Shanghai RAAS is a company that investors "love and hate", as one of the largest blood product companies in China today, Shanghai Caishi's operating income in 2022 will be nearly 6.6 billion yuan, ranking first among its peers with state-owned background, but those who are familiar with this company also know that its growth path is far more bumpy than that of ordinary companies, it took only 3 years to quickly grow from a little-known small company to a blood product leader with a market value of 100 billion, but in just a few weeks in 2018, It has experienced 11 consecutive falling limits, and the market value of 100 billion yuan has fallen by 6%, and it has not fully recovered its vitality.
On November 13, 2019, after the review of the 59th working meeting of the Mergers and Acquisitions and Reorganization Committee of Listed Companies of the China Securities Regulatory Commission in 2019, the major asset restructuring project of Shanghai RAAS was approved, and in March 2020, the restructuring was officially completed.
In the restructuring transaction, Shanghai RAAS purchased 40 outstanding Series A ordinary shares and 50 outstanding Series B ordinary shares of GDS held by Grifols by way of issuing shares, totaling 45% of GDS's equity. The transaction price is 19$2.6 billion (about 13.2 billion.)4.6 billion yuan). In addition, Grifols undertook in the transaction that GDS's cumulative EBITDA for the period from January 1, 2019 to December 31, 2023 would be no less than US$1.3 billion, and that if GDS experienced a decline in net profit due to a significant impairment of goodwill, Grifols would compensate in cash for the portion of the accumulated net profit that was less than the profit compensation commitment. Upon completion of the transaction, Grifols holds 2620% shares, becoming the second largest shareholder of Shanghai RAAS, Shanghai RAAS holds 45% of GDS shares of Grifols Holdings, becoming the second largest shareholder of GDS.
As a landmark case, the market has been talking about it for many years, and by March 2024, the completion of the restructuring will be 4 years old, and the performance commitment for GDS for the 5-year period will expire on December 31, 2023. Now when we look back again, for Shanghai RAAS, how should this deal be evaluated? Whether the performance commitment can be truly and effectively fulfilled, whether the impairment test of the huge goodwill during the performance commitment period is true and fair, whether the valuation of GDS as the only foreign asset harvested in the transaction is reasonable, and whether the restructuring fully protects the interests of small and medium-sized shareholders, all of the above are the work of major intermediaries (including sponsors, auditors, appraisers, etc.), including regulators, which are now being tested by the market, and all parties are waiting to see.
The logic of GDS industry integration has not yet been fulfilled, whether it is falsified
GDS is a global leader in nucleic acid testing, mainly producing and selling blood testing reagents and instruments. It belongs to the upstream ** business of Shanghai RAAS. GDS is the most important asset harvested by Shanghai RAAS in the restructuring, and on the surface, it is also an industrial integration merger and acquisition with industrial logic, but as of now, the cooperation between Shanghai Caishi and GDS is still in the first sales link, mainly selling GDS nucleic acid detection equipment and reagents, and the sales scale is relatively small, which has a weak impact on the overall performance of the company at this stage, and the relevant ** sales amount in the company's revenue structure in 2022 is about 61.04 million yuan, accounting for only 093%, and the amount of related party transactions with GDS is 88.2 million yuan, which is also insignificant in terms of scale. Nearly four years have passed since the restructuring, but the logic of industrial integration mentioned by the company at that time seems to be difficult to fulfill.
Be wary of high stakes implicationsGoodwill
Putting aside the logic of industrial integration, the most critical contribution of GDS to Shanghai Caishi after the restructuring is investment income. GDS in the 2020-2022 period respectively brought 55.3 billion, 52.5 billion and 39.2 billion investment income. The proportion of net profit attributable to the parent company in the current year reached % and 21% respectively, showing a significant downward trend, and the sustainability and stability of this part of the performance will also be the key influencing factors for the stability of Shanghai RAAS's future performance.
According to the appraisal report at that time, the appraisal agency's overall valuation of GDS was US$4.3 billion (about 296 yuan), an increase of nearly US$2.9 billion (about 20 billion yuan) relative to the book value of net assets of US$1.4 billion, with an appreciation rate of nearly 215%.
GoodwillAs of September 30, 2018, the carrying value of GDS goodwill was approximately RMB20.2 billion.
