The Real Steel
24th April 2000
What do you know about iSteelAsia.com Ltd (iSteelAsia), the steel-exchange portal spun off on GEM last week from main-board listed Van Shung Chong Holdings Ltd (VSC)?
B2B - Bound 2 Be good, right? Wrong. We'll show you how this deal was put together. Webb-site.com can reveal that the day before the prospectus was published, the Chairman of VSC, his mother, an "independent" non-executive director, and an "acquaintance" of the controlling family effectively bought 18.34% of iSteelAsia from VSC at HK$0.00596 per share, a 99.4% discount to the IPO price, and all without seeking independent shareholders' approval. Even after the initial drop in this dot-com stock, they are still sitting on a gain of HK$208.7m.
We'll also take a look at the involvement of iMerchants Ltd (iMerchants) in the project. Both GEM listings, now submerged like the Titanic, were sponsored by BNP Prime Peregrine, the people who brought you Tom.com and techpacific.com.
Background
VSC was founded in 1961 by Mr Yao Shu Sheng, Honorary Chairman and father of the present Chairman Mr Andrew Yao Cho Fai. VSC, which listed in 1994, began as, and still is, one of Hong Kong's leading importers and stockholders of high tensile steel reinforcing bars (rebars) for the construction industry. It claims a one third market share and in October last year it acquired Shougang Concord Steel Company Ltd which reportedly accounts for another third of the market. So if you are in HK, knock on the walls of your flat - with a two-thirds market share, the chances are your walls (and foundations) contain steel supplied by VSC. It also distributes H-piles, tube piles and other steel products, plastic resins (mostly from GE Plastics), injection moulding machines (from Japan Steel Works Ltd), Twyford baths from England and kitchen cabinets.
Apart from straight warehousing and distribution of its steel imports, VSC also does some processing such as slitting and cutting sheets from coils, and cutting and bending rebars into shape. All this is good steady business.
Trading Department
You might regard a sequence of buying, stockholding and selling a product to be a form of trading, but this is not how VSC defines it. They have had a "Trading Department" which has purportedly been run separately since Apr-97. The customers include end users, distributors and stockists in Southern China. In other words, the non-HK trading business.
Some of this was conducted through a BVI subsidiary called VSC (Far East) Ltd (VSCFE) which according to the annual report trades with Mainland China, Europe and America, while some of it was conducted through the main Hong Kong subsidiary, Van Shung Chong Hong Ltd (VSCH). Both are wholly-owned by VSC. We presume VSCFE was used for non-HK trading so that it would not be subject to tax in HK.
The iSteelAsia prospectus does not mention that VSC also has, or had, two PRC-based companies whose activities were listed in the Mar-98 annual report as "trading and stockholding of steel". Both were joint ventures with mainland steel producer, Shanghai Baosteel.
One of these, Guangzhou Free Trade Zone Baoshunchang International Trading Co Ltd, was 70% owned by VSC. It was trading flat steel products for use in things like electrical appliances and computer casings. Turnover in 1997/98 was HK$18.32m with a gross margin of 4.79%. However, the company suffered "keen competition" and bad debts from mainland customers, and was shut down at the end of 1998.
The other JV is Shanghai Bao Shun Chang International Trading Co Ltd, 66.7% owned by VSC. In 1998/99 its turnover fell 45% and gross profit fell 92%, with a gross margin of less than 1% and no contribution to net profit (presumably a loss). The JV's businesses in colour-coated coils and other flat products were hit by imports from Southeast Asia.
No transfer to iSteelAsia
The Shanghai trading JV is not being transferred to iSteelAsia and there is no mention in the prospectus of its chequered history or of its defunct Guangzhou counterpart.
The trading department (and its records, excluding the two JVs) which has been transferred to iSteelAsia forms the basis of iSteelAsia's 2 years and 9 months of track record. In a complicated restructuring, the assets, liabilities and businesses of VSCFE and the steel trading division of VSCH (but not the rest of it) were transferred to MetalAsia (Hong Kong) Ltd effective 31-Mar-00. That leaves VSCH largely intact, conducting its profitable HK importing, stockholding and sales business (but we mustn't call it trading, must we?).
Bearing in mind that the transfer was only effective on 31-Mar-00, accountants Arthur Andersen have had to review the combined track record on an "as if" basis, as if the iSteelAsia group had been in one piece as of 31-Dec-99 when the track record ended, extracting the track record from VSCFE and VSCH.
