IPOs: Privatization Wave: A House of Cards?

Bottom line: An ongoing wave of buyout offers for US-listed Chinese firms is being funded by speculative money that will quickly evaporate when China’s stock market rally fizzles, causing some deals to collapse when that happens.

Gamblers fund privatization wave

It’s a new day, which means it’s time to take a look at the latest US-listed Chinese companies receiving privatization offers from opportunistic investors looking for bargains. Today it’s data center operator 21Vianet (Nasdaq: VNET) and beleaguered social networking site (SNS) operator Renren (NYSE: RENN) that are headed for the exit door.

I’ve been writing about this recent flurry of privatizations for the last few months, which is quickly turning into a flood as investors scramble to assemble deals to buy companies whose shares have languished on Wall Street. The idea is that these companies would be far more appreciated, and therefore get much higher valuations, from investors in their home China market, where an ongoing stock market rally has seen the main Shanghai index more than double over the last year.

But rather than spend more time on writing yet again about this bigger trend, today I’ll take a look at who exactly is financing all these deals, and what’s the likelihood that some or even many may ultimately collapse. But first let’s recap these latest 2 deals, which come just days after solar panel maker JA Solar (Nasdaq: JASO) and online real estate firm E-House (NYSE: EJ) became the latest companies to receive similar offers. (previous post)

We’ll begin with Renren, whose privatization I’ve predicted for quite a while and which has finally come in a management-led buyout offer. That deal has the buyout group bidding $4.20 per American Depositary Share (ADS), representing a 22 percent premium over Renren’s average price over the last 30 days. (company announcement) Renren was once billed as the Chinese equivalent of Facebook (Nasdaq: FB) when it made its 2011 IPO at $14 per ADS. But the company rapidly lost momentum after that to more nimble names like WeChat, and its shares have plunged as its prospects faded.

Next there’s 21Vianet, which has received its own management-led offer to buy the company for $23 per ADS, representing an 18 percent premium over its price during the last 15 trading days. (company announcement) The company has done a bit better than Renren over the years, with the offer price representing a 53 percent premium over its IPO price in 2011. But 21Vianet also has much better prospects due to its status as one of China’s few private operators in the hot data center space.

Now that we’ve reviewed those deals, let’s look at who exactly is financing all these buyouts. I’ve looked at the announcements from the last 10 companies to get such offers, and it’s quite striking that 6 of those don’t name any backers beyond the company managers. That almost certainly means the main backers are domestic speculators who are probably counting on cash that could quickly evaporate if China’s stock market rally runs out of steam.

Of the remaining 4 companies who have disclosed buyers, 2 are getting their money from Chinese brokerages, many of whom are flush with cash from recent IPOs and also the stock market rally. But again, those brokers are likely to get cold feet if the stock market rally dies. The only 2 buyout candidates who have real named investors backing their bids are mobile game maker Sungy Mobile (Nasdaq: GOMO), which is being backed by the well-respected private equity firm IDG; and 21Vianet, whose buyout is being backed by well-known software maker Kingsoft (HKEx: 3888) and a fast-rising tech company called Unigroup affiliated with China’s leading science university.

If anyone senses this buyout wave could be a potential house of cards that might come crashing down at any moment, they might be right. In most of these cases timing will be critical. The average buyout deal usually takes 3-6 months to complete, which normally wouldn’t be a major concern. But the Chinese stock market rally is also likely to end in that time frame, meaning companies that fail to complete their buyouts before that happens could see their shares fall back to pre-offer levels and also be stuck in New York for the foreseeable future.

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