Edited by: William Billeaud
The recent widely publicized case of the scrapped IPO for the WH Group, the world’s largest pork producer, is a poster child for what has gone wrong in public markets as of late. The failed Hong Kong listing will give the sellers and its underwriters a lot of food for thought on how to conduct business going forward. The rest of us can also draw a number of valuable lessons on how to manage capital transactions.
Lesson 1: A company planning to go public should build a solid investment story ensuring no loose ends
The thematic angle of the WH Group story is the rise of the Chinese middle class, its affinity to pork and pork related products and the increasing per-capita consumption in China. The convincing strong top-down growth outlook alone without other supporting factors is not enough to ensure the success of the transaction.
Lesson 2: Businesses should not rush into a capital raising exercise until they have built a solid value proposition
The major point of the WH Group IPO failure related to the short time frame in getting the company listed post the acquisition of Smithfield Fields, a US-based company. Management should have spent several years, not six months before heading down the public route. “It’s like buying a house, ripping out the bathrooms and kitchen, and trying to flip it for a premium six months later,” said one senior equity banker. Just like you wouldn’t sell a renovation project before you have actually completed it, you cannot expect potential investors to open their wallet for a story that has not yet built a sustainable track record.
Lesson 3: Injecting leverage to accelerate growth can create deceptive shortcuts
Resorting to borrowing to grow your business is a measure that should be used in moderation. It can have disruptive effect even on the most solid of business models. The debt-to-equity ratio of the group shot up from 7.6% to 237% as a result of the Smithfield acquisition and the high leverage became a key source of concern for potential equity investors.
Lesson 4: The rewards of management should be aligned with controlling and minority shareholders
The $600mln+ share based incentive package shared by executives post the Smithfield Foods acquisition pushed the company’s bottom line into red in 2013. That sort of excess leaves a blemish on the company’s track record and speaks volumes of the corporate culture at the very top. Managers and rainmakers should be fairly rewarded for working hard to take strategic and building value as a result of those risks, but those nine digit figures are excessive by any sort of measure.
Lesson 5: Investors should be rewarded for taking a risk in your company
One of the key flaws of many Chinese listings is their ambitious growth projections and high valuation multiples. Rosy projections might work in times of irrational exuberance but in the long-run they undermine the credibility of issuers and their bankers. In the case of the WH Group, the sellers never bulged on the price anchoring the multiples at 14-20x times forward earnings, an attitude which certainly left the wrong impression on the other side of the table.
Lesson 6: Issuers should hire and retain a tightly knit and trusted circle of bankers and underwriters
The most widely quoted and amusing trivia of this story was the number of counterparties on the underwriting list. It is hard to imagine what kind of logic and effort the company put into hiring 29 bookrunners. It is a recipe for chaotic execution with loss of sight for the end goal. Investors get confused as they get multiple phone calls regarding the same deal.
Lesson 7: Every financial market operates within a certain absorption rate bandwidth
Each public and private market has its own specific absorption rate. Experienced underwriters are well aware of the limitations of each market when estimating the transaction size. The initial estimated size for the WH IPO was set at a ceiling of $6.2 bln but that number was later slashed to $2 bln, suggesting miscalculation of the absorption rates of the Hong Kong equity market.
Lesson 8: Securing the engagement of a top cornerstone investor boosts credibility
The announcement that GIC is slashing its commitment as a cornerstone did not break the bank but certainly added to the snowballing wave of negative impressions. Even though investors pride themselves on being strong independent thinkers, they directly or indirectly get influenced by each other’s decisions. Winning (or losing) a large or high-profile strategic investor will leave a strong impression with the new wave of investors.
Lesson 9: Companies raising capital should get it right the first time
The investment community has an elephant memory for failed IPOs. In the next several years the WH Group will have a tough time in executing a listing and securing high valuation for its assets on any exchange around the globe. The extra scrutiny and burden of proof will sit with them regardless of the funding channel they consider next time.
Lesson 10: Broad market sentiment is important factor to consider when timing an IPO launch
The uncoordinated and poorly executed issuance was the main reason for the failure of the WH IPO. Nevertheless, the poor sentiment in the Chinese economy and news of circulating deadly virus certainly did not help. External developments beyond a company’s control can magnify the weakest links in a company’s investment story. While issuers and underwriters do not have control over macroeconomic swings, they should be well prepared to anticipate and address investor concerns in times of heightened vigilance.
The image used is courtesy of artist Delilah Smith and dailypainters.com