SORL Auto Parts (SORL) – Going Private – 8% Upside

Current price: $4.37

Cash-out Price: $4.72

Upside: 8%

Expiration Date: expected in Q2 2020

Going Private Announcement

This idea was hinted by Brian

 

This is a rather standard case of U.S. listed Chinese company getting taken private by controlling shareholder. The spread likely reflects limited trust by U.S. investors towards similar management buyouts of China based micro-cap names. However, there is high likelihood this transaction will close. SORL is really cheap if the numbers can be trusted and there are reasons to believe buyer's intentions are real rather than only meant to manipulate the stock price. Also recent stats suggest majority of similar transactions with definitive agreements have successfully closed.

Insiders of SORL (via related party Ruili Group) have signed definitive agreement to cash-out minority shareholders at $4.72/share. Spread to the offer price stands at 8%. Insiders own 59% of the company and transaction is subject to approval by minority shareholders. Meeting date has not been announced yet. Downside to unaffected price is 23%. Management expects the transaction to close by Q2 2020.

The main risk is management cancelling the offer and I do not expect any pushback from minority shareholders.

 

Company background

SORL is manufacturer of automotive brake systems, mostly used in trucks and buses. The company supplies OEMs and aftermarket distributors. 82% of sales go to China and the rest are international. SORL operations are conducted through JV with Ruili Group, and majority of its assets have been acquired from Ruili Group as well. If my count is correct, insiders received a total of $109m by shifting assets from their private entity into the JV, but contributed only $5m in capital. This compares to current market cap of $85m for SORL and $35m required to cash out minority shareholders.

SORL is also tainted with heavy number (and amounts) of other related party transactions, raising questions if the reported numbers can be trusted. Having Malonebailey as auditors does not inspire much confidence either as Malonebailey has made its name by focusing on Chinese reverse mergers and auditor's track record is not spotless (albeit most indicated cases seem to relate to 2011). However, similar things could probably be said about most of Chinese companies, so not saying that SORL is standing out from the crowd in terms of shaky governance or questionable financials.

If the financials are real, then SORL is very cheap trading at less than 4xPE and at 40% of TBV while growing revenues at 10%+. This would also explain why insiders might be willing to acquire the whole company for themselves.

 

Previous Offers

Current buyout agreement follows non-binding offer made in Apr'19 at $4.26/share. Apparently, independent special committee managed to squeeze out additional $3.5m of cash for minority shareholders by increasing buy-out price to $4.72/share. This is rather unusual - if there was a real pushback by the special committee then this would be a rare case of U.S. listed Chinese company actually caring for the minority shareholders (i.e. SORL actually standing out from the crowd in a positive way).

Back in 2015 the same management also made a non-binding offer at $2.84/share - this one was simply withdrawn couple months later citing concerns over recent market conditions. China truck industry indeed experienced significant decline in 2015 but has picked up since (see page 22 and also here). Thus I do not believe that the cancellation of the 2015 offer is an indicator of how the current one will proceed. Improving commercial vehicle sales (and 2.5x higher SORL revenues vs 2015) also explain why insiders are being so generous and readily offering 65% higher cash-out price.

 

Majority of Chinese buyouts with definitive agreements close

Opposed to 2015 situation as well as the Apr'19 proposal, for the first time there is definitive agreement instead of a non-binding offer. Overview on the US listed Chinese companies’ privatization transactions (2019, 2018 summer and 2018 spring reports, compiled by Duff & Phelps) indicates that almost every case with a signed definitive agreement gets closed. SORL management's timeline (Q2 2020) also fits within the range of recently closed transactions.

13 COMMENTS

  1. Bulrathi

    Why you expect no push back from minority holders? Management has tipped their hands by going for real after the buyout, so its likely that the numbers are real. In that case, shareholders have a lot to lose by not staying in a super cheap growing chinese company

    1. dt

      – There are no large institutional holders who could run an activist campaign – Bridgeway Capital is the largest owner after insiders and holds only 1.7% of shares (or 4% of float excluding insiders). The Next one is Gabelli Funds (+GAMCO) with 1.3% ownership.
      – I doubt shareholders actually have a choice. If the transaction gets rejected, management will simply find a way to funnel value out of the company through related party transactions. So the current gesture seems already very generous.
      – I do not think anyone is expecting a higher offer if the current one fails to close – which means shares would probably revert to $3-3.5/share range.

      1. Zulu Investment Partnership

        No one is expecting a higher offer, but there is general consensus that the minority shareholders are being given a lowball price, so to speak.