More than twice its net worth. With the vast majority of the company's assets being goodwill, and such a high appreciation rate, the asset quality of GDS is worrying. So how will the impact of these goodwill on Shanghai RAAS be reflected?
First of all, after the reorganization, GDS is still a consolidated subsidiary of Grifols, and its goodwill will not be directly reflected in the balance sheet of Shanghai RAAS, but will be accounted for by the equity method for the long-term equity investment account of Shanghai RAAS, and Shanghai RAAS will account for the current investment income and adjust the book value of the long-term equity investment according to the net profit and loss of GDS in the income statement every year. If the goodwill impairment of GDS occurs, it will directly affect the net profit of GDS, which will then be reflected in the investment income of Shanghai RAAS. Between the scale of GDS's goodwill, the impact of goodwill impairment on Shanghai RAAS may even far exceed the previous "** thunderstorm event, after all, GDS nearly 20 billion yuan of goodwill 45% of 9 billion yuan, and Shanghai RAAS in 2017" ** the craziest time ** is only 3.1 billion yuan, the stock price still has the possibility of fluctuating up and down, but goodwill in the absence of disposal, especially combined with the rapid deterioration of GDS in the past two years, almost sooner or later will face impairment.
Obviously, the scale of GDS's goodwill can have a huge impact on the company's profit and loss, and investors are often afraid of such a company", so we might as well dig out, how is the goodwill of GDS formed, and what are the hidden interests in the formation of goodwill?
Of GDS's nearly $20 billion goodwill, 90 percent was formed by GDS's acquisition of Novartis' diagnostics business in 20144.2 billion yuan of goodwill and 107$4.6 billion goodwill.
Novartis Diagnostics was initially acquired by Grifols in 2013 and subsequently transitioned to GDS. According to public information, the acquisition consideration of Novartis' diagnostic business is about 16US$500 million, the fair value of net assets is approximately US$300 million, and the goodwill is recognized to be approximately US$13US$500 million, with goodwill accounting for more than 80% of the consideration. Another acquisition of Horojet's nucleic acid testing business generated more than $10 billion of goodwill, accounting for nearly 80% of the consideration.
This means that GDS can recognize a relatively low valuation of intangible assets at the time of acquisition, and can avoid excessive amortization of intangible assets to eat into profits in the following 3 to 5 years, but over time, goodwill will become a knife hanging over its head.
In fact, it is always inevitable to generate goodwill in mergers and acquisitions, and it is normal for acquisitions to expand and seize market share, so as long as the scale of goodwill is within a reasonable range, investors do not need to worry too much. If you compare the goodwill scale of GDS with the comparable companies selected by the appraiser, you may get a better idea of the scale of its goodwill. The goodwill to net assets of GDS at the base date is 217%, and the following table shows the ratio of goodwill to net assets of comparable companies screened by appraisers. The median is about 46%, which is significantly lower than the level of GDS.
Figure 1: Goodwill as a percentage of net assets of comparable companies.
Through the above analysis of the implied goodwill of GDS, it is not difficult to find that goodwill to a certain extent contains the company's trade-off between short-term interests and long-term development, which is not a problem under the premise of bright industry prospects and continuous business growth.
The valuation process is restrictedThe authenticity and reasonableness of GDS valuation are questionable
Based on the above analysis of implied goodwill, it is not surprising why GDS's poor asset quality can still be valued at US$4.3 billion (about 296 yuan), an increase of nearly 215% relative to its net assets. Regardless of the considerations of the parties to the transaction at that time to reach an agreement on this consideration, according to the standards, the appraiser should analyze the authenticity and reasonableness of the valuation corresponding to the consideration, so we may wish to conduct an in-depth review of the evaluation report of GDS at the time of restructuring, and investors can also have their own judgment on the reasonableness of the results.
According to the "Accounting Regulatory Risk Reminder No. 5 - Equity Transaction Asset Evaluation of Listed Companies" issued by the China Securities Regulatory Commission, under the premise of continuous operation, in principle, more than two methods should be used for evaluation, and in the case of low applicability of the asset-based method, Appraisers should use both the income method and the market method to cross-verify the valuation results, but this time Zoomlion only used the market method.
