Morgan Stanley participates in MBO of Chinese drug company

The Asian private equity arm of Morgan Stanley and a group of management shareholders yesterday announced that their offer to take Singapore-listed Sihuan Pharmaceutical Holdings Group private has been declared unconditional in all respects, meaning the buyout will go ahead.

The offering, which values the Chinese drug company at S$458 million ($318 million), will be the first successful take-private deal in Asia this year. However, the buyers had a good starting point since the company executives who have lined up with Morgan Stanley Private Equity Asia (MSPEA) in a consortium, already owed 76.6% of the company. Executive chairman Che Fengsheng who is the controlling shareholder of the holding company that owns close to 69% of Sihuan is supporting the buyout.

Following the buyout, the management will own 85%, while MSPEA will own the remaining 15%.

Because of the management's large existing shareholding, only $74.4 million is needed to complete the deal and according to the source, no new capital needs to be raised. MSPEA's share of the investment will be about $48 million. The private equity arm will make the investment through its third Asian fund, which has raised about $1.5 billion and is currently about 40% invested.

The deal became unconditional after the acceptance ratio reached more than 90% last week and the buyers chose to waive some other technical clauses. According to a source, the acceptance ratio has since risen to above 96%. The buyers intend to de-list the company and carry out a restructuring, although they haven't provided any specific information of what that restructuring may entail. They have said, however, that they currently don't have any plans to make major changes to the company's existing business, to redeploy the company's fixed assets or to lay off any of Sihuan's employees.

The consortium, through a company owned by MSPEA called China Pharma, made an offer to minority shareholders on August 24, saying it would pay 97.5 Singapore cents per share to buy them out. The price represented a 27.5% premium to Siuhuan's most recent closing price of S$0.765 and a 24% premium to the 30-day volume-weighted average price prior to the offer.

Not surprisingly, the share price immediately jumped to within a couple of cents of the offer price and has held there since amid thin trading. Yesterday, the stock closed at S$0.965.

In the offering circular issued in early September, the buyers noted that Sihuan operates in a competitive and highly regulated market where the government's implementation of healthcare reforms may present uncertainties for the industry and for the company's business. The company's growth is dependent in part upon its ability to develop new products for market entry, a process that is uncertain and where successful commercial results are not assured.

The buyers argued that privatising the company would give MSPEA and key management "additional flexibility to manage the company's business and allow [them] to make the necessary changes in strategy or investments without subjecting public shareholders to undue share price volatility."

The volatility in the share price is being exaggerated by the thin trading volume in the stock with less than 200,000 shares, or 0.04% of the issued share capital, changing hands on an average day over the past 12 months. Sihuan has been listed in Singapore since March 2007 and the offer will give the shareholders a "clean cash exit opportunity" to sell their entire investment at a 126% premium to the IPO price of S$0.43. The highest share price achieved since the listing was S$0.96, which the company hit in early October 2007.

Sihuan has a product portfolio of 38 drugs that covers a range of areas, including antibiotics, oncology and neurology. However, it specialises in the development and sales of drugs for cardiocerebral vascular disease - the second largest therapeutic area in China behind antibiotics. Its distribution platform reaches more than 4,000 hospitals across 30 provinces.

Investors are generally quite positive towards China's healthcare sector as government spending is still lagging well behind that in Western countries, implying significant growth potential as more money is directed this way. Other growth drivers include an aging population, urbanisation, and a rising disposable income. China's pharmaceutical market is the third largest in the world, and reportedly worth $118 billion. Other growth drivers.

DBS is advising China Pharma on the transaction.