    1. dt

      I think these are standard press releases / advertising by lawyers trying to attract new clients.
      Do not think there is any substance in these.

  2. over2u

    Detailed research on why you shouldn’t play gamble with SORL
    https://seekingalpha.com/article/4031681-time-to-pump-brakes-on-sorl-auto-parts

    In my view current upside is too small to compensate for potential risks related to the company/deal.
    What I have picked up from financials:
    – Working capital build up – the way to take the money from the company by majority shareholder through advancements
    – RPT in 2016, US$ 76m transaction with land and facilities (all money went to majour shareholder)
    It doesn’t mean that transaciton won’t happen, but the risk here maybe excessive in my view

    1. Writser

      I think you are conflating the risks of 1) owning a Chinese company that is mistreating minority holders with 2) betting on a merger where management can take said company private at a bargain valuation.

      Yes, management treating a company as a piggy bank is bad, but if they can use said piggy bank to buy out minority holders at a cheap valuation then I’d say management has all the incentives to pursue that merger and the deal is perhaps not more, but less risky than other deals.

      1. over2u

        My point is that with the management like this you never know what is a bargain valuation for them. If the bid will be revised down to $3 for example you don’t have a lot of alternatives. So in this case the downside for the transaction break/terms revision may be very significant.

        1. Writser

          A lot of Chinese deals in preliminary stage are revised, cancelled, delayed, etc. I have been burned by that before and I tend to be very wary of them. I think it’s at least partially a cultural difference. If an American buyer comes up with a (friendly) preliminary bid the deal is basically a done deal or there will even be a small bump to console minority holders. For a Chinese buyer a preliminary offer basically seems like the start of the negotiations.

          But anyway, once the offer is definite, as you can see in the Duff & Phelps reports, almost all deals close and there isn’t that big of a difference with other mergers. Not saying this is a super deal with a ~6% spread and an unclear timeline but I’m absolutely not scared of a downward revision.

  3. Zulu Investment Partnership

    The main elephant in the room to address is really how trustworthy management is and what the company really looks like. I did scan through the detailed research report sent by over2u. Thank you for the article. The issue is that the short case (which has fared badly for them) nitpicked on a lot of stuff that isn’t relevant to SSI who are holding this for a few months. Like the dirty floors and being number 37 on some list doesn’t really tell much. (BTW it’s a very rigged system to see who gets or doesn’t get mentioned.)

    1) Fundamentally long term, some of these can raise a concern, but then I ask you this: why would management offer $4.72/ share knowing all of these flaws about the company? Likely they think the company is worth $4.72 or more. It’s possible they can be doing this to manipulate stock price for related shareholders, only to withdraw this offer a few months down the road, and they have done that in the past. Unlikely with 59% ownership, unless there is a reported mass sale in the next quarterly report. Chinese laws have started to become more stringent and crack down on these kind of stuff but this is a real threat.

    http://www.xinhuanet.com/english/2019-06/29/c_138182574.htm

    2) All the Chinese auto stocks more or less trade very cheaply. China has a lot of room to grow in the auto industry and the recent slump in sales have caused the auto stocks to go through a minor correction. There’s also a little spat on the last earnings call with an analyst (likely a minority shareholder) making a case that this stock should be worth $8-$10/share which furthers my estimate that management is indeed trying to low-ball the minority shareholders. It’s possible litigations can ensue but with such a huge inside ownership in a foreign country like China where minority shareholders are treated like nuisance? Unlikely to make the deal fall apart.

    https://seekingalpha.com/article/4306908-sorl-auto-parts-inc-sorl-management-on-q3-2019-results-earnings-call-transcript

    https://seekingalpha.com/symbol/SORL/peers/related-stocks

  4. Zulu Investment Partnership

    Hi, with SORL approaching $4.60s, we think it is prudent to trim back on our current position as the IRR (~8%) is no longer as attractive as other investments here on SSI, especially with newer ones that came out recently.

  5. Zulu Investor

    I would recommend reopening this up as an active idea. the price dropped way below the first time this investment thesis played out in fact.

  6. Zulu Investor

    Recommend closing again with a 2% spread. If you were lucky enough to pick them around $3 ( I got most of mine at $3.50), one could have made about 28%+. Overall, well worth the risk IMO given the cheap valuation despite being a Chinese company. The first closing of this investment resulted in a 5% gain. The second time, 28%+ at least in 1 month. A cumulative 33% gain, which I think is pretty good.

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