Protecting minority shareholders from the bullying tactics of those eager to control public companies is an important task of market regulators around the world. However, at times those rules can go a little overboard.
Such is the case, according to frustrated companies and investment bankers, in the Hong Kong market when it comes to taking a listed company back into the private domain. The current rule, which requires 90 percent of the vote to be in favor of going private, has often made it hard to consummate transactions and left companies open to the risk of greenmail.
The Securities & Futures Commission (SFC) has come under fire for revising the takeover threshold that one investment banker refers to as ‘minority protection turned into minority prejudice’. The negative situation has been underlined by a number of publicized buy-outs that have fallen by the wayside due to the SFC’s ruling.
In the case of Huey Tai’s attempt to delist Asean Resources, a buy-out scheme was agreed by shareholders but thwarted by a small group of warrant holders eager for a pay-off. In Peregrine’s potential purchase of Kwong Sang Hong, 87.5 percent of those investors that voted favored the scheme, but one dissenting investor blocked the deal.
Two Options
There are two ways of taking a company private in Hong Kong. One is to put out an offering memorandum that sets in motion the purchase of stock on the open market. The second is a ‘scheme of arrangement’, under which 100 percent of a company is acquired in a process involving the courts, provided a specified percentage of shareholders approve. For simplicity’s sake, most buy-outs follow the scheme format. Under the offer route it is hard to purchase 90 percent of all stock outstanding, especially in the case of an old register filled with dead stock. Under the scheme a bidder is simply approved or rejected.
Few bankers would argue against the efficiency and fairness of the scheme format had the Takeovers Panel not proposed a voting threshold that is over and above the level required by the Companies Ordinance in Hong Kong. The Ordinance states that a scheme must be approved by 75 percent of the shareholders voting either by proxy or in person at a company meeting. This 75 percent conforms with current UK securities law but, to further protect minority shareholders, the SFC decided to increase the threshold to 90 percent.
‘This 90 percent may lead to a number of problems,’ says Frank Slevin, a director of Peregrine Capital Ltd. ‘The mechanics of attracting such a majority are not easy and, in the process, takeover candidates can easily become exposed to greenmail. Apathy dictates that you will often get less than 50 percent of the shareholders voting on a particular scheme, so the amount needed to block a scheme diminishes dramatically.’
A specialist in ‘privatization’ schemes, Slevin has worked on half of the eight or nine such schemes that have taken place in Hong Kong over the last three years – with a success rate of around 50 percent.
From an investor communications perspective, companies are faced with a major barrier in soliciting votes for buy-out proposals. One problem lies in the structure of the central depository of Hong Kong – CCASS. With often as much as 50 percent of the free float held under broker nominee names in CCASS, it is nearly impossible to directly reach the majority of a stock’s beneficial owners. Brokers have to be convinced that it is in their interest to bend over backwards in delivering proxy material. Unlike the US or UK where a proxy chase is possible, the structure of CCASS adds to voter apathy and drags down the average turnout to 30-50 percent of shares held.
Inexact Science
For this reason, companies resort to hit-and-miss advertisements in local dailies and sending reminders to the stockholders they can reach. ‘Investor relations is not an exact science in the buy-out business,’ says Slevin. ‘It is hard to know if advertisements are working because there is little or no feedback. On top of that, the Takeovers Code restricts the method by which you can advertise and imposes strict guidelines on solicitation. You cannot encourage investors to exercise their vote in any direction. All you can do is explain the situation and try to get them to vote.’
Difficulty in bringing out the vote was certainly a factor in losing the day for Kwong Sang Hong (KSH). With a 50 percent stake in KSH, Peregrine decided to make a bid for the company in late 1996. After an expensive and time-consuming effort, Peregrine managed to secure an 87.5 percent vote in favor of its proposal at a shareholders’ meeting – despite the fact that it could not vote itself at this scheme meeting.
That figure was good enough under Hong Kong law, but not enough under the Takeovers Code. The process was blocked by one holder of around 2 percent of KSH stock who did not want to sell for sentimental reasons. Alan Mercer, corporate secretary for KSH, points out that Hong Kong law, UK company law, and the law in Bermuda (where KSH is incorporated) all require a 75 percent majority to take a company private.
Mercer calculated that of the 600 mn KSH shares outstanding, and given a voter turn-out of 46 percent, a mere 14 mn shares, or some 2.3 percent of the company, blocked the buy-out.
