TPG runs rings around Li Ning shareholders

TPG is running rings around shareholders in Li Ning. The buyout firm has renegotiated the terms of a convertible bond it bought from the Chinese sports brand a year ago, and agreed to underwrite a deeply discounted capital raising. The deal leaves other investors in second place.

TPG got generous terms when it first came to Li Ning’s rescue in January 2012, along with Singaporean state investor GIC. For $121 million they received bonds paying a 4 percent coupon, convertible into Li Ning shares at HK$7.70 - a slight premium to the market price at the time.

For Li Ning’s board, that probably seemed preferable to raising regular debt. Crucially, however, TPG and GIC also negotiated the right to veto significant capital raisings, and a pledge that Li Ning wouldn’t increase its borrowings beyond three times EBITDA.

Since then, Li Ning’s performance has gone from mediocre to bad. The chief executive was ousted in July, and in December the company announced a potential $290 million charge for cleaning up unsold stock. Worse, by July, debt had blown out to 3.5 times annualized EBITDA, breaching the terms of the convertible bond.

That leaves Li Ning over a barrel. The company is raising $240 million through an offering of new instruments convertible into shares, underwritten by TPG and the company’s founder. But in order to get TPG and GIC’s approval, Li Ning has been forced to lower the conversion price on the duo’s existing convertible bonds. These can now be exchanged for shares at HK$4.50, a chunky 27 percent discount to the closing price on Jan. 23.

TPG looks clever. But the lowered conversion price suggests the buyout firm doesn’t have much faith in Li Ning’s turnaround, even though it controls two board seats. The decision to issue new securities that have most of the financial perks of equity, but trump regular shareholders if the company goes bust, is equally discouraging.

Other investors should feel aggrieved. They didn’t get a vote on last year’s deal, having already given the board the power to issue masses of new stock. They also don’t get to vote on adjusting TPG and GIC’s convertibles. The best they can do to avoid being diluted is to participate in the latest offering and hope that TPG’s turnaround plan has legs.