Boto's New Deal

Boto has at last announced amended terms for the proposed sale of its core businesses. We give our views.

Boto's New Deal
12th July 2002 (revised 13-Jul-02)

Boto International Holdings Ltd (Boto, 0585) today announced revised terms of the proposed sale of its core Christmas festive products and leisure furniture businesses, which accounted for 99.9% of unaudited turnover for the year ended 31-Mar-02.

Under the revised deal, partnerships "affiliated with" Carlyle would own 75% of the buy-out vehicle, Greenland Investment Holdings Ltd (GIHL), while Boto would own 25%. The price on the sale has been increased by HK$70m to $1,064m ($0.309 per share), while Boto would invest $88m for 25% of GIHL.

As in the previous proposal, Boto would also sell premises for $13.5m and receive a pre-completion dividend of $92.5m from the subsidiaries being sold. The net proceeds of the sale, including the premises, would be $1,069m. Adding the dividend and deducting the investment in GIHL, there should be net cash of $1,074m or about $0.312 per share.

The undertaking to retain net assets against sale warranties has been reduced to $170m from $200m. That would include the $88m invested in GIHL and any net assets of Imagi, the animation business. We'll assume zero net assets for Imagi, and that implies a minimum cash retention of $82m which can be used as working capital.

Boto has stated an intention to distribute "a substantial part" of the proceeds as a dividend, but has conspicuously failed to commit to any figure, and suspicions remain that it will keep an excessive amount of cash which inevitably will be discounted in value in the share price if the deal proceeds. Precedent indicates a 50% market discount will be applied to cash in the shell.

Boto will sign a 3-year consultancy agreement by which the services of Chairman Michael Kao Cheung Chong (Mr Kao), Philip Lam Pak Kin, Vivian Kao Wai Ming and Kui Yiu Ngok will be provided to GIHL in return for fees of $11.2m p.a. plus, bizarrely, a "discretionary fee" based on the financial performance of GIHL. As the announcement is silent on what the company will do with these fees, we can only assume that they will be passed through as salaries and bonuses to the four, so don't get excited, it's probably not for shareholders.

Option schemes

These four and their associates will "abstain" from voting a combined 60.6% of Boto on the transaction, although the announcement describes this as a "Major Transaction" but no longer a "Connected Transaction" as Mr Kao no longer has an initial stake in GIHL.

However, they do have a different interest to Boto shareholders: all of the four would be eligible to participate in two new share options schemes of GIHL over 10% and 5% of the fully diluted share capital. The exercise price on the first scheme is the same as the investment price for Boto, while the second scheme is at a generous 70% discount. Full exercise of these options could dilute Boto to only 21.25% of GIHL.

Listing Review Committee

Although the announcement doesn't mention it, we have been informed that the Listing Review Committee, when considering the original connected transaction, decided to allow one executive director, Ms Liliana Tsen Yun Lei, to vote on the deal, while barring another executive director, Mr Kui, from voting.

The Listing Committee operates in a form of secrecy that makes the Vatican look transparent, and unlike the SFC's Takeover Panel, it almost never announces its decisions or the reasons for them. Ms Tsen holds 5.54% while Mr Kui holds 2.12% of Boto. The committee also ruled that the trust established by a deceased co-founder and ultimately controlled by HSBC group, the lender to the buy-out vehicle, could vote its 4.08% stake.

Extracts of results

The announcement contains some extracts of the unaudited results for the year to 31-Mar-02, showing that turnover of festive products grew 7% for the year - still a good cash cow, and we hear breaking news from the North Pole that Christmas is coming again this year.

At same time, those leisure furniture sales for your patio grew a whopping 131%, even more than we had expected, help by a strong second half. Clearly from a standing start in 1998, this business is beginning to motor, as the following table shows:

The results also show an unaudited net profit for the year to 31-Mar-02 of $141.4m, down 9.6% on 2001, and significantly below Kim Eng's research forecast of $179.6m and our own expectation. However, we take it with a large pinch of sodium chloride, because it would be in the interests of management to paint a gloomy picture, and there are plenty of legally acceptable ways in which figures can, at least on a short-term basis, be depressed. All we got were figures for turnover, pre-tax and net profit. The board meeting for audited results has been set for 18-Jul-02 and the annual report should be posted by 31-Jul-02 under Listing Rules.

Held Hostage

One of several "events of default" in the shareholders' agreement is that if Mr Kao ceases to be a director of Boto, or if he ceases to have majority control of Sunni International Ltd (which owns 52% of Boto), or if he ceases to control Boto, then in any one of these cases, Carlyle gets the right to buy back the 25% stake in GIHL at the $88m cost.

This looks like a hostage to fortune - we are all mortal, and Mr Kao's death or resignation, would result in Boto losing its stake in GIHL for no return. This could result in substantial loss of value to Boto shareholders, particularly if the former core businesses perform as well as we expect, and would leave Boto as an animation start-up.

Conclusions

The increase in the proposed sale price is a paltry amount of just $0.02 per Boto share and offers no premium over market price for majority control of all the core business. Boto would at least get to keep 25% of the upside in its core businesses (or 21.25% after being diluted by the option schemes) but only if Mr Kao stays on board, failing which the upside could disappear.

We believe the US and European consumer is alive and well, and recent booming export figures through southern China's container terminals support this. One-time disruptions from the reorganisation of K-mart do not affect consumer demand. We are delighted by the strong 131% growth of the leisure furniture business which certainly does not look like having reached "a relatively mature stage with low growth prospects" as Boto claimed in April.

We and other investors remain opposed to this deal, which we believe is not in the best interests of the company. We intend to vote against it at the general meeting and urge others to do likewise.

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