It was supposed to be the planet’s second biggest food-and-beverage initial public offering ever. When China’s WH Group began marketing its listing on the Hong Kong stock exchange earlier this month, the indicative pricing implied total proceeds of as much as US$5.3 billion, overshadowed only by the US$8.7 billion that Kraft Foods raised in 2001.
And why not? “WH Group is the largest pork company in the world, with number one positions in China, the US and key markets in Europe,” the company boasted on its website.
On unaudited pro-forma basis, revenues topped US$21 billion in 2013 – although the group lost US$34 million because of costs associated with the purchase of 100% of Smithfield Foods, America’s largest pork producer. Formerly known as Shuanghui International, the group paid US$4.9 billion last year to acquire Smithfield.
“If the one-off expenses and share-based payments directly attributable to the acquisition . . . totaling US$729 million were to be excluded,” said Deloitte, its auditor and reporting accountants, “the loss for the year of the pro forma Combined Group of US$34 million would become a profit for the year of US$695 million.”
It was a seemingly seductive story that WH Group’s 29 underwriters – the most numerous ever in IPO history – tried mightily to sell. But investors were skeptical. Last week, WH Group cut the size of its offering by two-thirds, aiming to raise only US$1.9 billion at the higher end of the indicative pricing.
But even that failed to whet investor appetite. On 29 April, just 14 days after releasing the IPO prospectus, the listing was pulled. “In light of deteriorating market conditions and recent excessive market volatility, the Company, having consulted the Joint Sponsors, has decided that the Global Offering will not proceed at this time,” the WH Group said.
What went wrong
The failure appears to stem from a number of factors, chief among them the pricing. Citing unnamed fund managers and bankers it interviewed, Reuters reported that the implosion was the result of “WH Group and its owners seeking too high a price, hiring too many underwriters . . . as well as negative publicity over some sky-high executive compensation.”
In the run-up to the IPO, Chairman and CEO Wan Long, 73, was issued 573.1 million new shares while Yang Zhijun, 40, an executive director in charge of investment, M&A and financing, was granted another 245.6 million shares. The fair value of the shares at the time of the granting was estimated at US$597 million.
“The whole team didn’t listen to the market carefully,” one WH Group shareholder groused to The Wall Street Journal. At HK$8 to HK$11.25, the pricing had turned off some institutional investors. “The WH IPO looked expensive,” David Gaud, a fund manager at Edmond de Rothschild Asset Management, told the newspaper.
At that pricing, the Journal estimates p/e at 15 to 20.8 times forecast 2014 earnings. That’s pricey even at the lower end – Tyson Foods in the US has a forward p/e of 13 times. The WH Group was apparently unwilling to go low. Bloomberg reported that executives had told the bankers a valuation below 16.5 times was not acceptable.
Unlike the 83-year-old Tyson, which produces chicken, beef and pork products, the WH Group does not yet have a track record. The Smithfield deal closed only last September and exports to China started just in January. “The synergies between Shuanghui and Smithfield are untested,” Ben Kwong, associate director of Taiwan brokerage KGI Asia told the Journal. “Why do investors have to buy in a hurry? They would rather wait until the valuation is attractive.”
Complicating matters is the current stock market volatility, which has not been kind to recent large IPOs. Japan Display, which makes screens for Apple devices, raised US$1.9 billion in March, but has seen its stock price fall 25% since it started trading on the Tokyo Stock Exchange.
From the point of view of investors, the earnings forecast on which the WH Group’s forward p/e is based is predicated on a possibly iffy integration of Smithfield and the delivery of the “significant synergies between our China, US and international operations” that the group promised in its prospectus.
That may or may not happen. The Smithfield purchase is the group’s first ever overseas acquisition. “We do not have other experience integrating international operations,” it said in the prospectus. “We may fail to effectively manage Smithfield’s operations, effectively integrate them with our other operations or otherwise obtain the desired benefits from the acquisition.”
