Kunfair Transactions

Exhibition organiser Kenfair has caught our attention with two questionable transactions, first a website upgrade disguised as an investment in a zero-interest non-repayable exchangeable loan note, and now the payment of $19m for non-exclusive rights to use a glorified phone book, from a director of the IPO sponsor. We sent an intrepid agent to fetch a copy.

Kunfair Transactions
28th January 2003

We've now seen two questionable deals in a row (three if you count the IPO) for exhibition organiser Kenfair International Holdings Ltd (Kenfair, 0223) which is enough to put the corporate governance of this company in our black books.

The IPO: cashing out

Kenfair was listed on 10-Apr-02 in an IPO sponsored by Baron Capital Ltd. The controlling shareholder is Capital Concord Profits Ltd (CCP), owned as to 50% by Mr Ip Ki Cheung, the Chairman, 30% by Mr Cheung Shui Kwai, the Managing Director, and 20% by Mr Chan Siu Chung, the only other executive director of Kenfair.

The prospectus shows that of the 72m shares (40% of the enlarged capital) offered at HK$1 each, half were "old" shares sold by CCP, raising $31m net of expenses, which were evenly split with the company. The offer was oversubscribed and the over-allotment option for 10.8m new shares was exercised on 11-Apr-02, increasing the net proceeds to the company from $31m to $42m and leaving CCP with 58.6% of Kenfair.

The stated reason for the IPO was "to enhance the capital base" and "provide funding for future plans". However, this business is a cash cow with no need for funding. Kenfair's management had withdrawn a total of $119.1m in dividends in the 3 years and 7 months to 31-Oct-01, including $34.5m in the final 7-month period, which is more than the initial intended proceeds of the IPO. So if they had just left that last dividend in the company, the IPO would have been unnecessary as far as the stated reasons go.

Also, in the year to 31-Mar-01, the Managing Director sold his Bowen Road apartment to Kenfair, raising a further $15.2m. This apartment is still provided for free as his director's quarters with a deemed rental value of $720k p.a., which is not expensed through the profit and loss account.

Altogether then, with the IPO sales shares, the dividends, and the apartment sale, the management has extracted $165.3m of cash since the start of the IPO track record.

Upgrading the website

On 29-May-02, seven weeks after listing, Kenfair's first deal was announced - it was investing HK$23m on a "zero-interest non-recourse exchangeable note". If that sounds odd to you, it should. The "non-recourse" does not have the normal meaning that the parent of the borrower doesn't guarantee the loan. What it means in this case is that the loan note is not repayable!

The note is exchangeable within 1 year into either 100% of Asian Online Ltd (AOL), a BVI company with no initial assets, or 18% of International Information Ltd (IIL), which owns AOL. IIL was wholly owned by Mr Ben Yu Ansheng (Mr Yu). Our database shows a person of that name is an Executive Director of Asia Logistics Technologies Ltd (ALT, 0862) and prior to that was VP of Corporate Development for New World Cyberbase Ltd after being an investment banker.

IIL also owned ChinaEdeal Holdings Ltd (formerly China Global Capital Holding Ltd), a Cayman company which operated ChinaEdeal.com and its English counterpart GlobalEdeal.com, and had "strong partnerships" with China National Import & Export Corp (CEIEC) and China Electronic Chamber of Commerce.

As a term of the deal, and here's the meat, AOL would upgrade Kenfair's website, Kenfair.com, and all the rights to the upgrade would belong to Kenfair, regardless of which acquisition option they chose when the note is converted. The upgraded site was formally launched on 18-Oct-02.

In effect, Kenfair agreed to pay $23m to upgrade its website (we'll leave you to judge whether it was worth it) and get a possible stake in IIL. However, if it had paid for the upgrade directly, then it would either have capitalised it as an enhancement to intangible assets be amortised (charged to the income statement) over its useful life (say, 3 years at $7.7m per year) or it would have taken the entire $23m as an immediate expense. Instead, the $23m was recorded in the interim balance sheet at 30-Sep-02 as an "Exchangeable Note" investment. So they get an upgrade to the website with no immediate charge to the income statement.

The shareholder circular contains a valuation report on IIL by "independent" valuer BMI Appraisals Ltd (BMIA) at $130m, which of course means that 18% of IIL was worth $23.4m. This was a discounted cashflow valuation based on projections made by ChinaEdeal and a business plan "given...orally". You might think that for $23m they would bother to put the business plan in writing, but hey, this is the internet. The discount rate used was 28% and the projections were not disclosed. At the time, the net asset value of ChinaEdeal was only $0.21m and it lost $1.95m in the 16 months to 30-Apr-02.

Since then, BMIA has also done similar work as an "independent business valuer" for ALT (of which Mr Yu is a director), including a valuation of a BVI company called Fusion Tech Holding Ltd at $100m when it had net assets of just $0.11m, referred to in this circular dated 27-Sep-02.

Astonishing deal

The latest deal was announced on 18-Dec-02, in which Kenfair would buy a BVI company aptly named Astonishing Profits Ltd (Astonishing) from Baron International Investment Holdings Ltd (Baron). As part of the same deal, Baron would procure another BVI company called Baron International Consultants Ltd to provide services involving the production of a "strategic business plan in the PRC", finding, negotiating and dealing with a "strategic business partner" in the PRC and identifying "potential strategic business opportunities". Baron and the consultant are wholly owned by Joseph Wan Chuen-chung (Joseph Wan).

