Deals

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Smartphone users with children under the age of eight will be balefully familiar with Talking Tom -- an app featuring an animated cat that repeats a user's remarks in an annoying feline squeak.

It's a modern equivalent of the old fun-house mirror, making the mundane ridiculous by distorting its reflection. The Chinese company that just announced plans to buy Talking Tom's maker appears to be doing something similar in the field of mergers and acquisitions.

Zhejiang Jinke Entertainment Culture Co. will pay at least $1 billion to buy Outfit7 Investments Ltd. from closely held United Luck Group Holdings Ltd., the company said in a filing Wednesday with Shenzhen's stock exchange. United Luck, for its part, appears to be living up to its auspicious name: It's only five days since the announcement that it had bought Outfit7 from its founding owners for $1 billion. Any premium over that amount will constitute an impressive return on capital.

By the Book
Zhejiang Jinke's market capitalization is substantial next to the $1 billion it's paying for Outfit7 -- but net assets look short
Source: Bloomberg

The run of deals has everything you'd expect out of Chinese M&A: Little-known companies with seemingly fathomless reserves of cash; a publicity-shy rich-lister hovering in the background ; and a company with genuine expertise in one area buying another in an entirely unrelated sector.

Zhejiang Jinke, despite the Entertainment Culture bit of its name, manufactures hydrogen peroxide and other specialty chemicals, with blue-chip customers according to its 2015 IPO prospectus including Reckitt Benckiser Group Plc, Procter & Gamble Co., and Kao Corp.

Outfit7, too, is a more serious player than you might think for a company whose revenues depend on people buying virtual shoes and cocktails for imaginary pets. Back in 2012, its U.K.-based operating company was so small that it was exempt from filing full accounts with the country's corporate registrar; by 2015, net income had hit 87 million euros ($93 million). 

It's easy to get a $1 billion valuation out of those numbers. Assume Ebitda in 2016 grew at the same rate as it did the previous year and that the company kept its 2015 year-end net cash holdings of 18.6 million euros constant, and then apply the median 8.76 multiple in 60 entertainment software deals for which Bloomberg has data. That would comfortably produce a valuation of $1.15 billion.

That's the case for the defense. The prosecution has some powerful arguments, too.

For one thing, app-makers tend to live fast and die young: Rovio Entertainment Oy, the maker of Angry Birds, cut jobs for two years running after failing to repeat the success of that game, before the modest success of The Angry Birds Movie last year halted the decline. Activision Blizzard Inc. bought Candy Crush maker King Digital Entertainment Plc in 2015 for a 20 percent discount to its IPO price the previous year.

Repeating the Trick
Outfit7's net income has grown by leaps and bounds -- but appears to be slowing
Source: Company filings

Outfit7's earnings growth slowed in 2015 from 2014, so Zhejiang Jinke will have to hope it hasn't already peaked. The Chinese company is paying more than the value of its own total assets, which stood at 5.2 billion yuan ($760 million) at the end of September.

Then there's the question of synergies. If you're going to spend a 10-digit amount on an acquisition that will almost certainly require a hefty dollop of debt, you'd hope to be able to extract some pretty significant cost savings from the combination. But what possible common ground can be found between the worlds of industrial bleach manufacture and selling virtual goods in a smartphone app?

Still, for those inclined to see all this as evidence of a "Forget it, Jake, it's Chinatown" insanity unique to Asia, it's worth reflecting on whether western practices are much better.

China's external takeover boom certainly appears to be driven as much by the insatiable appetite of local investors to get their hands on overseas assets as any commercial logic -- but most deals in the West also succeed only in destroying, rather than enhancing shareholder wealth. Zhejiang Jinke certainly won't be the first or last company to pay a bubbly price for an app developer.

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

  1. United Luck's boss Ou Yaping is the former chairman of Shenzhen property developer Sinolink Worldwide Holdings Ltd., who's co-invested with Tencent Holdings Ltd. Chairman Ma Huateng in a healthcare business and, reportedly, with Alibaba Group Holding Ltd. founder Jack Ma in a private nature reserve in Sichuan.

  2. There are plenty of similarly odd deals out there. Metals and chemicals business Anhui Xinke New Materials Co. last year recently bid for control of Voltage Pictures, the Hollywood production company responsible for The Hurt Locker. In 2014, chicken producer Sumpo Food Holdings Ltd. bought Canadian video-gaming company Digital Extremes.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net