After a careful reading of the valuation report, the description of the methodology includes the following statement: GDS's disclosure of information is subject to the relevant requirements of the signed commercial confidentiality agreement and the ** regulations for Grifols. The disclosure of confidential information may have a significant adverse impact on the business development of GDS and the cooperative relationship with its business partners. In order to promote and safeguard the long-term interests of the relevant parties, the two parties to this transaction have reached an agreement based on the actual situation, and the valuer can only perform the verification procedure to a limited extent, and at the same time, based on the discussion with the client, taking into account the extent of possible information, this valuation adopts the market method for Grifols Diagnostic Solutions IncThe equity of all shareholders is calculated. "Zoomlion's appraisers are forced to use the market method for valuation because of the limited complete valuation process and the inability to obtain the required information, and cannot use the income method to cross-verify the results.
Comparable companies are questionable.
The appraiser chose the comparable listed company multiplier method in the market approach for valuation, which is arguably one of the least informative valuation methods among traditional valuation methods. Although the relative income method is closer to the market, and the valuation results can better reflect the value of assets in the public market, this method is too simplistic and crude", and the reliability of its valuation results is extremely dependent on the comparability of comparable companies, and the appraiser needs to have a deep understanding of the target company's own business and the industry in which it is located to ensure the comparability of comparable companies.
In this evaluation, Zoomlion selected as many as 12 comparable companies based on the following screening criteria: 1) European and American markets were selected according to the business scope of the evaluated enterprises, including Western Europe, North America, traditional developed countries such as Australia and New Zealand; 2) Listed companies in the healthcare industry under the Global Industry Classification Standard (GICS) and with a similar main business to the valued enterprise are selected as comparable companies; 3) Eliminate companies with incomplete data.
The number of comparable companies is as many as 12, which is relatively rare in the evaluation project, in fact, it is very difficult to find comparable companies with the same operating characteristics in the screening of comparable companies, and often the greater the number of comparable companies, the worse the homogeneity and the weaker the comparability. The similarity of the main business between companies is a key factor in comparability. Most of the comparable companies have a much richer business than GDS, such as Abbott, which has four business lines: diagnostics, medical devices, nutraceuticals and pharmaceuticals, and blood screening is only one part of its diagnostics business; Thermo Fisher Scientific also has four major businesses: Life Sciences, Analytical Instruments, Biopharmaceuticals and Diagnostics, of which Diagnostics is the smallest business. Zoomlion compares GDS, which is not a high-growth and low-value-added blood screening industry, with a leading enterprise in the IVD industry with broad prospects and rich business, and its rationality is debatable.
Figure 2: Comparable Company Value Coefficients.
If we look directly at the value multiplier values of comparable companies, although the appraiser calculates the mean, median and midpoint of the interval respectively, and the values of the three are relatively close, it can be found that the smallest of them is 106 times, the maximum is 412.To a certain extent, such a large difference also reflects the huge differences in the growth, operational risk, financial risk and other factors of these 12 comparable companies, and it is worth considering whether the practice of directly erasing the difference by removing the extreme value and taking the mean is rigorous and reasonable.
Figure 3Comparable Company Value Multiplier Statistics.
In general, the appraiser's selection of comparable companies is debatable, and inappropriate screening of comparable companies will seriously affect the reasonableness of the valuation of the target company, and in this case, there is a possibility that the value of GDS will be overvalued.
The rationale for using the market approach alone is questionable
Compared with the high dependence of the market method on the comparability of comparable companies, the income method pays more attention to the value creation mechanism of the enterprise itself, which helps the valuer to build an orderly analytical framework to understand the process of enterprise value creation, such as the growth rate and profit margin of operating income depend on the market prosperity of the company's industry and the company's competitiveness in the industry, etc., and the future capital expenditure and R&D expenditure required by the company to maintain competitiveness also need to be accurately measured, and various factors are presented in the form of cash flow. Finally, it is translated into the valuation of the company, so that it is relatively easy to avoid the bias of valuation results caused by the high dependence of the market method on the comparability of comparable companies.
It is not difficult to find that the number of parameters required and the corresponding basis for the income method is far greater than that of the market method, and it can better reflect a company like GDS with mature business but strong uncertainty about the realization of growth prospects. In the case of the income method, the regulator can judge the reasonableness of the valuation results relatively more effectively through the review and inquiry of various parameters and logic. Combined with the appraisal report, the appraiser was limited by the inability to obtain sufficient information about the target company, and the appraisal process was limited, so the market method was used for valuation. Whether this is simply due to the commercial confidentiality agreement signed between GDS and the partner, or because the parties to the transaction have concerns about the valuation results, it is difficult to meet the needs of the first easy consideration and respond to the review of the working paper by the regulator in the case of the income method, this issue needs to be considered by investors.
