On Tuesday, Morgan Stanley Private Equity Asia, a wing of Morgan Stanley (MS), announced its plan to invest $50 million in Yongye International Inc. (YONG), a Beijing-based leading agricultural nutrient company.
As per the terms of the agreement, Morgan Stanley unit will purchase $50 million worth convertible preferred share of Yongye at an initial conversion price of $8.80 per share. The conversion price could trend up or down on the basis of Yongye’s cumulative net income between 2011 and 2014. However, the price can climb up to a maximum of $15.00 per share.
Morgan Stanley also stated that the convertible preferred shares would be automatically converted into common stock after 5 years. Additionally, the holders of the preferred stock would get paid-in-kind dividend at an annual rate of 3–7%. They will also be able to get common stock dividend as and when the conversion takes place. The deal, still subject to customary closing conditions, is expected to close on June 10, 2011.
Further, Morgan Stanley will also have the right to obtain Yongye’s additional common stock in case Yongye fails to deliver certain net income targets and starts dilutive corporate actions.
Yongye is expected to utilize the proceeds of the deal to increase its capacity, repay its commercial bank debt, and address other general corporate purposes. The proceeds will also boost Yongye’s balance sheet and help meet the increased demand for its products.
Morgan Stanley’s unit head Mr. Homer Sun stated that the company had decided to invest in Yongye after proper due diligence. The company also believes that Yongye is an exceptional company with a significant brand name in China’s agricultural industry. Further, in relation to the transaction, Mr. Sun will be joining Yongye’s board of directors.
However, Morgan Stanley’s decision to invest in Yongye comes as a surprise to the financial industry. Over the last few months, various institutional investors have moved away from the Chinese small-cap companies that allegedly have links to a fraud scandal. The Securities and Exchange Commission (SEC) is investigating the scam, and at least 18 Chinese stocks trading on the U.S. bourses have been either put under a trading halt or de-listed.
However, we believe that Morgan Stanley’s investments in Yongye will be a sound one. With nearly $1.8 billion invested in Asia, the company has mainly targeted controllable buyouts in profitable growth-oriented companies and highly structured minority investments. This deal would not only enhance Morgan Stanley’s market share but would also provide the company with an investment avenue in the lucrative Chinese market.
Morgan Stanley currently retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating, while Yongye has a Zacks #5 Rank, implying a short-term ‘Strong Sell’ rating.
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