The Misconception
The prospectus tells us that iSteelAsia was conceived in Jun-99 and work commenced in mid-Oct-99. A BVI company, iSteelAsia Limited (iSAL) (not to be confused with the listed company) was incorporated on 27-Oct-99.
iSAL was originally set up with US$10 of capital as an 80:20 joint venture between VSC and iMerchants Group Ltd (iMG) (the unlisted parent of iMerchants). It borrowed HK$2m from VSC to get started, and it commissioned the iSteelAsia.com web site from iMerchants for US$500,000 (HK$3.9m) which was outstanding at 31-Dec-99 and at 29-Feb-00. In fact, in iMerchants' prospectus, it only recognises half of that fee as payable up to 31-Jan-00.
The core concept of iSteelAsia is a glorified e-mail system. When a buyer wants goods, he can post his requirements through forms on the site. The site then forwards the requirements to all suppliers by e-mail, and they can send back quotes on an anonymous basis. When quotes are accepted, identities are revealed and the trade is then finalised.
In practice there must be numerous parameters (other than price and volume) to be negotiated, and we remain sceptical that B2B exchanges of this nature can take a meaningful share of world trade. The whole point of the internet is to cut out the middle-men, not to introduce more. Exchanges work best when the item traded (such as shares in a company) are homogeneous, all items being of identical specification, when standard settlement and delivery terms apply and credit risk and quality control are non-issues. This allows buyers and sellers to place their bids and offers anonymously, for trades to be automatically matched, and prices and volumes for homogeneous or "fungible" items to be published and tracked.
That's the case with shares and bonds, or with silver futures or a particular grade of oil futures, but probably not with physical steel. When multiple parameters other than price need to be negotiated, or when each counterparty needs to assess the credit worthiness of the other, or the ability to fulfill a contract, then the "anonymous exchange" system becomes impractical and the ability to "auto-match" buyers and sellers breaks down. Direct negotiations then take place, and the counterparties regard the result as a commercial secret.
It is also the case that the large consumers and distributors of products like steel and paper will already have steady relationships with existing suppliers, who are in a sense "pre-qualified". Therefore, if a buyer wants to invite tenders from these familiar people, they can send out e-mails themselves, or set up their own tendering web-site (as have a number of the big auto firms) and invite bids from suppliers. They are unlikely to go to an exchange and pay someone else to do it. A web site can be established for minimal outlay.
Exchange, or tendering site?
There is a strong risk that iSteelAsia.com will simply end up as the purchasing web site of VSC, which can make its requirements known through that site. That's a good and valid use of the web. VSC has a large network of suppliers who can communicate with it via the web site. In the "old days" VSC would have used telephones and fax machines. The difference is, VSC did not try to float its telephones and fax machines as a listed company.
By the end of March, only 11 transactions had been concluded on iSteelAsia, which compares with the "more than a dozen trades" reportedly claimed by its Chairman (SCMP, 16-Mar-00). The prospectus is silent on how many trades involved VSC or its subsidiaries at one end of the deal. The first transaction was announced with fanfare on 20-Jan-00, a month after the site was launched. The trade, which took place on 11-Jan-00, was between Duferco Group of Switzerland and a party identified only as "Shougang Concord". It is unclear whether that is an external party or HK-based Shougang Concord Steel Co Ltd, which had earlier been acquired by VSC in Oct-99.
Don't be misled by the large number of registered users, currently at 928. We are one of them. It's easy to get registered with any name you choose plus an e-mail account. You can try this at home. If all our readers register, they'll have thousands of "users" by next week. We wonder how many members of the public signed up simply in the hope that they'd get a preferential allotment of dot-com shares, as they did in Tom.com and red-dots.com (for SUNeVision). Any such users were disappointed (or, in retrospect, fortunate) not to get any priority, as the IPO was done by way of a placing rather than public offer.
The real question is how many corporate users (who must be vetted) will actually do B2B trades between themselves rather than with VSC.
Restructuring
On 13-Apr-00, the day before the prospectus was published, there was a blizzard of restructuring transactions. Get your brain into gear and follow this, because it will be worthwhile. All this took place in one day.
The original joint venture, iSteelAsia Ltd (iSAL, which was 80% owned by VSC and 20% by iMerchants Group Ltd) was transferred to another BVI holding company called iSteelAsia Holding Ltd (iSAH), which was also owned 80:20 (4 shares and 1 share) by VSC and iMG. Nothing wrong with that.
