Pipes, but not of peace

Hostile takeover could create a gas giant. But will it break monopoly law?

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23 Mar 2012
Week in China

Thinking about the years leading up to the global financial crisis, M&A bankers tend to go misty eyed. Between 2005 and 2007, at least $1.6 trillion worth of leveraged buyouts were completed, says research firm Preqin, as cited by Bloomberg.

All of this came to an abrupt end, when the credit that fed the deals dried up.

But are there signs that the buyout boom could be back in vogue at state energy giant Sinopec?

Alongside private gas company ENN Energy Holdings, Sinopec has been working on a HK$25.5 billion ($3.3 billion) offer for China Gas Holdings, a gas pipeline operator. The bid values the target at 11.3 times earnings, the highest valuation for a cash acquisition of a pipeline or gas company since 2006, according to Bloomberg.

Offering shareholders HK$3.50 a share, ENN will pay 55% of the total, with Sinopec covering the rest.

The potential acquirers see different benefits in the deal. For Sinopec, it is an opportunity to move into downstream gas distribution at a time when it is signing up for long term natural gas contracts overseas.

Plus there’s the prospect of grabbing business from a major rival. Up to 80% of the gas pumped into homes by China Gas is sourced from PetroChina. Completing the deal would put Sinopec in a better position to become the main supplier.

ENN controlling China Gas is not acceptable because it can be understood as a small fish eating a large one.”

For ENN, the buyout is about creating a domestic gas powerhouse. The combined company would have 77 piped gas networks, accounting for more than 25% of the national total, well ahead of the 9.4% share held by its nearest rival, reports Guangming Daily.

The newspaper also voices concerns that the creation of such a large company could be anti-competitive, and the Ministry of Commerce has started an assessment of whether the deal falls foul of China’s monopoly laws.

An anti-trust ruling is not the only potential hurdle. There is also opposition from staff at China Gas, where 5,500 employees have signed a petition against the buyout. Nor is the China Gas board very keen, having continued to object to “a totally uninvited hostile takeover” since rejecting the first bid made late last year. This week it was still expressing its opposition “in the strongest terms” on news that the bidders were extending the deadline for negotiations to mid-May.

China Gas executives seem especially miffed by ENN’s involvement.

“ENN controlling China Gas is not acceptable because it can be understood as a small fish eating a large one,” a China Gas executive told Capital Week.

In 2010, China Gas had total assets of HK$30.9 billion, compared to ENN’s HK$23.1 billion.

ENN says it will finance the purchase through a combination of bank loans and its own cash. Rating agency Moody’s was cautious, noting that ENN’s debt would “significantly increase” although only a “minimal amount of cash flow” would be added,
reports Bloomberg.

That presupposes the initial bid proves enough for the takeover to go through. China Gas shares closed in Hong Kong at HK$3.76 on Monday, significantly higher than the offer price. If more needs to be offered, one option is for Sinopec to increase its own share of the bid. But its participation in the buyout is already controversial. Why? Because China’s market reformers see the gas sector as one of their success stories. Since deregulation in 2002 there has been a welcome infusion of private sector competition.

Sinopec’s attempt to enter the gas distribution market is viewed as another example of guojinmintui (‘the state advances as the private sector retreats’), a trend where government firms push their way into industries at the expense of their private sector rivals. That makes the timing particularly interesting. In recent weeks support for the guojinmintui policy seems to have dwindled, with the market reform faction regaining some of the political initiative (see WiC140). That could make it harder to get the deal approved.

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