In a significant move within the Chinese market, Bai'ao Chemical (603360.SH) has taken a major step towards diversifying its business operations by planning to acquire an entity in the semiconductor sectorThis strategic decision marks a pivotal shift for the company, which primarily focuses on the manufacturing of industrial biocidesBy engaging in this acquisition, Bai’ao Chemical aims not only to create a second growth trajectory but also to facilitate its own transformation in the rapidly evolving technology landscape.

Significantly, the signs of Bai'ao Chemical's entry into the semiconductor domain had already begun to materialize earlier this yearThe backdrop of this acquisition involves a strategic interplay among the company, the former controlling shareholders of the target acquisition, and existing stakeholdersThe transaction has captured the attention of the stock exchange regulators due to its complexity

The target company, known as Xinhui Lian, has reportedly seen a resurgence in profitability following an asset restructuring and a business expansion, although the identity of its new clients remains shrouded in mystery.

The acquisition plan devised by Bai'ao Chemical encompasses a two-phase approachInitially, the company intends to inject capital into Xinhui Lian via a fully owned subsidiary, valuing the pre-investment equity at around 800 million yuanBai'ao's investment is set at approximately 700 million yuan, thereby acquiring 46.67% of the target company’s equity and obtaining voting rights over an additional 8%, culminating in control over 54.63% of the voting power.

Following the initial investment, Xinhui Lian plans to spin off a new entity that will inherit its wafer bonding machine assets—an area expected to struggle with profitability in the short run

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The valuation for this new venture is capped at 700 million yuan, and Bai'ao Chemical is prepared to invest up to 100 million yuan in this new entity, further solidifying its stake in the semiconductor industry.

The groundwork for this acquisition was laid earlier this year when Bai’ao Chemical and Xinhui Lian signed a cooperation agreement focusing on the semiconductor equipment business in FebruaryThis agreement enabled Bai’ao to utilize its own funds to purchase semiconductor equipment through Xinhui Lian, which is responsible for remanufacturing and upgrading the equipment before reselling itThis strategic partnership served both entities well, creating a synergistic relationship that seemed mutually beneficial.

By May, the discussions progressed, leading to a preliminary agreement between Bai’ao and Xinhui Lian's actual controller, Liu Hongjun, concerning equity investment

This was not merely a financial transaction but was underscored by Xinhui Lian's aspirations to realize its capital market dreamsXinhui Lian, established in 2019, initially aimed for a public listing based on the "Fifth Set of Standards," forgoing short-term profitability in favor of long-term growthIt garnered support from notable financial institutions, including Dongzheng Capital and Longding Investment.

However, the shifting tides in the capital market proved challenging for Xinhui Lian as regulatory attention heightened concerning profitability in the semiconductor sectorWith difficulties in securing a clear path towards listing, Liu Hongjun faced substantial challenges, notably the pressure of maintaining profitability while managing the exit of existing institutional investorsReports suggested that several of Xinhui Lian's investments experienced freezing and subsequent unfreezing of shares, hinting at turbulence within its portfolio.

Amid these struggles, Bai'ao Chemical presented a timely opportunity

The company reported declines in both operating income and net profits, tapping the necessity for prompt transformationThus, this acquisition was viewed as a "warm embrace," designed to bolster both companies during uncertain times.

These dynamics indicate that the partnership is predicated upon shared goalsLiu Hongjun, in interviews following the acquisition proposal's announcement, mentioned how the commitment of Bai'ao’s leading team to transformation motivated their allianceThis collaboration offers Bai’ao Chemical a foothold in the semiconductor landscape while allowing Xinhui Lian to reshuffle its operations, enhancing its efficiency and scale whilst reestablishing its competitive edge.

The acquisition intricacies suggest a balanced compromise to maximize mutual benefitsThe operating strategy involves Xinhui Lian segmenting its less profitable wafer bonding equipment operations from its other business ventures while also introducing a remanufacturing segment promptly

These adjustments are anticipated to result in a significant improvement in profitability, drawing a stark contrast from previous years where losses were rampantNotably, projections outline a pathway to profitability with net incomes transforming from substantial deficits in 2022 to positive returns planned in the following years.

Further outlining the tactical approach, Bai’ao Chemical established performance benchmarks for Xinhui Lian post-acquisitionThe net profit targets set at 100 million yuan for 2024, 150 million yuan for 2025, and 250 million yuan for 2026 align with the previously mentioned pre-acquisition valuation of 800 million yuanThis methodical strategy bodes favorably for Bai'ao's stakeholders, providing a robust business framework underpinned by clear objectives.

The original shareholders' exit strategy has also been meticulously calculatedAs Bai'ao Chemical injects funds, an institution known as Minyin Jintou will acquire shares from four shareholders for approximately 16.97 million yuan, ensuring the valuation remains consistent with Bai’ao Chemical's incoming investment

This strategic move allowed for a seamless transition of ownership while maintaining investment reliability.

On November 6, Xinhui Lian launched its newly spun-off entity, officially commencing shipments of hybrid bonding equipmentSubsequently, Bai’ao announced plans to invest 10 million yuan to establish a wholly-owned subsidiary to further venture into the semiconductor industryThe sequential flow of favorable news has positively impacted Bai’ao Chemical’s stock value, propelling its market capitalization past the 10 billion yuan mark, a significant achievement considering the previous valuation hovered around 7 billion yuan.

While the newly created entity maintains Liu Hongjun's stewardship and is valued at up to 700 million yuan, several key investors remain unchanged, ensuring continuity in leadership and strategic directionThe outcome of this acquisition underlines a remarkable alignment of interests for both parties, enabling Bai'ao Chemical to leverage its recent market grow while providing Liu Hongjun with a fresh platform through which to pursue future growth aspirations.

As scrutiny surrounding the carefully constructed partnership heightens, regulatory responses reflect a keen interest in the structural and operational aspects of the transaction

Following the announcement of the acquisition strategy, Bai'ao Chemical received inquiries from the Shanghai Stock Exchange regarding the new business revenue stream, commitment to performance targets, and arrangements concerning the asset split.

Bai’ao responded with detailed insights about the business expansion of Xinhui Lian's new undertakings, projecting a substantial contribution from their advanced photolithography equipmentForecasts suggest that revenue from these new operations could represent over 60% of total income by the first half of 2024, revealing an ambitious intent and a concerted effort to bolster performance metricsNotably, some clients have already begun placing large orders, indicating a strong uptake of their new offerings.

The transition from equipment purchase contracts, valued up to 140 million yuan spearheaded through Xinhui Lian's remanufacturing efforts, adds another layer of revenue generation opportunities