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A Slice of Qihoo’s $9.3 Billion Buyout for Sale on China Streets

  • Promises of 500 percent returns lure high net worth investors
  • Individual investors fueling China’s largest leveraged buyout

On the streets of China’s eastern city of Hangzhou, a fluorescent board like those used to peddle sandwiches in a cafe is offering a piece of China’s biggest leveraged buyout.  

With the lure of 500 percent returns, wealth managers including Overseas Chinese Fund and Jinlu Financial Advisors are selling investments linked to Qihoo 360 Technology Co.’s $9.3 billion take-private deal and the promise of cashing in on a future re-listing in China. Offers for individuals to take part in a takeover are unusual, with funding for such deals typically coming from companies, banks and experienced specialists such as venture capital and buyout firms.

Across the country, financial institutions acting as middlemen are tempting individual investors to provide funding for Wall Street deals taking place on the other side of the world. Such intermediaries are seeking a quick return from management fees, which is fueling an investment frenzy that could increase risks for the less sophisticated investors.

“It’s a reflection of Chinese investors’ chase for high returns despite the greater risks,” said J.P. Gan, a Shanghai-based partner at Qiming Venture Partners, which manages four funds with more than $2.5 billion in assets. “This practice is rarely seen in the U.S. or other Western markets.”

Qihoo, which had net income of $307 million in 2015 selling security and browser software to the world’s largest internet population, announced a deal to be bought by an investor group in December last year with plans to complete the transaction during the first half of 2016. The buyers include senior management, along with Ping An Insurance Group Co., Sequoia Capital China, Golden Brick Silk Road Capital and New China Capital.

Street sales are unlikely to directly influence the Qihoo take-private deal, which Tencent’s has reported has secured funding and is in its final stages. It’s unclear how much of the money committed was repackaged by financial institutions into investment products sold by retail brokers like Jinlu.

The practice however raises questions of risk for individual investors. Shanghai-based Jinlu is promising investor returns of as much as 5.1 times their investment based on Qihoo attracting a multiple of at least 60 times earnings if it relists in China and generating net income of $1 billion by 2019, according to investor presentation material seen by Bloomberg. That would value the Internet security company are about $60 billion, more than six times the buyout deal.

The presentation doesn’t present a range, just the top estimate on returns.

That price-to-earnings ratio is a “conservative” estimate as most Chinese companies are fetching multiples of 100 and above, Jinlu said in its investor material. Media firm Baofeng Group Co. for example has a ratio of about 80 times earnings. In contrast, Apple Inc. trades at 11 times earnings.

Jinlu said investors who participate won’t be able to sell their stock during a lockup of at least three years. Qihoo’s profit will reach $1.3 billion by 2019, according to a financial presentation prepared by JPMorgan Chase & Co. for Qihoo in December.

The management fee charged by Jinlu is 2 percent while it also collects 20 percent of any returns that exceed 8 percent annually. A 1 million yuan ($152,000) investment threshold is required, Jinlu said in its marketing material, which stated that the funds raised will be used to help privatize Qihoo and relist on Chinese stock markets.

These new types of investments comes as the government tries to tighten the rules on wealth management products.

China Banking Regulatory Commission, the industry watchdog, issued a notice on May 13 barring banks from selling private fund products issued by financial institutions without licenses. The same day, the China Securities Regulatory Commission said there were unlawful practices in the private fund industry where products were marketed to unqualified investors, Caixin reported in May.

Multiple e-mails to Sequoia weren’t responded to. Ping An declined to comment. The CSRC did not respond to a faxed request for comment.

Jinlu didn’t respond to e-mails and calls requesting more details on its investment products. For Hangzhou-based Overseas Chinese Fund, the company set up a “China concept VIE return fund” to invest in companies including Qihoo, Momo Inc., E-commerce China Dangdang Inc., all of which are plan to delist in the U.S. to return to China, according to a statement on the company website.

A staffer surnamed Ye who answered the general line at Overseas Chinese Fund said the company has completed selling the products linked to Qihoo’s privatization fund, declining to comment further. Liu Li, a spokesman for Qihoo, declined to comment on the issue, any relationship with Jinlu and questions about the buyout.

Earlier this year, Jinlu suspended payments on some wealth management products jointly created with partner Shanghai Kuailu Investment Group because of a 300 million yuan cash shortage, according to a statement on Jinlu’s website.

The new type of investment offers come amid warnings by high-profile banker Fan Bao that individual investors are flooding into high-risk venture capital deals, disrupting markets by inflating values and potentially getting burned when the bubble bursts.

There’s also little guarantee that Qihoo can command current valuations if or when it eventually re-lists given the unpredictability of a domestic market. China was denied entry into MSCI Inc.’s benchmark indexes for a third time this month in part for that reason.

“The influx of retail investors into primary markets is dangerous,” Bao wrote in a column penned in Chinese and published online in the local magazine Caixin. “This market isn’t suitable for retail investors, it’s not the same as in secondary markets where price fluctuations correct rapidly.”

— With assistance by Tian Chen, David Ramli, and Dingmin Zhang

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