The chief of Harbin Electric (HRBN.NASDAQ) has made yet another move to rescue his company from the growing heap of battered Chinese equities that are piling up on US exchanges. Following accusations of fraud and mismanagement led by short-seller firm Citron Research, Yang Tianfu, the founder and CEO of the Harbin-based motor maker, has made a bid to take the company private.
Yang’s proposal, which shareholders have accepted, is to join hedge fund Abax Global Capital in buying back all of the company’s existing common shares – the roughly 60% of Harbin Electric’s public float that the two parties don’t already own – at US$24 each.
That offer represents a big premium over the current share price, which was just above US$16 as this magazine went to press. If the deal goes through as planned in the fourth quarter, investors who purchase stock now would receive a huge payout when the deal closes: a roughly 50% return. If the deal fails, on the other hand, the stock would likely plummet right off the boards.
Either way, Harbin is one of the few reverse-merger plays left in New York with the potential for dramatic movement. Fairly or not, the valuations of most other Chinese reverse-merger firms have been beaten down to the point where the returns from shorting are no longer worth the expense of taking out a loan.
Friends in high places
Judging from the parties that Yang has recruited to support his bid, the deal looks fairly legitimate. China Development Bank, the national policy bank, has agreed to offer US$400 million in financing to cover the transaction.
Meanwhile, hedge fund Abax Capital has signed on as a guarantor, meaning it would be on the hook if Harbin Electric defaults on its bank payments. Abax is no fly-by-night operation, either: The fund was launched in 2007 by Citadel Group boy genius Chris Hsu, who departed in 2009, and it was initially funded by Morgan Stanley Investment.
Some investors are nibbling at the bait. Harbin Electric’s stock price has inched up from around US$12 after the deal was announced on June 20. But despite a huge potential payout, the stock price remains well below the US$24 mark – suggesting that some investors are doubtful that the offer will go through.
The markets may be discounting Yang’s offer because it is the second time he has made it. Yang planned to join Baring Private Equity to make the same US$24 offer last October, but Baring backed out the following month without explanation. Retail investors who had bought shares in Harbin Electric assuming the deal would go through lost heavily.
Yang’s recent bid offers investors the same trade-off. If he does take Harbin private, the actual state of the books becomes moot the moment the deal closes. The question for investors, therefore, is whether the privatization will actually succeed.
Originally, Yang’s goal in taking his company private was likely to re-list Harbin Electric on the Hong Kong Stock Exchange. Ping Luo, an analyst at Global Hunter Securities who claimed to be familiar with what Harbin Electric’s management was thinking, told China Economic Review in early March that moving to Hong Kong would be profitable because of the wide gap in valuations of companies listed on the US and Chinese exchanges.
“They can take the company private at eight times price-to-earnings, and list in Hong Kong or the mainland for 15 times price-to-earnings or more,” she said.
Within weeks, however, Global Hunter Securities announced that Luo had left the company. Luo had consistently maintained a buy rating on Harbin, even when the first buyout attempt failed. Since her departure from Global Hunter Securities, many of the Chinese reverse-merger companies that Luo formerly backed, including China Media Express and ShengdaTech, have been accused of fraud and de-listed, casting suspicion on Luo’s business practices. In late March, the BuyerStrike investor blog deemed Luo “the high priestess of reverse-merger garbage.”
Even assuming the privatization deal goes through, its troubled reputation seems likely to prevent Harbin Electric from pulling off a quick switch to the Hong Kong exchange. If it does make the jump, the company will probably trade far below 15-times earnings. Skeptics also suggest that Yang and his backers are overpaying for his company at US$24 per share.
But even though it may be expensive, a buyout is a foolproof way to stop the slide in the company’s valuation, avoid an investigation by the US Securities and Exchange Commission, and shake off pesky short-sellers. For investors who think Yang is likely to pull off this strategy, then Harbin is a buy.
However, investors must also seriously weigh the possibility that the privatization bid will fail. After all, the deal contains an escape clause that would allow China Development Bank to back out from extending the US$400 million in credit necessary to finance the deal. In that event, shares of Harbin Electric would surely fall sharply. They may yet fall ahead of this if more bad news emerges regarding the company’s business.
Rarely is a company balanced so finely between two extreme possible outcomes.