Hobson's Choice on Privatisations
14 January 2001
Exploiting a deficiency in the Hong Kong Listing Rules, several controlling shareholders recently have been offering public minority shareholders a Hobson's choice between a rock and a hard place - either accept our privatisation offer at a deep discount to fair value, or continue to hold unlisted shares without any marketplace or any right to require a purchase.
The background to this type of takeover offer, where a person (the Offeror) seeks to take a public company private, lies in company law. There are 3 relevant jurisdictions for Hong Kong listings, namely Hong Kong, Bermuda and the Cayman Islands. Most HK-listed companies are incorporated in one of the latter two British colonies rather than this former colony.
Under the company law of the 3 jurisdictions, an Offeror can make a compulsory purchase (at the offer price) of outstanding shares if he manages to acquire 90% of the public shares in the course of an offer. For example, if he owns 40% already, then he must acquire a further 54% (90% of the public's 60%) before he can compulsorily buy the rest. Alternatively, under Bermudan and Cayman laws (but not Hong Kong), if the offeror ends up with 95% of the Company then he can buy out the other 5%.
The same law applies in reverse; in certain cases, if a public shareholder misses an offer but one person has acquired 95%, then he can force that person to acquire his shares at a fair price determined by the courts. In practice, this circumstance is rare.
As a result of the compulsory purchase laws, privatisations which are done by way of a voluntary "offer" often contain a condition that the offeror must receive acceptances of at least 90% of the public shares.
The Listing Rules
Although most voluntary privatisation offers contain the 90% acceptance condition, they also normally reserve the right to waive the 90% acceptance condition. Under its Listing Rule 6.12, the Stock Exchange of Hong Kong (SEHK) allows an issuer to withdraw its listing if it achieves approval of:
"a majority in number representing three-fourths [75%] in value of the [public] shareholders present and voting either in person or by proxy at the meeting"
This lower threshold means that the threshold for approval of a privatisation is in effect reduced from 90% to 75% of the public shares. Once delisting has been obtained, the Offeror can waive his 90% acceptance condition.
In addition to the risk of delisting, if the public shareholding is reduced to less than 25%, then the Stock Exchange may suspend trading in the shares anyway. We deal with that problem later in this article.
Recently issuers have used the delisting/suspension threat to add pressure to minority shareholders to accept offers which are often at deep discounts to the underlying asset value of the companies concerned.
Take for example last month's undervalued offer for the shares of Winsor Industrial Corporation Ltd, at a huge 53% discount to net asset value. Independent financial adviser Anglo Chinese Corporate Finance Ltd (Anglo Chinese) advised that the offer was "fair and reasonable". The offer document contains a letter from the board which says:
"Shareholders should note that if they elect not to accept the Offer and the Offeror elects to waive the 90% acceptance level condition and the Independent Shareholders of Winsor subsequently resolve to withdraw the listing of the Shares from the Stock Exchange, [then] Shareholders who have elected not to accept the Offer would be left holding shares in an unlisted company, in which circumstances the market for Shares may be illiquid."
The letter from the "independent board committee" is even more blunt, adding to the above a warning:
"In addition, under this circumstance, Winsor will cease to be subject to the Listing Rules and [Shareholders who do not accept the offer] will become investors in a less regulated company with less transparency, more limited financial reporting requirements and with fewer opportunities to vote on significant acquisitions or realisations of significant assets....."
Wah Kwong Shipping
Almost the same wording was used by the minority adviser in the offer for Wah Kwong Shipping Holdings Ltd in 2000, this time at a discount of 51% to net asset value. On this occasion Anglo Chinese advised Wah Kwong Shipping. In that case, the Offeror set a lower acceptance condition, requiring that it reach a total shareholding of only 50% (the minimum allowed under the Takeover Code). However, other substantial shareholders related to directors, who together held some 33%, had undertaken to accept the Offer (although they were barred from voting on the delisting), so the offeror, which controlled 42.3% of Wah Kwong, was sure of passing the acceptance condition. This left the delisting approval as the only real condition of the privatisation, which duly completed.
Ng Fung Hong
Another privatisation offer containing the delisting condition was Ng Fung Hong Holdings Ltd, where the delisting was approved on 27-Dec-00 although acceptances had only been received for 3.3% of the company, and 33% was still outstanding. The offeror, China Resources (which was advised by, guess who: Anglo Chinese), then waived the 90% acceptance condition on the public offer. Needless to say, acceptances of the offer quickly flooded in after the delisting left them with the certainty of no market in which to trade.
The reason for the 90% acceptance condition
Many listed companies and their advisers have in the past argued that a 90% public approval condition for privatisations is too high a hurdle to meet. They are talking their own book. The lower the hurdle, the cheaper the offer will be.
