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

agreed that an additional 8% of Hony’s shares would betransferred to company management at the same price uponits successful completion of the IPO. To ensure that thedesignated executives could afford the two share purchases,local banks and Hony agreed to provide loans on favourableterms. In return for this generous share purchase agreement,the executives signed long‐term contracts obligating themto remain with the company. Thus, Hony clearly understoodthe importance of ensuring a stable, highly motivatedmanagement team that would work seamlessly to build value.The value‐creation objective was most likely to be achieved bycreating an incentive‐based executive compensation schemelinked directly to company performance.Attracting a world-class strategic investorZhao and his Hony colleagues recognized from the outsetthe imperative of attracting a highly credible internationalstrategic partner to enhance the value of the deal, both forthe operational and technological expertise it would offerand the prestige it would add at the time of the IPO. Alarge, financially strong strategic investor with a long‐termcommitment to China’s glass industry also provided Honywith an attractive exit route when the timing was right.In 2004, even before the deal closed, Hony entered intodiscussions with senior executives at UK‐based Pilkington, atthe time the world’s largest flat glass producer with 23 glassplants in 11 countries. Although Pilkington had been operatingin China through several joint ventures since the 1980s its seniormanagement was convinced the company had to implement amore aggressive strategy in order to capture a larger share inthe country that accounted for one third of the world market.The optimal strategy, they believed, was to acquire a majorstake in one of the premier domestic manufacturers.During the due diligence phase of the Jiangsu deal, Zhaowas introduced to Gerry Gray, the senior Pilkington executiveresponsible for implementing the firm’s China strategy.According to Gray: “I knew that no deal in China would everbe legally airtight, but if we could find a partner with whom wehad a high level of trust, we could make it work. From the firstmeeting I had a strong sense that we could trust John, and thishas served as the cornerstone of our relationship ever since.”Based on pre‐close negotiations, Pilkington initiallysubscribed to 9.9% of the China Glass shares at the IPOoffer price. Hony and Pilkington also entered into twocall‐option agreements whereby Pilkington would eventuallyhave the right to acquire all of Hony’s shares in China Glass.The first call option, which had to be exercised within 18months of the IPO, gave Pilkington the right to acquire 20%of China Glass shares from Hony at a 5% premium to theIPO price. 9 The second option, which must be exercised by2011, allows Pilkington to acquire all of Hony’s remainingshares in China Glass at the 12‐month average price priorto the purchase. This carefully orchestrated arrangementoffered tangible benefits to both investors. Hony was seekinga strong strategic partner with a long and successful globaltrack record and a potential exit route, while Pilkingtonwanted to establish a stronger foothold in China by havingthe option to take control of a major domestic manufacturer,thus allowing the firm to become the dominant foreign playerin the domestic flat glass market.Preparing for the IPOIn addition to creating the new incentive‐based executivecompensation scheme and attracting a reputable strategicinvestor, Hony helped China Glass in a series of major structuralreforms to transform the formerly state‐owned company intoan attractive publicly listed company. These included:• Board restructuring: Prior to the Hony buyout, even thecompany’s CEO acknowledged that, like most SOEs, theboard was merely a rubber stamp, providing virtually nomeaningful oversight or governance of the company. Oncethe Hony deal was sealed, board composition, structureand functions were dramatically changed to provide thecompany with corporate governance standards andpractices that met the international benchmarks expectedby investors of publicly listed companies. For example:• The new board would be comprised of three seniormembers of management, two Hony representativesand three independent directors unrelated to thecompany. It was further agreed that the boardcomposition would further change after the IPO toinclude two representatives from Pilkington. (SeeExhibit 4 for profiles of board members prior to the IPO.)• Hony CEO John Zhao became chairman of the board• A number of committees, including audit, compensation,and compliance committees, were created• Regularly scheduled board meetings were mandatedat approximately one-month intervals• Management was instructed to provide all boardmembers with monthly financial and operating reports,using a newly created standard format• New accounting and audit standards: Immediate stepswere also taken to establish accounting standards andpractices that would fully comply with the GenerallyAccepted Accounting Principles (GAAP) required by HongKong Stock Exchange. An annual independent audit wouldalso be performed for the first time in the company’s history.• Obtaining international certifications: Operational standardswere improved and benchmarked against internationalstandards. Prior to the IPO, the company received anISO9001 certification for its quality assurance systemand another ISO certification for its environmentalmanagement systems.9This option has already been exercised in March 2007, increasing Pilkington’s holding in China Glass to 29.9% at the time.120 Case studies: Hony Capital and China Glass HoldingsThe Global Economic Impact of Private Equity Report 2008