The scale premium overestimates the value of GDS
In addition to the selection of the two valuation methods of the market method and the income method and the selection of comparable companies, the process of using the market method of valuation also involves individual parameter adjustments, which will have a significant impact on the valuation results, for example, the size premium is one of the parameter adjustments that appraisers usually need to implement when using the comparable company multiplier method.
The size premium was proposed by the American economist Banz in 1981. Most people will consider the size premium when using the income method to calculate the CAPM, but choose to ignore it when using the comparable company multiplier method, in fact, this adjustment will also have a huge impact on the valuation results of the market method.
The chart below shows the market capitalization of the 12 comparable companies selected by Zoomlion at the base date, with a median market capitalization of US$34,610 million, with most of them far exceeding the net assets of GDS of US$1,365 million, with only Neogenomics being close. However, in the face of such a disparity, Zoomlion did not make corresponding scale premium adjustments to the multipliers of comparable companies. The CSRC had sent an inquiry to Shanghai RAAS on this issue in the restructuring review, and Zoomlion's reply was that the operating conditions of the target company were not weaker than the average level of comparable companies, and the EBITDA as the base of the market method multiplier had already reflected the difference in scale, so it was reasonable not to make more quantitative parameter corrections. However, Zoomlion did not carry out any quantitative analysis of the above logic as a support, and did not reflect sufficient persuasion.
Figure 4Market capitalization of comparable companies on the base date.
The chart below shows a scale-premium adjusted comparison of comparable company EV EBITDA, and the adjusted value multiplier (median 16.)99) to be significantly smaller than before the adjustment (median 21.)90), and the valuation of GDS has also changed significantly, from the original $4.3 billion to about $3.4 billion, with a valuation difference of nearly $1 billion, which partly reflects the excess size risk that investors will take based on the smaller size of the target company, but this is obviously not reflected in the appraiser's original valuation.
Figure 5Comparison of the scale premium adjustment for the value multiplier.
Note: The adjustment method of scale premium is to obtain the capialzation rate by taking the multiplier of comparable companies, and the capitalization rate also represents the yield and risk to a certain extent, and then the difference in the scale premium corresponding to the target company and the comparable company is considered in the capitalization rate (the numerator and denominator need to be further adjusted for EV EBITDA), and the angle number is re-taken to obtain the adjusted multiplier.
Figure 6: GOS valuation adjusted for size premium.
Sum up. Through the in-depth interpretation and analysis of the GDS valuation report, the appraiser's practices in the selection of valuation methods, the selection of comparable companies, and the adjustment of scale premium are debatable, resulting in the possibility of overestimating the market value of GDS in the valuation results.
In fact, the actual operation of GDS in the past three years has also made the best confirmation objectively. Thanks to the surge in demand for nucleic acid testing during the new crown epidemic, GDS's performance has increased significantly, but with the relaxation of epidemic prevention policies, its operating situation has deteriorated rapidly, and the growth rate of operating profit in 2021 and 2022 will be -1893% with -2988%, the revenue of the NAT nucleic acid business line, which accounted for 60% of the revenue in 2022, fell by 32%, even excluding the impact of the new crown epidemic and Zika testing, the revenue of this business line still fell by nearly 10%, not only that, but the revenue of the recombinant protein business line also fell by nearly 6%, although the blood group testing business line increased, the total operating income still fell by nearly 18%, and the situation in 2023 is also not optimistic, and its operating profit continues to decline. Operating income in the first half of 2023 decreased by 62%。It is not difficult to see that with the disappearance of nucleic acid testing dividends, the growth of GDS business has been greatly challenged, and it is obviously difficult to support its high valuation at that time, and the risk of huge commercial impairment has actually been "imminent", the Shenzhen Stock Exchange has been inquiring about the goodwill of GDS for several years, although GDS has conducted a goodwill impairment test implemented by a third-party appraisal agency every year, and reviewed by KPMG, but we are all aware of Grifols Group as the client, It is possible to exert pressure on appraisal and audit institutions to delay the occurrence of impairment and maintain the valuation level of GDS as much as possible until this "burden" is thrown off, so it needs to attract special attention from the majority of investors.
