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Chinese Companies' Privatization Analysis

Summary

Time matters. Many privatizing Chinese companies will soon announce their entry into definitive agreements. Take advantage of that.

Size matters. Bigger companies may take longer to close their deals, so be patient.

Buyer and valuation gap matters. Choose companies backed by big buyers. A bigger gap in value means a better chance.

Timing

As we all know at the moment many U.S. publicly listed Chinese companies have been privatizing. This report is to help traders and investors capitalize on this rare opportunity more efficiently.

First of all, to explain my idea and analysis better, I want to define an indicator called 'Investor Confidence Level' for privatization:

Investor Confidence Level for Privatization (ICL) = Closing Price on a specified date / Privatization Price

ICL shows how sure the investors are regarding the 'go-private' deal.

For example, on December 18, 2012, Chinese media company Focus Media (NASDAQ:FMCN) announced that it has finally entered into a definitive merger agreement. The closing price on that day was 25.25, and we know the privatization price offered for FMCN is 27.5 by the consortium. To calculate ICL, we divide the closing price of 25.25 by the privatization price of 27.5, leading to an ICL of 91.8%. This means, after Focus Media announced that it made a definitive merger agreement, investors were 91.8% sure that FMCN's privatization can be a success at the end.

Big Picture

Based on the company's press release, there are 6 main stages throughout a company's privatization. Basically, the pattern is that once a new stage has been reached, the ICL will increase by a great chance, which virtually means stock price will go up. When a company gets to the final stage (announcement of completion of the merger), the ICL mostly will be 100%. Let's check out three examples which have already done the mergers.

Chart made by author. All information is from company's investor relations.

Chart made by author. All information is from company's investor relations.

Chart made by author. All information is from company's investor relations.

In above 3 charts, we would be able to find out the ICL values at each stage, and how long it took from stage one. The recently delisted company, China Mobile Game Entertainment (NASDAQ:CMGE), finished the whole process in only 84 days. As soon as CMGE received privatization proposal, the ICL immediately went up to 95.6%. That means investors for CMGE were extremely confident about its privatization, and this also means we would have little profit in this case because it lacked uncertainty: roughly 4% return in 84 days, if we did it perfectly.

Focus media (FMCN) and Perfect Word (NASDAQ:PWRD) obviously had spent much longer time than CMGE.

How does a definitive merger agreement affect the stock price?

We all have a general idea that a stock will go up if the company announces that it finally made a definitive merger agreement, and the probability of merger completion increases significantly because of that. But how does the stock price actually go? Let's have a look.

I did research on 5 stocks, all of which have already made definitive merger agreements recently. They all made agreements in 2015, except FMCN, which finished in 2012. To evaluate the effect of a definitive agreement, I took two values: the closing price from one day before the announcement day, and the closing price on the announcement day.

Table made by author. All...


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