Would you sell your shares of a rapidly growing company with $667 million of net assets, $641 million of revenue, and $175 million of income over the past 12 months for a price that values that company at only $339 million?
That's the question facing shareholders of Chinese crop nutrient manufacturer Yongye International (NASDAQ: YONG) as the company moves toward a possible buyout. Yongye has had an eventful history since it began trading via a 2008 reverse merger. In the years that followed, several reverse merger Chinese companies, including Yongye and China Green Agriculture, Inc (NYSE: CGA), were accused by short sellers of fraud, with many investors concluding that their financial performance was too good to be true, resulting in extremely low multiples on their stock prices
Yongye emerges
After receiving several years of clean unqualified audit opinions from Big 4 audit firm KPMG, a $50 million preferred stock investment by an affiliate of Morgan Stanley, MSPEA Agriculture Holding Limited, and now an offer involving the company's CEO and MSPEA to take the company private, it appears likely that Yongye's performance and financials are the real deal.
While there are some shareholders that believe $6.69 is reasonable, many others feel that the buyout offer has placed an artificial cap on the stock price, and that the shares should trade significantly higher if the offer gets voted down. It's not hard to make a case that the shares should be worth $20 or more given the company's performance and prospects.
Let's summarize some key financial details (in $millions)...
| 2010 | 2011 | 2012 | 9 Months 2013 | |
|---|---|---|---|---|
| Revenue | 214 | 390 | 443 | 570 |
| Net Income | 48 | 85 | 94 | 156 |
| Net Assets | 225 | 398 | 448 | 667 |
...and percentage growth for each year:
| 2010 | 2011 | 2012 | 9 Months 2013 | |
|---|---|---|---|---|
| Revenue | 118% | 82% | 13% | 29% |
| Net Income | 2,106% | 75% | 10% | 67% |
| Net Assets | 70% | 76% | 23% | 37% |
Note that all 2013 amounts in the tables above only include the 9-month period ended September 30, 2013. Therefore the $6.69/share offer price represents a P/S ratio of 0.6 and a P/E of 2.2 even before Q4 2013 is factored in. By any measure, that is minuscule for a company that should grow both the top and bottom lines by more than 30% in 2013.
Where are the other offers?
If the company is truly worth as much as its financial performance suggests, why are there no competing bids for Yongye? In connection with MSPEA's preferred stock agreement, they have veto rights over corporate actions and material transactions. As a result, if MSPEA believes Yongye is worth much more than the current $6.69 offer price, as I suspect they do, even a significantly higher offer would be vetoed. Therefore, other potential suitors may not feel it is worthwhile to perform their diligence and submit a bid that will most likely be rejected, even if it were higher than the current offer.
This is why I see only two options: Either the company gets taken private by the current buyers, or it continues to be a publicly traded corporation.
The fairness opinion controversy
As independent financial advisor for the go-private transaction, Houlihan Lokey provided Yongye's Special Committee of the Board of Directors with an opinion that $6.69 is fair, from a financial point of view. Upon review of the discounted cash flow analysis used to support their opinion, several significant assumptions appear suspect.
Even after deducting a huge $571 million for working capital requirements over the next few years, the most controversial deductions relate to another $99 million of "cash necessary to finance short-term operations" and $94 million in cash allocated "for the imminent construction of a new manufacturing facility". These two items alone total $193 million or nearly $4 per share, but were never disclosed to the company's owners/shareholders previously, leading some to question whether they are true necessary expenses.
On the quarterly earnings call in November 2013, Yongye's CFO was directly asked about this new imminent $94 million manufacturing facility and asked to quantify how much had already been spent. He would not answer the question, leading some to believe that this facility is not really imminent. In the past, Yongye has always given shareholders advance notice when additional manufacturing capacity could be needed. Therefore, it may not be appropriate to reduce the DCF by these items, which would result in a valuation several dollars higher.
The $100,000 payment that Houlihan Lokey stands to receive only if shareholders approve the buyout comes across as an incentivized conflict of interests as well.
Better to liquidate?
It can also be argued that the company could simply sell remaining inventory, collect outstanding receivables, pay off all remaining debt, and be left with significantly more than $6.69 per share to pay out to shareholders in liquidation, potentially as much as $11 or 12 per share. This has some scratching their heads trying to understand how $6.69 per share could be in the best interests of the company's current shareholders.
The voting agreement
Shareholders involved in the buyout, including MSPEA, and the CEO, signed a voting agreement, pledging to vote their shares, representing 33% of outstanding shares, in favor of the buyout. This does not mean that only 17% of the other shares are needed for the deal to close. In a crucial vote required for the go-private to close, only shareholders excluded from the buyout group have the right to vote, so the voting agreement shares will not be counted. If more than 50% of these minority shareholders either vote against the deal or do not vote at all, the deal will not pass and Yongye will remain publicly traded.
In October, 2013, Glenhill Advisors, LLC, filed a Form 13D showing that they are owners of 3.8% of Yongye and they stated that the "Purchase Price is inadequate" and they "do not intend to support the Merger." They believe the company should instead list on the Hong Kong Stock Exchange, noting that another Chinese agricultural company, China Blue Chemical, trades at a P/E of 10 on the Hong Kong exchange. A similar multiple on Yongye's income for the first nine months of 2013 alone would equate to a stock price of more than $30 per share.
Could the buyout really get rejected?
A vote against the buyout is certainly not out of the question. Just a few weeks ago, a buyout offer for Brazil Fast Food Corp (NASDAQOTH: BOBS) was voted down by shareholders.
Shareholders opposed to the Yongye buyout have recently voiced their opposition by voting against the company's board of directors in the annual proxy vote. On December 4, Yongye filed a Form 8-K showing that approximately 4.5 million shares were voted against the board, compared to only about 230,000 last year. Those 4.5 million votes actually exceed the number of votes in favor of the board after backing out the 19.2 million excluded shares, assuming that all voting agreement shareholders voted in favor of the current board members.
Considering that excluded shares will have no say in the most crucial buyout vote, and that all shareholders that do not vote at all will count as votes against the buyout, it appears that Yongye's privatization has a legitimate chance of being rejected.
A huge opportunity ahead
If Yongye were to remain publicly traded, the future looks bright thanks to their distribution network, consisting of nearly a thousand provincial and county level distributors and more than 35,000 branded retail stores throughout China. This led to a successful launch of two new products last year, in addition to growth in their core Shengmingsu nutrient product. Their future growth could be significant if they continue to capitalize on the major trends of increasing food consumption in the largest population in the world, requiring getting more crops out of the same, or shrinking, arable land.
The vote is expected to take place in Q1 2014. It will be very interesting to see what percentage of shareholders are willing to accept the buyout group's current offer.
