Huge Chinese Pork IPO Fails

For the past couple of years, right up to the start of 2014, the sky was the limit for IPO filings. Investors couldn’t get enough of them, and couldn’t spend enough on them.

But over the past couple of months, the sky has been falling.

Yet another public offering has been cancelled due to a lack of investor interest. China-based pork producer WH Group withdrew what could have been the world’s largest IPO of the past 12 months.

What was the hang-up? “The whole team didn’t listen to the market carefully [on valuations],” a prominent shareholder admitted. Everyone, “from management to shareholders and the underwriters, miscalculated investor demand.”

WH’s cancellation is the latest in a string of bad news and disappointments from the IPO corner of the market.

Ever since King Digital Entertainment (NYSE: KING) — the maker of the popular Candy Crush online video game — broke the IPO winning streak with its 16% loss on its first trading day four weeks ago, the once on-fire IPO market has been put on ice.

Isn’t this what market bears have been warning us about? When we see the IPO market start to crack, isn’t it supposed to serve as a warning that the stock market as a whole is about to crumble around us?

What’s really behind WH’s cancelled IPO? What’s really going on in the IPO space in general? And horror of horrors… What’s going to happen to what many expect to be the biggest public offering in history – Alibaba?

WH Group Leaves a Bad Taste in Investors’ Mouths

It would help ease our fears immensely to know that the lack of investor interest in WH Group’s offering is more due to company specifics than it is to the broader market in general. There are a number of issues with the pork producer that have left a bad taste in investors’ mouths.

The first mistake management made was thinking that last year’s widely praised acquisition of Virginia-based Smithfield Foods would deliver the world to their feet.

It truly was a prudent and farsighted deal, tapping the largest hog producer and processor in America to supply the world’s largest pork demand in China.

With hog prices in the U.S. typically running at half the price in China – primarily due to cheaper corn feed in America – the acquisition gave WH a monstrous edge over its competition.

But management overestimated the reception of their $5.3 billion offering, which would have priced WH shares at roughly 50 times earnings. Yes, China is the world’s largest consumer of pork. And yes, WH is getting its pork at half the price. But even their worst priced competitor stocks are trading at 20 times earnings.

So the group cut its estimation of the company’s worth down to size, reducing their asking price by some 65%, slashing the amount sought to just $1.9 billion, bringing its earnings multiple in line with its competitors’, ranging from 15 to 20.

But they still couldn’t find enough interested underwriters even at that lower price. The 29 banks involved with the deal struggled to sell shares, with Singapore private-equity firm Government Investment Corp reducing its orders, while Chinese private-equity firm CDH and Goldman Sachs’ private-equity firm withdrew their plans to sell shares all together.

Why the trepidation? “The synergies between Shuanghui [WH Group’s previous name] and Smithfield are untested,” revealed Ben Kwong, associate director of Taiwanese brokerage KGI Asia Ltd, who has not purchased any shares. “Why do investors have to buy in a hurry? They would rather wait until the valuation is attractive.”

That’s another sour taste upsetting some underwriters… the company’s hurry. The Smithfield acquisition is not even 7 months old, with the newly amalgamated business model not satisfactorily tried and tested. WH may be in the hog market, but something about the IPO’s timing smells fishy. The rush to sell shares to the public seems to be born out of worry.

Ever since a hog disease that kills piglets broke out in the U.S. a few months ago, hog prices have been climbing – from 86 cents per pound in February to over $1.20 currently, a jump of nearly 40% in two months. That seriously undermines WH’s competitive edge, hence the rush to sell shares before the company’s profitability worsens.

But there’s more that makes investors feel hog-tied and taken advantage of – the awarding of a $597 million “bonus” to WH Group’s top two executives, Chairman and CEO Wan Long and director Yang Zhijun, in “recognition and reward for [their] contribution to the acquisition of Smithfield”, the prospectus declares. That $597 million bonus divided by the $1.9 billion to be raised equals 31.42% of the IPO going to the number one and number two men. Eating a little high on the hog?

In all fairness, the Smithfield operation does gross $13 billion a year in revenue. But the bonus becomes quite comical when you consider the IPO’s intent is to pay down debt incurred in the Smithfield acquisition, which grew the company’s total debt to over $7.4 billion. The bonus amounts to 8% of the company’s total debt, or 5% of Smithfield’s annual revenue.

After two weeks of order-taking, only roughly one-third of the amount allocated to the Hong Kong retail public – some 5% of the IPO – was bought, leading WH to cancel the IPO at this time, citing “deteriorating market conditions and recent excessive market volatility”.

Have IPOs Had Their Day?

While weakness in the IPO market can signal the depletion of investment capital, in today’s market of near historic low bond yields, we can’t really say that investment interest in IPOs has dried up. The hunt for yield and reasonable returns is still drawing investors to higher risk investments, including IPOs. They’re just getting a little more selective, that’s all.

Since King Digital’s IPO disaster on March 26th, the number of IPO failures and cancellations has indeed increased. On just day alone – April 11th – out of eight IPOs set to debut, four were postponed. Of the three IPOs placed last week, all are negative: Quotient Ltd. (NASDAQ: QTNTU) down 6.9%, Lombard Medical (NASDAQ: EVAR) down 9.1%, and Viggle Inc (NASDAQ: VGGL) down a whopping 27.5%.

But April has still had some stunning IPO successes stories, including: Sportsman’s Warehouse Holdings Inc. (NASDAQ: SPWH) up 12.7%, IMS Health Holdings Inc. (NYSE: IMS) up 16.7%, Phibro Animal Health Corp. (NASDAQ: PAHC) up 17%, Enable Midstream Partners LP (NYSE: ENBL) up 24.9%, GrubHub Inc. (NYSE: GRUB) up 26.1%, and Zoe’s Kitchen Inc. (NYSE: ZOES) up a stunning 84.9%.

Much of an IPO’s performance has to do with the price set by the underwriters the night before. If they get too greedy and ask for too much, the stock will plunge. So, really, an IPO’s success still rests with the companies themselves.

IPO Cherry Picking

What the recent ups and downs of the IPO market are showing us is that investors are getting finicky. They are no longer simply tossing everything at anything anymore, as evidenced by their recent rejection of WH Group.

If investors see a great deal, they’ll take it in any market, IPO included. And they’ll likely find the deal of the decade in Alibaba. More than just China’s top e-commerce company, Alibaba is a group of 25 e-commerce companies – with a complete e-commerce ecosystem from merchandising, to auctions, to coupons, to social networking, to e-payment systems – all precisely fitted together like a tightly woven net that will capture more business off the internet than any other web-based company in the world.

Demand for Alibaba’s shares is expected to be so high, the company recently announced it would release more, raising the size of its offer from a Facebook-like $16 billion to possibly well above $20 billion – within striking distance of the all-time record set by Agricultural Bank of China when it raised $22.1 billion in 2010.

So don’t let IPO failures like King Digital, or cancellations like the recent WH Group cause you to turn your back on all public offerings indiscriminately. Be selective, as there are still some great deals to be had from initial outings – with Alibaba poised to be one of the greatest of all.

Joseph Cafariello