* Hutchison to use proceeds to pay special dividend
* A.S. Watson IPO expected in next two to three years
* Deal values A.S.Watson at $22.8 billion (Adds context on IPOs, details on previous offerings by Li Ka-shing companies)
By Denny Thomas and Donny Kwok
HONG KONG, March 21 Singapore state investor Temasek Holdings has agreed to buy just under a quarter of health and beauty retailer A.S. Watson for about $5.7 billion in what would be its single biggest investment and one that would boost its exposure to Asia's fast growing consumer sector.
The purchase of the 24.9 percent in A.S. Watson, owned by Asia's richest man Li Ka-shing, is part of Temasek's aggressive reshaping of its $170 billion portfolio to ensure higher returns by increasing its exposure to unlisted companies. The state investor's returns have often lagged its own internal metric in recent years as it focused on blue chip stocks.
Retail sector investments are seen as a way to profit from rising consumer spending in emerging Asian markets such as China and Indonesia. A.S. Watson's business includes personal care stores which dominate the beauty and health market in China, a sector forecast to grow by around 40 percent to $186 billion by 2015.
"The consumer retail sector is a good proxy to growing middle income populations and transforming economies," Chia Song Hwee, head of the Temasek's investment group, said in a statement. "This is very much part of our investment themes as we shape Temasek's portfolio for the long term."
Billionaire Li's Hutchison Whampoa, which owns A.S. Watson, had planned to float part of the retailer in an initial public offering slated for this year and which would have been the world's biggest retail sector IPO.
Recent stock offerings, however, have been hit by investor worries about China's economic slowdown, a factor that has partly pushed the benchmark Hang Seng index down 9.1 percent so far this year and led to two Hong Kong IPOs being pulled this month.
Three of Li's businesses have also underperformed the broader market since their IPOs. Hutchison Port Holdings Trust has tumbled 37 percent since its Singapore IPO in March 2011. Hui Xian Real Estate Investment Trust (REIT) has dropped 34.5 percent since its Hong Kong listing in April 2011 and HK Electric Investments is down 10.1 percent since its January listing.
"We have a very good relationship with Temasek," Li told reporters after the A.S. Watson deal was announced. "Sometimes we are not only looking at the pricing. If the partners like it very much and consider we are doing the right thing, we are happy."
Hutchison was far advanced with its plans for an A.S. Watson IPO when Temasek expressed interest in buying a bigger stake in the company and a deal was struck within two weeks, a person familiar with the matter said.
EYEING CHINA CONSUMERS
A.S. Watson would join Temasek's portfolio of 24 consumer-related direct investments, according to Standard & Poor's CapitalIQ database. These include China online education services company TutorGroup, global sourcing firm Li & Fung Ltd and Indonesia retail giant PT Matahari Putra Prima TBK .
Last week, a Temasek-led shareholder group offered $2.1 billion in cash for the shares in commodities trader Olam International Ltd they don't already own. Reuters previously reported the state investor was seeking to sell a stake in Thai telecoms operator Shin Corp.
Hutchison Whampoa said in a statement on Friday that it would use part of the proceeds from the stake sale to pay a special dividend of HK$7.00 per share to its shareholders.
Li said he was still considering an IPO in A.S. Watson in Hong Kong and Singapore, but that any such offering was likely to happen in two to three years. The offering was aimed at raising money to expand the health and beauty business in China.
Temasek's investment in A.S. Watson values the company at HK$177 billion ($22.8 billion). A.S. Watson's business includes supermarket chain ParknShop and the Watsons and Superdrug and Kruidvat personal care stores.
Last year, Hutchison Whampoa scrapped the sale of ParknShop after bids for the company came in below expectations.
A.S. Watson last year generated $19.2 billion in revenue from some 11,000 outlets worldwide. Its net profit rose by 13 percent in same year to HK$7.8 billion, Hutchison said in the statement.
Bank of America Corp, DBS Holdings, Goldman Sachs Group and HSBC acted as advisors for Hutchison Whampoa, the statement added. ($1 = 7.7645 Hong Kong Dollars) (Additional reporting by Stephen Aldred, Donny Kwok and Yimou Lee in HONG KONG and Saeed Azhar in SINGAPORE; Editing by Ryan Woo and Miral Fahmy)
WORLD NEWS SCHEDULE AT 1800 GMT/2 PM ET
Iraqi forces free hundreds of civilians in Mosul Old City battles as death toll mounts