The Global Economic Impact of Private Equity Report 2008 - World ...

Establishing early agreement on post‐investmentobjectives and strategyThis initial compatibility of objectives allowed due diligenceto proceed rapidly and smoothly, with a minimal amount offriction along the way. One of the most striking aspects ofthis pre‐closing period was the time and attention devotedto planning and agreeing on the post‐investment strategy.Zhao’s criteria with all Hony deals is that there must be aclear agreement pre‐investment on the post‐investmentvalue-creation strategy. This, he believes, requires a clearalignment of interest between Hony and management abouthow to grow the company. This was clearly the case withJiangsu Glass.Both sides agreed from the outset that their singular focusshould be on the execution of a number of concrete actionsthat would transform the company into a market leader. Butgiven the industry’s cyclicality and their expectation that priceswere likely to peak in late 2004 or early 2005, time was of theessence to raise capital on favourable terms. Among the mostimportant components of this strategy were:• CEO Zhou Cheng would relinquish his position as anofficial of Suqian City and work full-time for the company• Preparations would begin immediately to position thecompany to execute an IPO on the Hong Kong StockExchange (HKSE) as soon as legally possible. (To conformwith HKSE listing requirements, the company would needto be legally transformed from a Chinese joint stockcompany to a limited liability company, and then, priorto the IPO, a wholly foreign‐owned enterprise.)• Proceeds from the IPO would be utilized to buildadditional production lines and to expand productionvia acquisitions• Immediate efforts would be made to identifyacquisition targets• Immediate efforts would be made to attract a world‐classglass manufacturer as a shareholder and strategic partnerStructuring and closing the transactionThe key to implementing the post‐investment growth strategywas executing the IPO as quickly as possible, ideally bymid‐2005. Rather than listing on one of the two domestic stockexchanges, from the outset, Hony targeted the China Glasslisting for the more demanding HKSE, where its more rigorouslisting requirements would demonstrate to international investorsthat the company satisfied the highest standards of financialreporting, transparency and corporate governance.But the HKSE listing requirements stipulated there must beno material change in company ownership for at least oneyear prior to the offering, in addition to a number of otherlisting requirements (e.g., independent audit, compliance withHKSE GAAP). In order to meet their aggressive IPO timetableand remain in compliance with HKSE regulations, therefore, alegal purchase agreement was first signed on 31 December2003 whereby Hony Capital took control of Jiangsu Glassfrom the Suqian State‐owned Assets Supervision andAdministration Commission, with an independent valuationconducted two weeks later and the agreed sum paid byHony in February 2004. Hony then spent 10 more monthsnegotiating for and completing the transaction of theremaining minority shares from two government‐ownedasset management companies. The entire process wasfinally completed in December 2004, a year after the legalshare purchase agreement had been signed.Although unusual by Western standards, this methodicaland drawn‐out process of negotiations, valuations andapprovals is not unusual for Chinese SOE privatizations.Even as negotiations were continuing, Hony assumed therole of controlling shareholder and immediately began tomake changes in the company in preparation for theanticipated IPO. During this interim period, prior to the finalacquisition of the minority stakes, the company’s entireaccounting and financial reporting systems were revamped,an independent audit was conducted and a new Board ofDirectors was established. In addition, with an eye toenhancing the company’s perceived value with prospectiveIPO investors, a formal long‐term relationship was negotiatedwith a highly reputable, globally recognized strategic investor,as described in the next section. (See Exhibit 3 for the majorsteps in the time line of the transaction.)In sum, Hony acquired the stakes of Jiangsu Glass for RMB93 million (about US$13 million), 8 an amount that equalledabout one third of Hony’s entire first fund. Zhao believed“our willingness to make such a relatively large commitmentshortly after we had established our first fund was a goodindication of our confidence in the company”.Executing the value enhancement strategyHony and the Jiangsu Glass management team had ashared vision for the post‐buyout company from the verybeginning of their interaction. By the time the buyout of thecontrolling stake was officially closed in February 2004, theyalso reached complete agreement about the strategy toachieve the vision. The most urgent task was to prepare thenewly named China Glass for the HKSE IPO. Once thecompany held a deeper pool of long‐term capital, attentionwould shift to transforming the company by expandingcapacity through the construction of new production linesand a series of acquisitions. In pursuit of these objectives,some of the significant actions included:Creating financial incentives for key managementFirst, Hony’s 100% ownership stake was immediately reducedto 96% with a pre‐arranged agreement to sell 4% of its sharesto the company’s seven most senior managers at the sameprice Hony originally paid for its shares. Simultaneously, it was8As is customary in Chinese practice, the valuation is based on net asset value plus the assumption of all outstanding debt obligations.The Global Economic Impact of Private Equity Report 2008 Case studies: Hony Capital and China Glass Holdings 119