NEW YORK, April 5, 2016 /PRNewswire/ -- The following is an open letter sent April 5, 2016 to the Board of Directors of China Cord Blood Corp (NYSE: CO) from Jayhawk Capital.
It is clear that the Board should accept a privatization offer only if ALL shareholders will receive the same $15+ per share ($6.40 in cash and $8.68 in Nanjiang Xinjiekou Department Store Co., Ltd. ("NXD") shares) at which Golden Meditech Holdings Co Ltd ("Golden Med") has agreed to sell its stake. China Cord Blood Corp ("China Cord" or the "Company") should be negotiating directly with NXD and no longer allow Golden Med to be the go-between whose sole intent is to take all the profit for itself.
The pattern of taking value away from shareholders of China Cord has become standard practice. Consider the convertible bonds issued in 2012 to KKR and then to Golden Med at low prices, thus diluting the existing minority shareholders. The proceeds from the bonds were never needed or used, and the bonds ultimately eliminated $525 million of value for China Cord shareholders (based on the value Golden Med is receiving for them from NXD).
Consider too the share-based incentive compensation for management adopted by the Company in December 2014 whereby nearly 10% of the outstanding shares of China Cord are to be awarded for hitting modest growth targets management was already expected to meet. Golden Med has announced plans to vest these shares immediately as part of the NXD transaction, despite only being one year in and despite even those modest incentive goals not being reached. This will cost shareholders over $100 million (7,080,000 shares x ~$15 per share). Self-interested transactions like these must stop immediately. However, the privatization effort by Golden Med is clearly another disaster waiting to happen for China Cord's minority shareholders.
China Cord has been performing strongly and is expected to continue to do so as the effect of the Chinese Government relaxing the one-child policy begins to be felt more dramatically. China Cord is generating cash of approximately $25 million per quarter and has $440 million of cash on the balance sheet. Furthermore, profit guarantees included in the NXD agreement indicate profits of at least $46 million in 2016, $56 million in 2017 and $67 million in 2018. Assuming the convertible bonds are redeemed by using cash on the balance sheet, these profit guarantees would suggest a stock price of $35 per share (40 P/E x $56mm / 73mm outstanding shares, + cash). If China Cord had not issued the convertible bonds or share-based compensation or dilutive secondary transactions and bought back shares using the cash generated during the previous six years as Jayhawk repeatedly suggested privately and publicly, the stock price could be approximately $90 per share (40 P/E x $56mm / 25mm pro-forma outstanding shares).
NXD has purchased 75% of the Shandong cord blood bank for about $1 billion. China Cord owns the other 25% of the Shandong cord blood bank license plus 3 others: Beijing, Zhejiang and Guongdong. These three wholly-owned licenses are fully operational with larger population bases and should theoretically be valued higher. But applying the valuation of the Shandong license to China Cord's licenses would make the stock worth $67 per share, assuming the convertible bonds are redeemed by using cash on the balance sheet. If China Cord had not issued the convertible bonds or share-based compensation or dilutive secondary transactions and bought back shares using the cash generated during the previous six years as Jayhawk repeatedly suggested privately and publicly, the stock price using this metric would be well above $100 per share.
As publicly disclosed by NXD, both the Shanghai Stock Exchange (on January 20, 2016) and China Securities Regulatory Commission ("CSRC") (on March 14, 2016) have made inquiries on a number of topics related to the proposed transactions between NXD and Golden Med, including a request for an explanation of why the shares Golden Med already owns are valued at $15+ per share, while the minority shares are valued at only $6.40. The CSRC also requested an explanation of the share-based compensation and for the large cash balance so it appears they are also aware these are unusual and unnecessary. Also included are several requests related to how fiduciary duties under U.S. and Cayman laws are being met and how they are addressing the risks of minority shareholder lawsuits related to the transactions.
One of the principal fiduciary duties of the Special Committee is to evaluate the Golden Med offer and require that each shareholder of China Cord be treated fairly. Acting in the best interest of China Cord does not mean acting solely in accordance to the wishes and interests of China Cord's majority shareholder. If the Special Committee allows the actions taken by the executive board of China Cord and its majority shareholder, Golden Med, to go unchecked, the members of the Special Committee will effectively be breaching their duties as directors. The Special Committee should also have negotiated with Zhongyuan Union Cell and Gene Engineering Corp, which indicated a willingness to bid for the Company at similar prices to NXD. The interests of all shareholders must be considered. Failure by the Special Committee to negotiate and reach a price reflecting fair value for all shares in China Cord will be challenged in the courts. The Special Committee should investigate the facts outlined above (e.g. the convertible bonds issued in 2012 and the share-based incentive compensation for management) and seek fair value for all shareholders of China Cord. The Cayman Islands Court in the Integra decision has held that fair value is a value that is "just and equitable" and provides adequate compensation consistent with the requirements of justice and equity.
Neither the Cayman Islands Court nor the United States Courts will uphold the actions that have been taken by China Cord and its majority shareholder which effectively perpetrate a systematic fraud on minority shareholders.
NXD has made multiple international acquisitions and has appeared to act in a professional and ethical manner. The Special Committee could and should be negotiating directly with NXD for a sale of 100% of China Cord for the same cash plus stock deal Golden Med is receiving. This would provide the minority shareholders the opportunity to participate in the continued success of China Cord if the stock price of NXD appreciates as expected. As part of discharging its fiduciary duties, the Special Committee should evaluate and pursue competing offers and require equal treatment for all shareholders. For the Special Committee to allow Golden Med to hijack the process to keep all the profits for itself would be an appalling breach of fiduciary duties.
Michael D. Schmitz
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SOURCE Jayhawk Capital