The safety of GDS funds is in doubt
Not only does the GDS itself contain risks, but the Grifols Group has not played an active role as a controlling shareholder in the past few years. After the restructuring, Shanghai RAAS received 55.4 billion yuan, 52.5 billion yuan, 39.2 billion and 1The investment income of 9.4 billion yuan accounted for % and 21% of the net profit attributable to the parent company of the year, respectively, but it should be noted that these investment income is still only book profit for Shanghai RAAS at present, not real cash flow. The Grifols Group has set up a cash pooling program for many years, into which the cash of the Group's subsidiaries is usually managed and distributed by Grifols, and each subsidiary of the Group is deposited and withdrawn according to its own needs. Over the years, GDS's net profit has declined much slower than its operating profit. The interest income from the pooling program is a key factor. In the first half of 2023, GDS's interest income is nearly US$33 million, and it is expected to be nearly US$65 million for the whole year, combined with GDS's cumulative EBITDA of about US$1.3 billion in the past five years, but no cash distribution has been made, it is reasonable to guess that these cash may be injected into the pool to provide liquidity for the entire group, and GDS will receive interest income of about 5% per year 。
Here we have to mention Grifols' own financial situation, which is currently 12904%, due to the decline in business growth in recent years, the turnover rate is deteriorating, the working capital has continued to increase in the past five years, and the company's cash flow situation is not happy. Grifols announced in February 2023 a cost mitigation plan that expects savings of around €400 million in 2023 and the loss of around 2,300 jobs worldwide, in the fourth quarter of 2022. Grifols has closed and restructured some of its underperforming centers to improve efficiency and reduce costs. Due to the deterioration of the group's financial situation, Grifols, as the controlling shareholder, "cleverly used the liquidity pool" to occupy a huge amount of GDS's funds for acquisition and expansion, but the risk was left to the entire GDS owners, which inevitably raised concerns about the financial safety of GDS. In addition, it is foreseeable that the interest rate hike cycle in the United States has come to an end, and there is a high probability that it will enter the interest rate reduction channel in 2024, and the decline in interest rates will directly affect the interest income of GDS, and then the investment income of Shanghai RAAS, not to mention that nearly half of these cash belongs to Shanghai RAAS, but it is occupied by Grifols all year round.
The Window closes, how Shanghai RAAS "broke free from the quagmire".
Whether you have been "accompanied" by Shanghai Caishi for many years, or attracted by this "milestone" merger and acquisition, everyone must expect this "fateful" company to get better and better, and one day return to the "leader" position of blood products. What this article does is to reveal to investors the core risks left over from the restructuring of Shanghai RAAS from the valuation, goodwill, capital security and other aspects of GDS, and hope to arouse the attention of the company's management, major intermediaries and regulators involved in the restructuring, and even the management of Grifols to this core risk.
For Grifols, GDS is indeed close to meeting its performance commitments on time and in full. However, we have also seen that major risks such as goodwill impairment and capital security have been forcibly suppressed and hidden, and the continuous decline of GDS's core business has become obvious, while the huge goodwill is still stuck on GDS's balance sheet. It's not hard to guess. As long as Grifols succeeds in Shanghai RAAS in the future, it will be able to really drop the "time bomb" of GDS to Shanghai RAAS, and the subsequent "thunderstorm" will ultimately damage the interests of all A-share shareholders, and Grifols will naturally have nothing to do with Grifols on the NASDAQ. However, as such a significant restructuring case, should we also question whether the major intermediaries involved in this restructuring, including sponsors, independent financial advisers, auditors, appraisal agencies, law firms, and even regulators, have fulfilled their responsibilities, whether they have conducted due diligence, valuation, review and approval of the project fairly and rigorously, and whether the interests of minority shareholders have been reasonably and legally protected.
At this point, the settlement of the performance commitment is "imminent", and Grifols' ** plan is also "ready to go", but in this important final "window period", we still have the opportunity to see that these issues are properly handled, whether the assessment agency can professionally and independently implement the 2023 GDS impairment test, whether the audit agency can be rigorous and responsible, and whether the major intermediaries and regulators can attach great importance to and supervise the follow-up treatment of these risks. And whether Grifols can truly demonstrate the ethical standards of a global leader in the blood products industry, and fulfill its due business responsibility?
As the "window" gradually closes, the final moment to solve these problems has arrived, and the market is full of worries and expectations, so let's wait and see.