Next, iSAH assumed liability for the HK$2m previously borrowed from VSC by iSAL. Then VSC converted the loan into 7,996 new shares in iSAH. At the same time, iMG paid US$500,000 (HK$3.9m) for 1,999 new shares in iSAH, which effectively capitalises the fee for producing the web site. The iMG subscription is equal to the amount owed by iSAL to its listed subsidiary (iMerchants) for producing the web site. So iMerchants records real revenue.
Net result: VSC and iMG have put in HK$2m and HK$3.9m for 80% and 20% respectively of iSAH. Pretty simple so far.
On the same day, the "Trading Department" of VSCFE and VSCH was transferred to a new HK company called MetalAsia (Hong Kong) Ltd in exchange for shares, and these were then transferred to a BVI company called MetalAsia Holdings Ltd (MAH), wholly owned by VSC. Again, nothing wrong with that. The nominal price on the transfers was HK$3.5m, but as VSC was the ultimate 100% owner the whole time, it doesn't really matter.
To even things out, on 13-Apr-00 VSC sold 20% of MAH to iMG for a consideration of HK$17m. This amount was the same as the amount due for the placing by iMG to VSC two weeks earlier, of 11,488,000 shares in iMerchants at the iMerchants IPO price of $1.48. So effectively it was a share swap. Net result: iMG has swapped about 1% of iMerchants for 20% of MAH, to match its 20% holding in iASH. These two companies are essentially the entire group that was floated - the Real Steel comes next...
Now the good bit
First, a quick who's who. Andrew Yao Cho Fai (Andrew Yao) is Chairman of VSC. His mother is Yao Lin, Shiu Mei (Ms Yao). Another player is Sophia Liang Ho Hang Chong (Sophia Liang) who is described in a 28-Mar-00 VSC press release as an "independent third party" but in the prospectus is more curiously described as an "acquaintance of the Yao family", whatever that means. Moses Tsang Kwok-tai (Moses Tsang) was appointed as an "independent non-executive director" of VSC on 29-Sep-99.
Moses Tsang was until 1994 Chairman of Goldman Sachs (Asia). Perhaps by coincidence, a person called Moses K. Tsang was a director until 1-Dec-99 of Alexus Co Ltd, the holding company of EC Link Shenzhen, which as we explained in a previous article became the track record vehicle for Tom.com. But we digress...back to the story:
On 13-Apr-00, Andrew Yao, Ms Yao, Sophia Liang and Moses Tsang (we'll call them the Fab Four) bought 10%, 6%, 5% and 5% (total 26%) of iSAH and MAH from VSC for a total cash payment of HK$1,586,000, which, as we will show, was a tiny fraction of their worth based on the IPO price. As a result, iSAH and MAH were owned as to 54% by VSC, 26% by the Fab Four and 20% by iMG.
The Fab Four and iMG then transferred one fifth of their holdings in iSAH and MAH to a new BVI company called TN Development Ltd (TND) in exchange for its shares. VSC similarly transferred 10% out of its 54% stake. As a result, iSAH and MAH were owned as to 44% by VSC, 20.8% by the Fab Four, 16% by iMG and 19.2% by TND, while TND was owned 54% by VSC, 20% by iMG, 10% by Andrew Yao, 6% by Ms Yao, 5% by Ms Liang and 5% by Moses Tsang.
TND will be used to grant options to employees and customers at 5% of the IPO price. The exercise proceeds of $13.27m will eventually belong to the shareholders of TND as and when the options are exercised, but we will ignore that benefit for now.
Final step
Following the above transactions, iSteelAsia (the IPO vehicle which prior to this had no shares in issue) acquired 100% of iSAH and MAH by allotting 2,300,000 shares in proportion to the shareholdings acquired. Then a bonus issue was made of about 555.5 new shares for each share held, raising the issued share capital to 1,280m shares. That's the end of the long day of 13-Apr-00, and that is all that happened prior to the IPO.
As a result of the final step, the Fab Four swapped their 20.8% of iSAH and MAH for 20.8% of iSteelAsia, or 266.24m shares. Here's a summary of the amounts paid by the Fab Four for their resultant shares in iSteelAsia, the listed company:
As you can see, the Fab Four have paid just $1.586m, the day before the prospectus went out, or an average price of just $0.00596 per share, or a 99.45% discount to the IPO price, for shares valued at $287.5m. That's a 181.3-fold return. Even at the first day's closing share price of $0.79, it's a 132.6-fold return and the parties are sitting on 18.34% of iSteelAsia and paper profits of HK$208.7m.
