Some Observations on Hong Kong's Recent Surge in Privatisations

We have been seeing a marked increase in the number of deals where controlling shareholders of companies listed on The Stock Exchange of Hong Kong Limited (the Exchange) are taking their companies private (i.e., delisting the shares from the Exchange). With stocks of traditional companies trading at what some commentators believe to be historically low price-to-earnings multiples in the first half of 2020, the market had presented opportunity for privatisations. We have taken a look at privatisation offers launched in the past 18 months (the relevant period) and are sharing our observations in this Legal Update.

Marked Increase 

The first half of 2020 has seen more privatisation offers than the whole of 2019:

Offer Prices at Significant Premium

Perhaps with two exceptions, the offer prices of the privatisations launched in the relevant period have commanded at least a 20% premium (with more than half of them showing at least a 50% premium), when compared to the corresponding average closing prices for the previous 60 trading days.

Scheme of Arrangement Remains Preferred Structure

A vast majority (20 out of 27) of these privatisation offers were structured as schemes of arrangement. A scheme of arrangement (Scheme) is a proposal made by the listed company in question to cancel the shares not held by the offeror. Shareholders needs to approve a Scheme and a court in the place of incorporation of the company needs to sanction it, thereby binding all shareholders.

During the relevant period, ten of the privatisation Schemes were subject to sanction by the courts in the Cayman Islands, four in Bermuda and six in Hong Kong. Among them, the quickest Scheme took slightly more than two months from launch to delisting.

Voluntary General Offer

An alternative way to take a listed company private is to launch a voluntary general offer (VGO), with a 90% acceptance condition, upon closing of which the offeror then invokes statutory compulsory acquisition (squeeze-out) rights under the law of the place of incorporation of the listed company to buy out the non-accepting stakes. Most companies listed on the Exchange are incorporated under the laws of the Cayman Islands, Bermuda and Hong Kong whose jurisdictions have statutory compulsory acquisition rights.

Though less common (six out of 27), VGO can be the preferred structure sometimes. For instance, cancellation of shares (capital) as contemplated by a Scheme may be inconvenient or impracticable for regulatory reasons. "Headcount test", which requires more than half in number of disinterested shareholders present to vote in favour of a Scheme in addition to votes count, is still relevant for many privatisation Schemes (see Note 2 to the comparison table below). This headcount requirement may present anomalous result, whereas a VGO simply requires the accumulation of 90% for acceptance.

The VGOs during the relevant period we observed include:

• One privatisation offer which set the acceptance condition at 90%. This offer had all conditions satisfied and proceeded to invoke compulsory acquisition rights.
• Two VGOs which set the acceptance conditions at 50%, citing that the offeror may privatise if acceptance reaches 90%. These two VGOs were launched between January 2020 and June 2020. They are not all-or-nothing privatisation offers as acceptance conditions were set at 50% instead of 90%, which is required to trigger the compulsory acquisition rights.
  • One of the offers closed without privatising the listed company.
  • The other, as of the date of this Legal Update, has further extended the offer period.
• Three privatisation offers which were launched for H shares of companies incorporated under the laws of the People's Republic of China (PRC):
  • Two were completed with shares delisted, of which one effected a merger by absorption (see below for further discussion) following the VGO where dissenting or non-accepting shareholders were bought out at the offer price; and the other managed to obtain a waiver from the Hong Kong Securities and Futures Commission (SFC) and proceeded on the basis of no compulsory acquisition.
  • One was announced recently, seeking to obtain an SFC waiver to proceed without compulsory acquisition.

Statutory Mergers

Not all jurisdictions have statutory compulsory acquisition rights. The laws of the PRC, under which all H-share companies listed on the Exchange are incorporated, do not provide for such rights. However, if the offeror chooses to effect a merger by absorption under PRC laws (whereby the listed company and the offeror will legally merge into a single entity) , the dissenting or non-accepting shareholders in the VGO could be bought out upon the merger. A merger could be effected with or without a VGO. During the relevant period, we observed two H-share privatisations conducted by way of mergers; one proceeded with a VGO, the other without a VGO.

It is feasible for companies incorporated in jurisdictions other than the PRC (e.g., the Cayman Islands) to effect statutory mergers. However, given the market’s familiarity with Schemes, we do not see compelling reasons for Hong Kong-listed companies, which are incorporated in these other jurisdictions, to do so.

Schemes v. VGOs

Schemes are by far the preferred structure to effect a privatisation offer for companies listed on the Exchange. The illustration below compares Schemes and VGOs:

Note 1: 

A privatisation Scheme needs to comply with the voting requirements under the Hong Kong Code on Takeovers and Mergers (the Takeovers Code) as well as those under applicable company law. Subject to Note 2, the Takeovers Code and the Companies Ordinance (Cap 622 of the Laws of Hong Kong) (or, as the case may be, the Companies Law of the Cayman Islands or the Companies Act of Bermuda) impose equivalent voting requirements. However, the definitions of “disinterested shareholders” are not exactly aligned between these instruments. The Takeovers Code generally excludes a larger subset of shareholders (i.e., offeror and its concert parties) from being counted for the votes; while the respective company law may exclude a smaller subset (e.g., offeror and its associates). It is therefore important at the outset when structuring an offer to ascertain whose votes count and whose don’t, and for what resolutions.

Note 2: 

The so-called "headcount test" is abolished and removed from the Hong Kong Companies Ordinance for privatisation Schemes of Hong Kong-incorporated companies. Such test remains relevant for Cayman Islands and Bermuda Schemes.

Note 3:

The Takeovers Code and applicable company law (e.g., the Hong Kong Companies Ordinance, the Companies Law of the Cayman Islands or the Companies Act of Bermuda, as the case may be) require that a minimum level of acceptance must be achieved (i.e., 90%) before an offeror can exercise compulsory acquisition rights. Again, similar to the situation explained in Note 1, who may or may not be counted towards such 90% is not exactly aligned between these instruments. In addition, compulsory acquisition rights may be construed more strictly and are available in much more limited circumstances under applicable company law than the Takeovers Code may allow. It is therefore important at the outset when structuring an offer to ascertain whether and how the compulsory acquisition rights are to be invoked.