel agent at US$4.4 billion. Those cases, also filed in the Cayman Islands, haven't yet gone to trial.

PAG and Senrigan were among investors challenging the valuation of the Qunar buyout. E-Commerce China Dangdang's privatisation last year, which valued the online bookseller at US$556 million, was challenged by Hong Kong-based Senrigan Capital and another investor. Maso wasn't involved in the Dangdang case.

Dangdang, Qihoo, Ocean and International, which partly owns Qunar, didn't respond to requests for comment. PAG and Senrigan declined to comment on their dissensions.

After a raft of short-seller reports earlier this decade depressed valuations, many Chinese companies sought to leave US exchanges with an eye to relisting at a higher valuation in Asia. Many were domiciled in the Cayman Islands, a jurisdiction long known for comparatively lower taxes. Cayman Islands law has a provision allowing investors who dissent from a merger to ask the court to determine the fair value of a company's net assets.

"Historically there hasn't been much recourse for minority investors in the Caymans, until now under the merger regime," said Douglas Freeman, a Hong Kong-based partner at law firm Goodwin Procter, who has represented buyers and target companies in the take-privates of US-listed Chinese firms. "Buyers and companies are starting to catch up on this."

Such pushback has the potential to reshape the way buyouts are structured. David Lamb, a Hong Kong-based partner at law firm Conyers Dill & Pearman, which has represented Shanda Games as well as private equity buyers, said in some cases he has advised companies to consider shifting their domicile out of the Cayman Islands or weigh alternative ways to delist instead of a merger.

The Shanda Games privatisation, which had valued the company at US$1.9 billion, provided a legal precedent for would-be dissenters. The Grand Court of the Cayman Islands ruled in May that the company should have paid shareholders US$16.68 per American depositary share, more than double the $7.10 that they were offered by the management buyout group. Shanda Games's own expert witness determined a price of US$9.56, according to parts of a judgement released in April.

The court ordered Shanda Games to pay Maso US$42 million plus interest on top of what the hedge fund received in the buyout.

In his 112-page judgement, Justice Nicholas Segal referred to instances where Shanda Games's internal financial projections weren't necessarily reliable. 

In one example, "games with a relatively low revenue intensity were shown as carrying licensing and royalty fees attributable to games with much higher revenue intensities," Mr Segal wrote. "How this could be possible was not properly explained by Shanda."

The final acquisition price was about 26 per cent more than the closing share price of US$5.65 on Jan 24, 2014, the last trading day before the company disclosed it had received an initial going-private proposal. 

A spokeswoman for Shanda Games declined to comment, citing a pending ruling on its appeal.

Fair Value

The Cayman Islands allows founders to vote on their own takeover deals, creating conflicts of interest that work against minority investors, according to Maso's Jain. Company forecasts provided by management can also be biased in favor of buyers, said Mr Jain, 39.

What the court found to be fair value in the Shanda Games case was well beyond what is commercially viable for deals to get done in the market, Mr Lamb said.

"If you ask companies if they would be prepared to pay that, nine times out of ten they would say no."

Trina Solar, a Chinese solar product maker being challenged by Maso on the valuation of its buyout, said in an e-mail that it sees its merger process as having been fair and transparent.

"We are absolutely confident that the court will decide that the merger price was very fair," the company said.

A broader range of investors is starting to take notice. Funds affiliated with Prudential Financial, T Rowe Price Group and D E Shaw joined Maso and Senrigan in dissenting against the buyout of Nord Anglia Education.

The take-private by Baring Private Equity Asia and Canada Pension Plan Investment Board valued the Hong Kong-based international school operator at US$3.4 billion. Nord Anglia filed to the court Nov 9 to determine fair value.

Still, investors challenging valuations have to contend with the unpredictability of court outcomes. The risk involved is the reason litigation isn't necessarily a one-way, money-making opportunity, Maso's Jain said.

At the same time "every day that goes by there's more case law being set, often set by us in one of our cases," Mr Jain said.