All prospectuses enumerate a litany of risks, of course, but those discussed in the WH Group’s document do not seem particularly remote. For example, hog prices can be volatile. In the past, pork prices in the US can be much lower than prices in China because feed is cheaper in America. The group’s strategy of importing cheap Smithfield pork into China is partly based on this calculation.
However, pork prices in the US has recently surged because a virus killed some 7 million piglets. The US National Pork Producers Council has said hog prices could rise by 15% to 25%.
The cost of corn, soybean meal and other feed ingredients can also fluctuate. “We cannot assure you that all or part of any increased costs experienced by us from time to time can be passed along to consumers of our products, in a timely manner or at all,” WH Group said in the prospectus.
To be sure, the company has not been shy about talking up the China story. According to the prospectus, the plan is to import into China “safe, high-quality and cost competitive fresh pork from the US, which we believe will positively affect turnover and margins for our China operations. We also expect that a consistent and large source of demand from China for our US fresh pork products will provide healthy turnover growth in our U.S. operations.”
“We plan to leverage our US brands, raw materials and technology, our distribution and marketing capabilities in China and our combined strength in research and development to expand our range of American-style premium packaged meats products offerings in China,” said the group. “We expect [this] to positively affect our turnover and profitability.”
Over to you, CFO
Officially, the IPO is only delayed, not cancelled, but it is unlikely that the WH Group will restart the process any time soon. That puts some pressure on CFO Guo Lijun, 43, to find alternative ways to retire the debt the company took on to finance the Smithfield acquisition.
The company had intended to use about US$4 billion from the IPO proceeds to repay a three-year syndicated bank term loan that matures in 2016 (interest rate: LIBOR plus 3.5%) and a five-year tranche that matures in 2018 (interest rate: LIBOR plus 4.5%). Currently, 12-month USD LIBOR is at 0.54%, so the interest rates on the debt are 4% and 5%.
Because the debt is so large, the interest expense is substantial. The early repayment from the IPO proceeds was expected to reduce it by around US$155 million on an annualized basis – that’s nearly 5% of the US$3.1 billion in gross profit last year (unaudited and pro-forma).
Guo can possibly tap the bond market, but coupon rates are essentially at par with the terms of its syndicated loan. For example, China Power International has just issued a three-year RMB2 billion (US$324 million) dim sum bond in Hong Kong at a coupon rate of 4.5%.
In the US, Apple just issued a US$12-billion seven-part bond offering, which included a US$2.5 billion tranche priced at 3.45%. Given Smithfield’s 78-year history, the WH Group can possibly achieve a similar pricing, although the uncertainty around integration, the quality of Chinese management and other issues may give some investor pause.
Or the WH Group can focus on putting its house in order while waiting for a more opportune time to go public. The best option is still a listing, which may be attempted again next year.
The challenge for finance and others in the business is to prove that the oft-cited synergies are there and that the company has the ability to capture them. Actions that cause negative optics, such as the large share awards granted to Wan and Yang, should be avoided or at least explained clearly.
It is also helpful for the management team at Smithfield to be retained. Retention award schemes are in place for a number of senior executives, covering the three years after the acquisition. Still, the Chinese owners and their executives must be sensitive to potential cultural misunderstanding and other clashes that can drive them away.
And the crowd of underwriters should be thinned. Citing a source close to the company, the South China Morning Post reported that a meeting of WH Group senior executives on 30 April blamed poor communications among the banks. "Some of them were too confident, and even a bit arrogant, when they tried to price the deal and coordinate with each other," said this source.
The company has arguably been too hasty in going to the market, barely seven months after the Smithfield acquisition. It will now need to show strong results in the next year or two to get a second crack at an IPO – and command a valuation in line with its expectations.
There are good lessons here for CFOs and other executives.
About the Author
Cesar Bacani is Editor-in-Chief of CFO Innovation.
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