Editor’s note: I have corrected several mistakes that were posted in the original piece, such as mis-identifying China Development Bank and the amount of money Baring’s was going to be required to invest if the original transaction was completed. I regret these mistakes.
I have also added some links to research reports and added FI.com’s analysis.
Update: I added some analysis of the share pledge agreement.
Harbin Electric and its chief executive officer Tianfu Yang are going to have to find another bride since they have just been left at the altar.
Baring Private Equity Asia Group Ltd., the PE fund willing to partner up with Harbin, is now an erstwhile suitor according to a filing made last last night. The language is convoluted and seems to have been written to save face, mentioning as it does Yang’s openness to having Barings contribute up to 10% of a future management buyout if it wants to. Still, the thrust is clear enough: Baring’s has backed out and is not likely to be participating in the deal.
There is an allusion to alternative financing “being in place” upon completion of the deal but few specifics. The separation appears mutual and, unlike busted American deals, there does not appear to be any litigation pending.
The PE fund may or may not back Yang in some future limited capacity but when it came to committing about a chunk of its newly raised $1.5-billion, they walked away. Indeed, it will be difficult for even the most ardent Harbin bull to avoid the fact that there was no reduced price or counter-bid. Baring’s, in other words, was interested at $24 but not at a lower price. With full access to Harbin’s financials and operations, they walked rather than bid $20 or $17. The SEC filing is mum on what they saw. It almost certainly closes the door on the likelihood that another high-profile PE fund will back Yang and Harbin.
Yesterday, the stock shot up 95 cents to $17.90 on the news that the China Development Bank is providing a $35-million working capital loan, $15-million of which was to be used to pay off a 10%, five-month loan from Abax Capital. To secure this loan, Yang pledged seven million of his 9.6-million shares. Traditionally this would suggest that until the loan is paid off, he cannot repledge those for any purpose, including to the LBO. What this means for the shape of the transaction going forward is uncertain. In turn, this brings in the risk of a stock price decline and the China Development Bank seeking more collateral; if the demand is not met, the bank has the right to sell the shares.
It has been a rough week for Harbin investors who saw their share holdings decline in value more than 11% on Friday alone. In conjunction with a series of FI.com reports that raised concerns over the company’s financials and the cast-of-characters affiliated with its founding, the Muddy Waters Research shop (which presumably had a short position) released a devastating report on RINO. On Friday, management released an 8-K for the ages in which it confirmed both the scope of the fraud and the suspicion that they were not very engaged with operations.
It would appear that the rough times for Harbin Investors are just beginning.
There are dissenting views.
Maxim Group, for one, sees an opportunity for more bidders to come into the process and is retaining a Buy on the company. Roth Capital, while making some of the same points as Maxim, is even more expansive, reiterating its Buy and arguing that an overlooked quirk of Nevada law derailed the Baring’s bid (and presumably little else.)
Both firms argue that Goldman can still sell the $470-million in loans laid out in the original proposal, and with Barings chipping in 10%, or $52-million, the deal would readily get done.
FI.com is deeply skeptical of this.
Here is where FI.com’s background as a reporter colors a view. We see Baring’s perhaps differently than many Harbin bulls in that private-equity funds, in FI.com’s experience, have been really good at getting deals done but that it is the rarest of PE funds that actually improves the company it buys without massive legal or federal forebearance. [FI.com does not consider extended cost-cutting--the second favorite tool in the PE fund playbook--as managerial expertise; it considers it cost-cutting. Expertise is carefully and discreetly navigating a difficult environment and building enterprise value. Warren Buffet's shareholder letters are instructive to this end.]
There is one caveat to the above however.
PR funds are KILLER in sussing out cashflow. Nobody, ever is as good as a PE shop is in figuring out how to squeeze cash out of an asset. No one. Not because they terribly much care about improving the asset, but because they want fees and dividends.
Barings, had they remained committed to the deal–which is to say that they found enough cash to generate a suitable internal rate of return– would have assuredly found a way to see it through in some fashion. Even as the stock corrected over the past few weeks as, per FI.com’s comments, Harbin’s margins were proved to be unsustainable and their auditors revealed to be incompetent or wholly negligent, it is difficult to see how Baring’s and its bankers at Goldman could not have worked some sort of deal out.
As it is, whatever cash-flow Harbin can generate–and FI.com has argued that much of its cash-flow from operations is illusory–after a large capital-expenditure program and slowing business conditions are considered, would be consumed with debt repayment and interest.
FI.com argues that flat revenues and earnings, the sheer absurdity of the LBO idea from a business perspective and a host of accounting and governance problems is going to keep other PE funds far, far away.
Everywhere the serious investor turns in analyzing Harbin, it is difficult to argue anything other than what FI.com has said several times now: Something is really wrong here.