SOHO China (0410.HK) – Merger Arbitrage – 22% Upside

Current Price: HK$4.10

Offer Price: HK$5.00

Upside: 22%

Expected Closing: end 2021

Offer document

 

This is a short note on Blackstone's partial acquisition of a Chinese real estate developer. The spread exists mostly due to regulatory approval concerns and significant potential downside (37%).

On the 16th of June, Chinese real estate developer SOHO China announced a voluntary conditional cash offer from Blackstone at HK$5/share (valuing the company at a total US$3bn equity value). SOHO founders (Chinese billionaire power couple - chair and CEO) have agreed to sell a majority of their 64% stake in the company. Further shareholder approval is not required. The price looks favorable for the buyer - it is 17% below the $6/share negotiated in the Q1'20 last year (the talks were abrupted by the COVID) and also comes at just 0.65x BV vs second largest peer China Evergrande (US$13bn market cap) trading around its book.

Initially, SOHO price jumped up to $4.60/share (leaving 9% spread), but over the month, the spread has gradually widened to 20%+ due to regulatory concerns. A pre-condition to this offer is consent from the Chinese antitrust watchdog - China's State Administration for Market Regulation (SAMR). Blackstone has already submitted the relevant documents and both parties are waiting for the review. Scheme document dispatch was also adjourned till the receipt of regulatory consent. The longstop date is Dec'21.

Despite significant skepticism from the market, there are a few reasons to believe that the regulatory approval should eventually be granted:

  • Blackstone is a purely financial buyer with over 10 years of experience in Chinese RE investments (i.e. here, here, here). It currently owns 6m sq. m. of properties in China. The fact that they are pursuing SOHO for over 1.5 years gives confidence that the regulatory environment was investigated in detail before putting this acquisition in motion.
  • SOHO will remain listed and the buyer intends to continue the "business as usual" - no big management changes or asset sales are planned.
  • Chinese real estate market is highly fragmented and Sohu is a relatively small player.
  • Founders (chair and CEO) will remain the second-largest shareholder with a combined 9% stake but will resign from their managerial positions.

Nonetheless, the regulatory risk still remains and the downside in case of rejection is significant - pre-announcement price stands at HK$3.80, however, SOHO stock started soaring two weeks prior to the announcement. This was probably due to some kind of rumor although the only rumor I found was released just one day before the announcement. Anyways, the real "last-close" price is probably much lower and in case the deal breaks, Sohu's share price could tumble to around HK$2.60 (37% downside).

One more note - the fact that Blackstone intends to make the offer for all SOHO shareholders and yet keep the listing is a bit ambiguous as the stock exchange can delist the company if the float goes below 25%. However, the acquisition document didn't mention anything about the proration and stated that if the float gets below the satisfactory amount, shares may get temporarily suspended until sufficient float is attained. The offer is most likely structured this way in order to incentivize shareholder participation. I expect Blackstone to cash out all tendering shareholders.

 

SOHO China

The company develops high-class buildings, mostly office, and commercial, in Beijing and Shanghai. SOHU is regarded as "one of the country's most high-profile real estate firms", which buildings are recognized for their unusual futuristic and modern designs.

9 COMMENTS

  1. snowball

    “stock exchange can delist the company if the float goes below 25%.”

    No, to squeeze out minority shareholders and delist in Hong Kong, one needs to reach 90% threshold.

    If float goes below 25%, trading will be suspended, but the company is not delisted.

    The most common remedial action taken by a company will be to do a private placement, raising some capital to restore float to above 25%, which I believe is what Blackstone plans to do after completion of the tender offer.

    The rationale behind the plan to keep the company listed and to roll over a 9% stake for the two founders is unknown, and very unusual, but I don’t think it is a random choice.

    The design could be serving an important purpose in countering the pubic impression/backlash that the two controversial founders are cashing out and fleeing China with “profits made from Chinese people” .

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    1. Blenner

      “If float goes below 25%, trading will be suspended, but the company is not delisted.”

      This is also not correct.

      If the percentage of public float falls below 25%, the Exchange reserves the right to suspend trading until appropriate steps have been taken. However, if the public float falls below 15% (or 10% in the case of an issuer who has been granted a public float waiver under rule 8.08(1)(d) at the time of listing), the Exchange will normally require trading to be suspended.

      If suspended for >1 year, the Exchange now has the power to force delisting, In accordance with Rule 6.01A(2)(b)(ii).

  2. Tan

    Any thoughts on the price action today? Seems rumor that Blackstone may pull out from the deal.

    1. snowball

      Today’s sell-off not likely about Blackstone pulling out.

      The focus is always on obtaining approval from relevant authorities.

      Reuters reported today that a document/report being circulated among investors/lawyers suggests that the deal may face regulatory hurdles, citing two sources.

      The founder couple currently reside in the US and it is unknown whether they have plan to return to China anytime soon.

        1. snowball

          Below is a Link to a Chinese language news article on Reuters website (I couldn’t find the original English version on internet). Also see the Google-Translated version below:

          * A media report circulated among investors and lawyers groups seen by Reuters stated that SOHO China’s sale to the Blackstone Group is facing regulatory obstacles related to the founder. The report cited two sources.

          * It is reported that the CEO and Chairman of SOHO China are currently in the United States and it is unclear whether they plan to travel to China in the near future.

          * Soho China did not immediately respond to Reuters’ request for comment.

          * Soho China said last month that the US private direct investment company Blackstone Group is close to reaching a deal to acquire SOHO China, an office building operator listed in Hong Kong.

          * The transaction must be approved by the Chinese competition authority.

          https://cn.reuters.com/article/%E3%80%8A%E8%82%A1%E5%B8%82%E7%AE%80%E8%AE%AF%E3%80%8BSoho%E4%B8%AD%E5%9B%BD%E8%82%A1%E4%BB%B7%E6%9A%B4%E8%B7%8C21%25%EF%BC%8C%E5%AA%92%E4%BD%93%E7%A7%B0%E5%85%B6%E4%B8%8E%E9%BB%91%E7%9F%B3%E7%9A%84%E4%BA%A4%E6%98%93%E9%9D%A2%E4%B8%B4%E7%9B%91%E7%AE%A1%E9%9A%9C%E7%A2%8D-idCNXXS2P504O

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  3. Ilja

    So apparently amidst the ongoing crackdown Chinese regulators hijacked the merger after all. This was a major risk and as expected, shares took a major dive. -44% in 1.5 months.

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