Deals

Matthew Brooker is an editor with Bloomberg Gadfly. He previously was an Opening Line columnist, an editor and a bureau chief for Bloomberg News. Before joining Bloomberg, he worked for the South China Morning Post. He is a CFA charterholder.

Hong Kong tycoons are used to getting their way, even to the extent of pushing through multibillion-dollar takeovers without offering a premium. Not always, though, it appears.

Win Some, Lose Some.
Source: Bloomberg Billionaires Index

Li Ka-shing could be forgiven for low balling Cheung Kong Infrastructure's $12 billion buyout offer for Power Assets Holdings, the latest step in a reorganization of the octogenarian billionaire's business empire. After all, the much bigger takeover of Hutchison Whampoa passed with barely a whisper earlier this year.

In that deal, Li's Cheung Kong Holdings offered $24 billion in stock to acquire Hutchison, creating a new group flagship in a transaction that granted no premium to the target's shareholders. While the terms and structure of CKI's bid for Power Assets broadly mirror those in the Hutchison takeover, this time there are some key differences.

Most importantly, markets were buoyant in the first half of the year. Hutchison shares jumped on the announcement and had surged more than 30 percent by the time the merger took effect in June, compared with a 15 percent gain for Hong Kong's benchmark Hang Seng Index. Voting down the deal would have risked unraveling those gains.

With a more diffused shareholder base, Power Assets is a different proposition. The stock has gained about 9 percent since the buyout was proposed -- not enough to cement independent shareholder support for the deal. Proxy advisory firms Institutional Shareholder Services and Glass Lewis have both recommended voting against the offer.

Li might have seen this coming. The lure of Power Assets is its $8.7 billion of cash, partly the legacy of spinning off the old Hongkong Electric into an investment trust last year. Li's flagship CK Hutchison controls CKI, which in turn is the largest shareholder in Power Assets. Combining the latter two would streamline the group's structure, bring the cash hoard under the more-indebted CKI's control and give it the firepower to pursue global infrastructure acquisitions. The two companies already cooperate closely, with 11 joint ventures.

This isn't the first time a bid has been made to shift cash from Power Assets to CKI. Earlier this year, Power Assets proposed to buy as much as $1.6 billion of debt securities from CKI. The resolution was voted down by independent shareholders at the company's annual general meeting in May. Brokerage CLSA estimates that 15 percent to 25 percent of Power Assets' shareholders voted against proposals on ISS's advice. With only 6.1 percent of shareholders needed to block the CKI merger, the bind facing Li is clear.

ISS and Glass Lewis have both criticized the proposed exchange ratio of 1.066 CKI shares for each Power Assets share as too low. That ratio had already been raised from 1.04 when the buyout was announced on Sept. 8. Based on Tuesday's closing prices, the offer represents a discount of about 1 percent to Power Assets shares.

While conceding the strategic rationale for the combination is sound, ISS noted ``inherent conflicts of interests'' and bemoaned the absence of an arm's-length negotiation between the Power Assets board and CKI.  (The companies have several directors in common, including Li's son Victor and trusted lieutenants of the billionaire such as Canning Fok and Frank Sixt.)  

Both proxy advisers note that CKI chose an opportune time for the merger, with the ratio of the two companies' share prices declining this year from an average of about 1.3 previously:

Opportune Timing
CKI versus Power Assets share-price ratio
Source: Bloomberg

ISS says there's no ``reasonable explanation'' for CKI's outperformance, adding that the company's higher earnings growth has been driven by acquisitions financed by debt and a capital raising. Based on a sum-of-the-parts valuation, it estimates a fair exchange ratio of between 1.09 and 1.2 times. Morgan Stanley estimated in September that CKI would need 1.15 to 1.2 times to satisfy Power Assets shareholders.

With Li having blinked once already, some investors may be tempted to gamble. If they fail to wring out a higher offer from CKI and the deal collapses, there remains a chance that Power Assets will be pressured into paying a special dividend (rather than the proposed post-transaction dividend that would be split with CKI shareholders.)

For a man so revered for his investment prowess he's known as ``superman'' to local media, Li looks to have got his timing wrong on this one. Hong Kong's great asset trader has a decision to make. Another slight increment in the merger ratio probably won't cut it this time. With minority investors emboldened, any revised offer will need to be closer to the upper end of the band. How much does he want it?

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Matthew Brooker in Hong Kong at mbrooker1@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net