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Privatization of US-Listed Chinese Companies

Chinese companies listed on US stock exchanges have seemingly always been subjected to a higher level of regulatory and shareholder scrutiny as compared to US-based and other foreign companies.  However, in recent years, Chinese companies have experienced a dramatic increase in regulatory proceedings, shareholder litigation and scrutiny from the business media.  Much of this increased scrutiny is focused on perceived or actual financial-related impropriety or misinformation, in many cases amounting to fraud.  One result of this development was a dramatic increase in class-action securities litigation involving Chinese companies, as well as several cases of regulatory proceedings and delistings over the past year. Unfortunately, a secondary result has been that virtually all Chinese companies listed in the US have experienced lower stock prices. How can the true value of a US-listed Chinese company be determined in this environment?

Much of the concern regarding the integrity of Chinese companies traded on US stock exchanges relates to companies that gained access to the US equities markets through a transaction known as a reverse takeover (RTO, also known as a reverse merger or a Chinese RTO).  In an RTO, an existing US-listed shell company (typically defunct) acquires a private entity and then turns over control to the nonlisted company’s owners, who can then issue equity, essentially avoiding the regulatory hurdles, cost and scrutiny that would be encountered in a standard IPO registration process. The PCAOB and SEC have both reported a high incidence of substandard financial reporting among entities created through the RTO process, and have found outright fraud in many.  The SEC and PCAOB issued several alerts in 2011 to investors and members warning them of problems associated with China-based RTO investments.  In the summer of 2011, the SEC formed a task force to study these companies in greater detail, and on November 9, 2011, the SEC approved substantially revised rules for RTOs for the three major US listing markets, designed to increase the regulatory rigor faced by companies that gain access to these markets through the RTO process.

As a result of these recent developments, together with several other related factors, managements of many US-listed Chinese companies are exploring options to privatize their companies.  Many such privatizations of Chinese companies have taken place over the past year.  Often, in such privatizations, a special committee is formed and a valuation or independent fairness opinion is obtained to protect the integrity of the privatization transaction.

With substantial experience and established offices throughout the United States and in China, American Appraisal is well situated to provide the valuation or opinion service needed to assure a smooth privatization transaction in this difficult environment.  American Appraisal has firsthand experience with assisting such companies, including the following recent example.

A New York-based law firm, representing a US OTC-listed Chinese biotechnology company that wanted to go private, contacted American Appraisal through its Shanghai office. The company’s management, on the advice of its professionals, wanted a valuation of the fair value per share of the common equity, in connection with its approval of the buyout, to protect it in the event minority shareholders challenged the transaction under applicable state law. Our valuation team in Shanghai was engaged, and the scope of the assignment included:

  • Review of historical financial data
  • Discussions of the company’s market development and product strategy
  • Discussions of outstanding debts
  • Discussions of financial projections and business plans
  • Industry research reports
  • Review of draft agreement of the proposed transaction
  • Review of historical and current prices of common shares and trading volume

The valuation team interviewed company management, gathered market data and information, and then performed the valuation utilizing several accepted valuation methodologies:

  • The guideline company method of the market approach, which reviews and analyzes financial ratios of comparable companies
  • The discounted cash flow method of the income approach, in which future net cash flows are discounted to a present value at a discount rate reflecting return requirements and risks
  • The guideline transaction method of the market approach, in which recent sales of comparable companies are analyzed

The Shanghai valuation team worked with American Appraisal business valuation staff in the United States, reviewing the analysis to ensure compliance with local state law and appropriate valuation standards. Our use of accepted valuation methodologies and our thorough review of applicable local laws resulted in an objective, supportable analysis, providing comfort to the company and its attorneys that they were protecting themselves against potential litigation in the transaction.

American Appraisal has provided valuation and opinion services in connection with numerous China-US transactions.  Seamless collaboration between our US-based valuation consultants and our offices in Hong Kong, Beijing, Shanghai, Guangzhou and Shenzhen leaves us uniquely situated to provide our clients and their legal professionals the services needed in these sometimes-challenging situations.