The following commentary comes from an independent investor as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
) -- Given the carnage in the China small-cap space, many investors are hopeful that management buyouts will be the catalyst for rising share prices. There have been a number of recent developments that are worth evaluating.
Tongjitang Chinese Medicines
(formerly TCM) recently completed its MBO at $4.50 after almost a year in the process. TCM's MBO demonstrates that these deals can get done. However, there are a number of reasons why this success should not be extrapolated to other potential MBOs.
First, from a financial standpoint TCM was a no-brainer. As of the last 20F filing, TCM had total assets of $191 million and total liabilities of only $55 million. The majority of the assets consisted of liquid cash, bank deposits, receivables and inventories. Second, the chairman and the other going-private buyers already owned over 80% of the company, so as a result they only needed to raise just over $20 million to gain control over 100% of the assets.
Third, the deal took nearly a year to complete due to the complexities of these transactions. Finally, the price paid to U.S. investors was only a 14% premium over the previous closing price. This was a balance sheet trade which was a phenomenal deal for the chairman. The deal was small and very easy to finance, particularly given that TCM was audited by a big four auditor.
China Security and Surveillance
( CSR) recently filed a very detailed 8K detailing its definitive merger agreement, the parties involved and the expected timing. This is a very encouraging development, particularly considering the formal disclosure of the parties involved, including Skadden Arps, Shearman & Sterling, White & Case, Bank of America / Merrill Lynch and China Development Bank. A link to the 8K and the merger agreement can be found
It should also be noted that CSR has a top 10 auditor.
The announcement was made after market close last Thursday and in the pre-market, shares jumped as much as 25% to $5.79 on substantial volume. But as a warning to the overenthusiastic, the shares traded as low as $5.30 intraday -- down 8% from the pre-market trades. The stock currently sits at $5.55, a 14% discount to the $6.50 offer price. Again, this is a balance sheet trade. CSR has over a billion in assets, with nearly half a billion in liquid assets. The current 14% discount reflects uncertainty that the deal will get done, as well as the timing which may take as long as six months, as disclosed.
CSR is not the slam dunk no-brainer that TCM was. Despite this, lawsuits are already being filed suggesting that the takeover price is too low. As a negative, this could cause additional delays in completing the transaction. As a positive (for investors) this could result in an even higher takeout price. Now that the stock has popped, there is not a tremendous amount of upside remaining in this trade. However, if the stock drops, I would certainly consider a moderate size position in CSR.
( HRBN) has also been on the rise, in part due to the prospects for other MBOs but more so due to recent comments by the CEO. Two weeks ago, the CEO selectively leaked information to sell side analysts that the financing was lined up and that a bid would occur on April 18. Analysts selectively released a research note, which quickly found its way to online bulletin boards, driving the share price up from $18.50 to nearly $21.00.
This was a clear violation of Reg FD and HRBN's lawyers quickly moved to issue an 8K after the fact. The wording of the 8K was notably quite odd. It simply stated that HRBN (the company) "understood that the following conversation took place" between the CEO and the analysts. In no way did the 8K confirm the truthfulness of the facts represented by the CEO's comments.
A link to the 8K can be found
April 18 came and went and there was no bid, no news and no comment from the company. This latest behavior at HRBN adds to a long list of red flags and following the jump in the share price, I have chosen to go short. The stock currently trades at a 14% discount to the proposed bid price, meaning that my downside is limited and I believe there is a reasonable probability that this deal will not go through.
If, for any reason, this deal does not go through, there is huge downside risk in HRBN. Short interest currently stands at over 6 million shares, indicating that investors are betting over $120 million against this deal going through. If the deal does demonstrate some progress, it should be expected to take many months for the deal to be complete and for investors to receive cash in hand. Until then, the usual arb spread should apply.
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Disclosure: The author is short HRBN
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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.
Rick Pearson is a Beijing-based private investor focusing on U.S.-listed China small-cap stocks. Until 2005, Pearson was a director at Deutsche Bank, spending nine years in equity capital markets in New York, Hong Kong and London. Previously, he spent time working in venture capital in Beijing. Mr. Pearson graduated magna cum laude with a degree in finance from the University of Southern California and studied Mandarin for six years. He has frequently lived, worked and traveled in China since 1992.