Experience has shown Webb-site.com that on past occasions, there are cases where the "public" shareholding includes parties very close to the offeror, who are secretly attempting to influence the outcome of the privatisation. There are plenty of ways to evade or avoid this using relatives, trusts, nominees or offshore companies with untraceable shareholders.
For example, suppose a controlling shareholder has a disclosed 75% of a company (the maximum allowed) but he or his associates have secretly acquired another 12.5% of the company. That leaves 12.5% in public hands. Of the public, many do not realise that a vote is taking place, or fail to get their votes back in time for the meeting. Hong Kong's multi-layered custody system makes communications with public shareholders difficult. Let's suppose a relatively high turn-out, with half of the public shares voting, or 6.25% of the company.
Then if just a quarter of the public votes (1.5625%) are in favour of a delisting, and three quarters (4.6875%) want to remain public, the company will be delisted. The controller will secretly cast 12.5% in favour, making the vote 14.0625% in favour, and 4.6875% against. Motion carried 75:25, listing removed.
That is the reason for the 90% condition. It ensures that unless all but 2.5% of the company has accepted, they cannot be compulsorily acquired.
Schemes of Arrangement
The same logic applies to privatisations done by way of a "Scheme of Arrangement" rather than a general offer. In this legal procedure, a "Scheme" or takeover plan is put to shareholders for a vote. If the Scheme is approved, then it is binding on everyone, and if it is not approved, then no shares are acquired. The Hong Kong Takeover Code (Rule 2.10) requires that the Scheme is either:
approved by a majority in number [of public shareholders] representing 90% in value of those shares that are voted.... or
if not so approved by the requisite majority, not disapproved by [public] shareholders... holding more than 2.5% of the total number of shares in issue.
The second part of the condition was put in a few years ago to prevent a tiny minority from spoiling a deal in the event of a low voter turn-out. Readers should note that without the 90% condition, Webb-site.com might not have achieved an increase in Wheelock's offer for Lane Crawford back in 1999 by gathering together enough votes to block an undervalued offer.
The current Listing Rule 6.12 is quite clearly in conflict with the Takeover Code, as it allows a route for controlling shareholders to threaten minority shareholders with becoming shareholders in an unlisted, unregulated company. Faced with that, they are more likely to accept a miserly offer. This in turn means that minority interests in companies will trade at a substantial discount to fair value because of the risk of being forced to sell out at a discount. As we have pointed out before, this increases the cost of capital for all companies, good and bad, which makes Hong Kong's companies less competitive in the global market.
Apart from privatisations which result in 100% ownership by one party, there is no conceivable circumstance in which it is in the interests of public shareholders to have a listing cancelled, as it strips them of regulatory protection and a visible marketplace for their stock.
Therefore Listing Rule 6.12 should be scrapped, and instead controlling shareholders who wish to privatise a company should be required either:
- to include in the offer a 90% acceptance condition which gives them the legal right of compulsory purchase, and undertake to use that right; or
- if they set a lower acceptance condition, they must undertake, if they do not achieve 90% acceptances from the public, to sell down their stake to raise the public holding back to the level needed to maintain a listing without suspension.
Obsolete Free Float Percentage
The question of whether the SEHK minimum free float of 25% is appropriate (Listing Rule 8.08) should also be addressed. Other markets have long recognised that the ability to manipulate a company's stock price depends not so much on the percentage of the shares that are held by the public, but on the dollar size of the "free float" held by the public, and the number of public shareholders. They therefore allow companies to remain listed even when the public percentage is very small, so long as there is a viable market size.
Public shareholders have no more rights when they have 25% than when they have 10% of a company, so this is not a question of votes.
In Hong Kong, the SEHK will accept listing applications on the main board with only a HK$50m (US$6.4m) free float, but requires all companies with market value of less than HK$4,000m to have a free float of at least 25%. This gives rise to the ridiculous situation where a company with a market value of $3,900m but a free float of $900m (23%) may be suspended from listing, while one with a free float of only $50m is free to trade.
The SEHK should therefore scrap the 25% requirement and allow listings to be maintained so long as the market value of the free float does not fall below HK$50m, or whatever minimum dollar value is set.
The risk of market manipulation when a free float (however large in value) is held by a small number of shareholders remains, but the way to deal with that is by prosecution of the offending shareholders, not by penalising the innocent with a suspension of trading in their stock.
© Webb-site.com, 2001
Organisations in this story
- China Resources Ng Fung Limited
- WAH KWONG SHIPPING HOLDINGS LIMITED
- WINSOR INDUSTRIAL CORPORATION, LIMITED