Monday, November 15, 2010

Bain Gets a Break with Gome Truce

Bain Gets a Break with Gome Truce

Private-equity firm Bain Capital LLC can breathe a sigh of relief at the rare truce brokered in a war for control of China's best-known electronics retailer—and, for now, enjoy the returns on its risky investment in the company.

On Thursday, Gome Electrical Appliances Ltd. said it had reached an accord with its imprisoned founder, Huang Guangyu, to bring two of his representatives—his lawyer and his sister—onto the company's board. Shares of the Hong Kong-listed company jumped as investors saw the agreement as a sign the company would now be freer to focus less on corporate infighting and more on expanding the business. On Friday, the shares closed at 3.18 Hong Kong dollars (41 U.S. cents), up 17% from their level before the announcement.

The particular circumstances surrounding Bain's dealings with Gome and Mr. Huang are unique. But like other foreign private-equity players looking to profit from China's growth, Bain faces the challenge of exercising influence without actually having control. For private equity, China offers minority stakes at best, not leveraged buyouts.

All considered, Boston-based Bain has done well with Gome. Its roughly 10% stake, at least on paper, is now worth about US$684 million, or nearly three times the US$233 million it agreed to invest in June 2009.

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Huang Guangyu, shown in 2006
.Not bad, considering the guerrilla warfare Mr. Huang, 41 years old, has waged against Gome's current, Bain-backed management, all while being under arrest, and later imprisoned, for insider trading, corruption and bribery.

Bain's investment in 2009 was an unusually chancy move, given the uncertainty surrounding Mr. Huang. Gome's founder and biggest investor—he currently owns 32.47% of the company—quickly dashed any hopes Bain might have harbored that he would sit idly by while the private-equity firm set about improving Gome's operations and repairing the company's damaged brand.

In August 2009, while being detained by Chinese authorities, Mr. Huang participated in a rights offering, thwarting Bain's efforts to increase its stake. This past September, he called a shareholders' meeting in a bid to oust his former protégé, Chen Xiao, as chairman. Though shareholders blocked that move, they sided with Mr. Huang on another issue by preventing Gome from issuing new shares that would have diluted his holding.

But Bain had insurance of a sort. The convertible bonds it bought offered a 5% coupon and guaranteed it a return of at least 1.5 times its outlay. And while Mr. Huang was a wild card, Bain knew it had the support of the new chairman, Mr. Chen, as well as the board.

Gome is growing despite the management turmoil. In the first half, it said profit rose 66% from a year earlier to 962.3 million yuan ($145 million) on the back of a 22% jump in revenue amid a recovery in China's economy. Thursday's agreement prompted Nomura to raise its price target for Gome to HK$4.10, nearly 30% above Friday's close.

The truce with Mr. Huang looks fragile. The agreement noted that he had "no current intention" to nullify management contracts between Gome and hundreds of stores he owns that aren't part of the listed company. Earlier, he had threatened to cancel those deals if the management changes he sought weren't approved. That kind of language suggests he is keeping his options open should warfare resume. And Gome still has lawsuits pending against Mr. Huang in relation to actions taken against him by securities regulators.

For now, Bain will be hoping that Mr. Huang chooses to take to heart the words of Sun Tzu. In "The Art of War," China's great military philosopher advised those contemplating war to "let your object be victory, not lengthy campaigns." If Mr. Huang views victory as a rise in the value of his stake in Gome, letting Bain and Mr. Chen get back to work while Mr. Huang's new eyes and ears on the board provide constructive input is the way to go. If victory means kicking out the interlopers, Bain will have its hands full for some time.

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