By Paul J Davies in Hong Kong and Simon Rabinovitch in Beijing

From Financial Times

Former factory worker Wan Long is no stranger to complexity when it comes to owning a business. The chairman of Shuanghui International, which is paying $4.7bn for one of the US’s biggest pork producers, spent much of the past decade trying to engineer a management buyout of his Chinese group and separate it from state ownership.

At the end of 2010, he finally pulled it off, using holding companies, joint ventures and offshore and onshore Chinese entities – and only after some painful missteps that drew the ire of both regulators and shareholders.

To buy Virginia-based Smithfield, the world’s largest pork producer, private equity-backed and Cayman Islands-registered Shuanghui International will be loaded up with debt. Its only asset is its 51.5 per cent stake in Shenzhen-listed Shuanghui Investment & Development, the Chinese meat processor and holder of the assets of Wan Long’s original pork business.

Some analysts have questioned whether the offshore holding company can afford to buy Smithfield – and whether the takeover has anything to do with the actual Chinese business at all.

Others see the deal as a potential game-changer – one of the first big Chinese acquisitions using western-style financing rather than the cheap state-sponsored lending of traditional Chinese banks.

Neither picture is strictly accurate. Chinese companies have long used offshore vehicles and complex structures when doing deals abroad, because tight capital controls make it very hard to get funds in and out of China, particularly with any speed.

Every international bond issued by a Chinese company is done via an offshore, often tax haven-registered entity that retains some kind of guarantee from a domestic company that does not itself usually maintain direct ownership.

On the Hong Kong stock market, there are numerous listed Chinese companies that also are registered in the Caymans or British Virgin Islands.

There are simple reasons for using these structures, says a senior Hong Kong banker, including autonomy and ease of operation, and to lower tax bills or avoid double taxation.

“Chinese groups trying to do anything offshore use these Cayman Islands-type vehicles all the time, firstly for tax efficiency; and secondly, because it stops you having to go back in and out of China to get permissions and approvals on everything you do offshore in your operations or your financing,” the banker says.

Oliver Rui, professor of finance at the China Europe International Business School, notes that typically when companies do deals, they use some combination of their own shares, cash and borrowing.

But for Chinese companies, borrowing is often the only option. Non-state-run groups, in particular, rarely have shares listed abroad that could be used as currency with international sellers. It is also cumbersome to gain approval from Chinese regulators to take cash abroad.

Shuanghui International is owned by Chinese management and staff and a short list of investors.

CDH Investments, a China-focused private equity firm, holds about one-third, as does Heroic Zone, a vehicle owned by senior management and staff of Shuanghui in China.

Kerry Group, a vehicle of Hong Kong’s Kwok family that counts the Shangri-La hotels chain and the South China Morning Post among its holdings, has a stake of just over 7 per cent. Goldman Sachs has about 5 per cent; Temasek almost 3 per cent; and New Horizon, a vehicle set up by the son of Wen Jiabao, China’s former president, owns about 4 per cent.

To pay for Smithfield’s stock Shuanghui International is taking on some $4bn in debt, supplied by Bank of China New York, and another $3bn, organised by Morgan Stanley, to refinance Smithfield debt.

Servicing all that debt looks tough.

Shuanghui Investment & Development paid out Rmb1.5bn ($245m) in cash dividends last year – more than 50 per cent of its profits and about five times what it paid in 2011. More than half of the dividends go to Shuanghui International, but that rate of payment would not make much of a dent in a $7bn debt pile.

Smithfield has never paid a cash dividend, due to restrictions under its current debt agreements, according to its latest annual report.

But the onshore business has both cash and room to borrow more.

Shuanghui Investment & Development had more than Rmb5bn in cash on its balance sheet at the end of the first quarter, nearly triple the level of a year earlier. It also has very limited borrowing. Its debt-to-asset ratio was 25 per cent at the end of the first quarter, down from 45 per cent at the start of last year.

Bankers and investors in Hong Kong and China expect that ultimately the only way to fully finance the deal is to list Shuanghui International in Hong Kong – providing both an exit for private equity investors and the chance for Shuanghui to raise the necessary equity.

Acquisition financing begins to take off in China

If Shuanghui pulls off its audacious acquisition of US meat producer Smithfield, the deal is likely to go down as a near-classic case of acquisition financing, a scenario that has bankers rubbing their hands together in anticipation, write Paul J Davies and Simon Rabinovitch.

“Whenever you do M&A, the opportunity to provide acquisition finance is one of the more attractive parts of the business, but it’s really not been available with Chinese [state-owned enterprises] because no one can compete with Chinese state banks,” says a Beijing-based banker.

However, this year UBS made more than $100m in fees from providing bridge financing for CP Group’s purchase of HSBC’s stake in Ping An, according to people familiar with the situation – a deal that was originally going to be funded by China Development Bank.

The leveraged loan being provided for Shuanghui’s acquisition is more in line with international norms, the banker says.

“It could be the opening of an era where, from an investment banking perspective, M&A financing is on the menu in China”.

For more on this story go to:

http://www.ft.com/intl/cms/s/0/aa8a2628-cf55-11e2-be7b-00144feab7de.html#axzz2Vw6AW0Ex