The price on this deal is $28.75m, of which $5m is in cash and $23.75m by the allotment of 19m new shares at $1.25 each, equivalent to 9.06% of the enlarged issued share capital. Of the total, $19m is apportioned to the acquisition of Astonishing, and $9.75m for the services. $19m is the same figure that "independent valuer" BMIA (yes, them again) came up with, based on unpublished projections produced by Astonishing, using a discounted cash flow model with an unspecified discount rate.

What the announcement did not mention is that vendor Joseph Wan is a director of Baron Capital Ltd, the Sponsor of Kenfair's listing. Now he is about to receive $5m and become a 9% shareholder, at least temporarily. The deal contains no restrictions on his ability to sell the shares and no statement on what he intends to do with them. The holding is below the current 10% disclosure threshold.

On 2-Aug-00, "Beijing Shang Wen Guang Gao Advertising Ltd and the Editorial Committee of the Imperial Guide" assigned all the data contained in the Imperial Guide to Xiong Zi Wen and Chen Jia Ju (Licensors) in return for a token fee of RMB1.00. The Licensors in turn licensed the Right to Astonishing for 10 years for an annual fee of RMB1.00.

Did you spot the words "non-exclusive"? This means the Licensors could grant an identical right to anyone they choose. The announcement, under "reasons" for the deal, states that "Copies of the Imperial Guide are mainly distributed in Beijing and no copies of the Imperial Guide are distributed in Hong Kong". Which makes it sound somewhat exclusive, except that anyone could stick one in their luggage and bring it back to HK.

Yellow pages for all

Note the choice of the word "distributed" rather than "sold". Yes, this is in fact a Beijing yellow pages, and is available for free, which according to our detailed calculations, is a lot less than $19m. Presumably collection of a copy gives you the non-exclusive right (along with anyone else who has one) to "use the data" inside it - by reading it, for example, or calling up the advertisers.

We sent an intrepid agent along to the publisher in Beijing, who came away with a copy of the 2002-3 edition, which has 777 pages, including 114 pages of colour adverts, city information and index, and 663 yellow pages, with about 70 entries per page, or around 46,000 in total. In fact, you don't need to go the trouble of picking one up in Beijing, because the content appears to be online at the publisher's website www.bjall.com.

The brief INED

The Astonishing announcement stated that Joseph Wan is the brother of Thomas Wan Chuen-fai (Thomas Wan), who was appointed as an "independent" non-executive director of Kenfair on 18-Jul-02 and resigned on 10-Dec-02, as announced on 13-Dec-02, just five days before the Astonishing deal.

As Thomas Wan was a director in the last year, the Astonishing deal with his brother is a connected transaction requiring independent shareholders' approval at a meeting on 30-Jan-03. But don't get all excited now, because Kenfair management (through CCP) own 58.6% and are allowed to vote, so it is a done deal.

The circular

After we pointed out the facts to the Stock Exchange, the shareholders circular came out on 14-Jan-03 and did contain acknowledgement of Joseph Wan's role in the IPO sponsor. We suggested to the Exchange that it might be somewhat cheaper for Kenfair to call the publishers and ask them to send a copy of the Imperial Guide by DHL rather than pay $19m to Joseph Wan.

We would have thought that the "nature of businesses" would be fairly obvious from the categories in the yellow pages (sorry, Imperial Guide) which in English starts with "Acupuncture/massage, moves through "adult shops" and ends with "Weights and measures" and "Zhongguancun" and also includes larger box advertisements. For whatever reason, Kenfair says this information will "greatly facilitate the development" of its PRC exhibition business.

Elsewhere in the circular, Hantec Capital Ltd, the Independent Financial Adviser, spoke of the "Rights" obtained by Astonishing on 2-Aug-00 as being the: "non-exclusive right to use the Private Version of the Imperial Guide" which "further specifies the business scope, legal representative, person in charge, fax number and website (if any) of each of the enterprises."

The circular also stated that Astonishing was "founded" by the Licensors, the chief editors of the Imperial Guide, and reveals that they sold it to Joseph Wan on 31-Aug-00 for HK$1.9m. So astonishingly, the value of Astonishing has increased 10-fold to $19m in a little over 2 years, without the company doing any business activity whatsoever apart from preparing its 3-year business plan and financial projections which are relied on by the valuer.

The directors of Kenfair ascribe this increase to the change in "market circumstances in the PRC" sine Aug-00 due to the entry of the PRC into the WTO and "that the whole PRC import and export is under a different market".

Firstly, China's final entry into WTO was hardly a surprise - China and the US reached bilateral agreement on the subject on 15-Nov-99 (nine months before Astonishing was sold to Joseph Wan) and paving the way for WTO entry . Secondly, the PRC economy has been growing at about 7% per annum, and the export sector at maybe 20% per annum, but not by 1000% every 2 years! Indeed, if anything, the export sector will consolidate into fewer, larger and more efficient companies as a result of WTO, which reduces the difficulty in contacting them. There are also numerous other sources of business information on China, such as the famous Kompass books for China and globally and the Global Sources directory.

The obvious question is this: why does Kenfair need to buy Astonishing for $19m when it could obtain the same non-exclusive rights by dealing directly with the Licensors. They only got $1.9m the last time round, and should be happy to get some more money for another non-exclusive license to their Private Version of Imperial Guide. It seems unlikely that they would charge more than the $19m Mr Wan is charging.

What a shame

Underneath all this, Kenfair has a lucrative business with its trade shows, particularly the annual October Hong Kong International Toys and Gifts Show which until now has accounted for about 90% of the firm's annual revenues. It's just a shame that they've indulged in such dubious transactions. Put the two deals together and they have cost $28m in cash and 9% in dilution of existing shareholders - if this is the shape of things to come, then the stock deserves its lowly rating.

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