In essence, Peregrine’s offer of a share and cash package significantly over the market trading price was squelched by one person who could not be swayed. And, since the failure of the buy-out, KSH shares have fallen back down to previously low levels.
High Hurdle
‘The Takeovers Code is a voluntary code, not a statutory code,’ notes Mercer. ‘It is not enacted by the Legislative Council or anyone else for that matter. The Takeovers Panel decided the existing law was just not good enough, and it put in place a very high hurdle to take a company private. In reality, 75 percent is already a high enough hurdle. However, under the current situation the majority of minority shareholders are prevented from getting a fair value for their holdings. The situation has taken minority shareholder rights to absurdity.’
Peregrine bid for KSH when its stock was at a relatively low level, but placed a substantial premium on where the stock was trading. ‘Though the buy-out was priced at a discount to net asset value, we felt it was fair,’ says one publicity-shy UK fund manager that held a large stake in KSH. ‘Peregrine offered cash as well as paper in the new vehicle. In the end, Peregrine’s balance sheet would have been substantially improved, and its stock would have been significantly more attractive with KSH inside. As it is, minority shareholders were held to ransom by another minority shareholder with an agenda all his own.’
A number of shareholders were extremely disappointed. Some are rumored to have written directly to the Takeovers Panel. Matters were made worse when Peregrine agreed to buy out whatever stake minority shareholders wanted to sell and appealed to the Takeovers Panel for the right to do so.
‘That was a win-win situation as far as the shareholders were concerned,’ recalls the UK fund manager. ‘The shareholders who wanted to sell could, and those that did not could hold on to their shares.’
In the end, the Panel decided that it was not in the best interest of minority shareholders to allow this purchase to proceed. ‘We wanted to make a general cash plus share offer to all minority shareholders and we were turned down,’ says Mercer. ‘In this situation, Peregrine would have maintained the KSH stock listing, but taken as many of the shares onto its own books as possible. That was a variation on our original plan.’
Peregrine was turned down on the basis that the Takeovers Code requires one buy-out offer to be made, and if that offer is rejected another one cannot be put forward for at least twelve months.
Strange Times
The Huey Tai International and Asean Resources Holdings case was equally strange from a shareholders’ perspective. Both Huey Tai and Asean are Hong-Kong based property companies, each with an HKSE market capitalization of around HK$2.5 bn. Huey Tai, which has has been listed on the Hong Kong market since 1970, purchased an approximate stake of 35 percent in Asean in 1991. That stake rose to some 70 percent by last June, and Huey Tai felt that it was time to merge Asean stock into the fold to increase shareholder value in both vehicles.
‘The merger of these two companies makes a lot of sense,’ says Alvin Wong, general manager of Huey Tai and Asean Resources. ‘Bankers and investors are somewhat confused by the fact that they are essentially doing the same business. [Taking the company private] would have allowed us to merge Asean into Huey Tai and create a stock with more liquidity, not to mention a better valued stock for shareholders. There is little doubt that our discount to asset value would have been decreased.’
Wong took his proposal to investment bankers, who set about presenting the scheme of arrangement to the SFC. The proposal offered a premium to shareholders of some 30 percent, and the subsequent sale would have been made at a record Asean stock price. Though there is no direct comparison between the shareholder package and the warrant holder plan, the offer of an exchange of Asean warrants for Huey Tai warrants created substantial value.
‘We never expected any problem with the warrant holders when we went into the meeting,’ recalls Wong. ‘Still, we knew warrant holders had to be onside. By exercizing their warrants they could hold some 10 percent of Asean stock.’
In the case of the warrant holders, Huey Tai needed 75 percent of outstanding warrants to vote in favor of the buy-out. In the event, warrant holders rebeled and blocked the deal, deciding to use their leverage to push for a pay-off estimated at around HK$1 bn. Ironically, nearly a year after the proposal, the warrants have expired and investors are looking foolish for turning down a deal that would have offered considerable value.
The situation now is up in the air. While the SFC was unavailable for comment, rumor has it that the regulatory body is considering the release of a consultation paper to solicit views from the industry of the 90 percent threshhold, and certain investment banks have taken the cause to heart.
If Hong Kong regulators find that the current rules are unfair for minority shareholders, a change could be in the offing sometime within the coming year. In the meantime, companies interested in going private can only grin and bear it.
