CRE: more needed on the port flip
28 January 2011

In yesterday's newsletter, we said that "there's still no disclosure from China Resources Enterprise (291) on what, if anything, its 50% profit-share is on its former stake in Hutchison's ports, which its parent China Resources Holdings flipped to HPH". That wasn't quite accurate. In an announcement on the evening of 24-Jan-2011 which was clarifying press coverage about the new beverage joint venture with Kirin Holdings Co Ltd, China Resources Enterprise, Ltd (CRE) also included this paragraph:

"Reference is also made to the Company's announcement dated 29 October 2009 and the press coverage regarding the disposal by China Resources (Holdings) Company Limited ("CRH") of certain assets, including (but not limited to) its interests in container terminal operations. The board of directors of the Company wishes to clarify that the Company has obtained the relevant particulars from CRH on its recent disposal and the Company confirmed that it is not entitled to receive any payments pursuant to the terms of the asset swap agreement dated 29 October 2009 referred to in the said announcement as a result of CRH's disposal of the minority investments in container terminal operations that it acquired from the Company under the asset swap agreement."

This minimalist form of disclosure does not go far enough. The sale of its port assets by CRE to its parent CRH was a connected transaction for which there was an independent financial adviser's report and independent shareholders' approval was required. It is not enough for CRE, still controlled by CRH, to simply tell the market that "our parent doesn't owe us anything".

On the face of it, we have the sale of port assets by CRE to CRH for HK$3.3bn, and the onward sale of the port assets plus some other assets by CRH to either Hutchison Whampoa Ltd (HWL, 0013) or its 80% subsidiary Hutchison Port Holdings Ltd (HPH, BVI) for $5.7bn. CRE was entitled to a 50% share of any excess over $3.3bn received by CRH in selling the port assets.

The calculation of this amount in itself amounts to a connected transaction between CRE and CRH. There should be full disclosure of the apportionment of the $5.7bn proceeds received by CRH for its sale between the assets it acquired from CRE and any other assets bundled into the sale to HWL/HPH. This should be backed up by independent valuations and a fairness opinion from an independent financial adviser. As a reminder, the assets CRH sold were:

1. 10% of HIT Investments Ltd (HITIL, BVI) with shareholder loan
2. 10% of Hutchison Ports Yantian Investments Ltd (HPYIL, BVI) with shareholder loan
3. 12% of Omaha Investments Ltd (Omaha, HK): this had an audited net asset value at 31-Dec-2009 of $1,784m, so 12% of its NAV was $214.1m. According to HWL's annual report, the business of Omaha is "property owning"
4. 110/242 (45.45%) of the property at 9 Chong Yip Street, Kwun Tong, Kowloon: the book value of this property at 31-Dec-2009 was HK$390m. 45.45% of that is $177.3m. It is listed in HWL's 2009 annual report as a commercial investment property, so that was valued at market value. It has a floor area of 124,724 sq ft, so that is a valuation of $3,127 per sq ft, which we consider reasonable for that area of Kowloon at the end of 2009.
5. 10% of Splendid Century Ltd (Splendid, BVI): this had an audited net asset value at 31-Dec-2009 of HK$1m, so 10% of its NAV was $0.1m
6. 10% of Eckstein Resources Ltd (Eckstein, BVI): this had audited net asset value at 31-Dec-2009 of HK$28m, so 10% of its NAV was $2.8m

Now, the net asset value or book value of assets (3) to (6) above adds up to $394.3m. Let's be generous and say that they all increased in value by 20% between 31-Dec-2009 and the transaction date of 31-Dec-2010. That would make $473.2m. Let's also be generous in assuming that none of these assets was included in the connected transaction sale by CRE to CRH. So we'll deduct that amount from the proceeds of $5.7bn. That still leaves HK$5,227m of proceeds apportioned to the port stakes, assets (1) and (2) above. So without any better information, it appears that CRH did indeed make a substantial profit above the $3,300m it paid CRE for these assets, a gain which we conservatively estimate to be $1,927m. CRE is entitled to half of any such gain. To simply dismiss that with a one paragraph announcement is unacceptable.

There may be a genuine explanation for CRE's claim that there was no gain - for example, CRH may have increased the amount of shareholders' loans to HITIL and HPYIL since it bought them from CRE, but until we see the full calculation and valuations, confirmed by an independent financial adviser, we are entitled to be sceptical.

The IFA in the original connected transaction was Platinum Securities Co Ltd (Platinum), which noted on page 49 of the circular that the Price/Earnings Ratio (PER) for the CRE port disposal was only 5.3. That is very low by any measure, but particularly for what amount to cash-cow utility companies. It was also very low compared with an average of 19.5 for comparable port companies, but Platinum drew comfort from the fact that CRE would be entitled to 50% of any dividends and interest on the port stakes exceeding $220m per year, and 50% of any profit if CRH sold the stakes for more than $3,300m. Platinum wrote:

"Having considered the above, we are of the view that although the Port Disposal has a lower PER as compared to the Comparable Port Companies...the income and profit sharing mechanisms with CRH Group which entitle the Company to share in any future income and capital gain from the Port Interests ensure that the interests of the Shareholders will be protected"

That's all well in theory, but have CRE shareholders interests really been protected? Not yet. For that profit-sharing entitlement to be worth any more than the paper it was written on, it has to be backed up with independent verification to protect the interests of independent shareholders.

We note that Platinum has been wheeled out as IFA to CRE on two more occasions since then, including the proposal in Dec-2010 for loans to CRH and to sister companies, which Platinum recommended shareholders to support. Independent shareholders voted 49.2% against that advice.

© Webb-site.com, 2011

Organisations in this story

• China Resources Beer (Holdings) Company Limited
• HUTCHISON PORT HOLDINGS LIMITED
• Hutchison Whampoa Limited
• PLATINUM SECURITIES COMPANY LIMITED

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