Since both Andrew Yao and Moses Tsang are directors of VSC and Ms Yao is Andrew's mother, and they were all buying shares in its subsidiaries, these transactions should surely have been treated as connected transactions, but they were not. The VSC public shareholders had no say in it. The transactions were not even announced - the "reorganisation" was just presented as a done deal in a pro forma tree diagram in a 28-Mar-00 announcement. That announcement concerned only the transactions with iMG. The Yao family holding company (which holds more than 50% of VSC) approved those on the basis that it had no conflict of interest.
We call upon the Stock Exchange and VSC to explain why these transactions, which were so plainly beneficial to the parties involved, were not subject to independent shareholders' approval.
There can be no suggestion that the transaction size fell below the minimum disclosure threshold given that the value of the shares, at the IPO price (which was the most reasonable basis at the time) was $287.5m, or over 64% of VSC's last audited net assets.
We also believe this and a number of recent transactions demonstrate that the Stock Exchange should require all IPO prospectuses to state clearly what the average purchase price of each existing shareholder is. You should not have to rely on Webb-site.com to figure this out.
iMerchants
On 15-Mar-00, prior to its own IPO, iMerchants conditionally agreed to acquire from its parent (iMG) any iSteelAsia shares received by iMG, for a consideration of 85% of the IPO price of iSteelAsia. That turns out to be 85% of $1.08, or $0.918 per share. As a consequence of all the shuffling referred to above, iMG receives 204.8m shares (16% pre-IPO, 14.1% post-IPO) of iSteelAsia, so iMerchants will purchase those for a headline figure of $188,006,400.
However, the consideration for the purchase by iMerchants is to be the issue of new iMerchants shares at higher of the Offer Price and the 5-day average closing price of iMerchants immediately prior to the first day of dealings in iSteelAsia. That average price turned out to be $0.66 compared with the offer price of $1.48, so the iMerchants shares will be issued at $1.48. Divide that into $188m and you get 127,031,351 new shares in iMerchants equal to 10.90% of its existing share capital or 9.83% of the enlarged.
The share price of iMerchants has plummeted since its IPO, down 64% to $0.53 on 20-Apr-00. So the new shares will be worth $67.33m at market price.
In summary, iMG parted with 11,488,000 shares in iMerchants (now worth $6.1m) plus US$500,000 (HK$3.9m) to refund the web development costs (total: HK$10m) in exchange for 204.8m shares in iSteelAsia (now worth HK$162m at market price), which it will swap for HK$67.33m of shares in iMerchants. On the other hand, iMerchants itself ends up with US$500,000 in web development fees and 204.8m shares in iSteelAsia.
The iSteelAsia deal takes the iMG shareholding in iMerchants up from 62.0% to 65.6%. The new iMerchants shares will be locked up for 2 years, but it makes little difference because iMG can still sell other shares after 6 months and the newly locked-up shares will count towards the 35% stake that it must hold for 12 months after listing.
Going forward, iSteelAsia will trade heavily with iMerchants. The development and maintenance of the web site will continue to be outsourced to iMerchants for a lump sum of HK$950,000 plus US$85,000 per month. That adds up to HK$8.9m in the current year - or almost twice all of the revenue of iMerchants in the year to 31-Mar-99. Overtime is extra, subject to an overall cap on the fees of HK$15m.
Enter Li Ka Shing
Just as the deal began to look a bit "sticky" as they say in investment banking, it was revealed that God was investing. Well not quite God, but the Li Ka Shing Foundation Ltd subscribed shares in what was called a "pre-placing". That deal was conditional on the IPO completing, so it was in practice part of the IPO, but the foundation got the shares at a price of HK$0.80 per share, a 26% discount. Not only that, but the 72m shares represent 4.96% of iSteelAsia. That's an important point, because by staying below 5%, the foundation is not a "significant shareholder" under GEM rules, and avoids having its shares locked-up for 6 months. It can sell whenever it likes.
In an SCMP article on 17-Apr-00 Andrew Yao was quoted as saying that the lower price was because the agreement had been reached in December. Funny that it wasn't announced sooner then - perhaps this is because the placing agreement was only entered into on 29-Mar-00.
Expenses high
The IPO placing of 100m shares at $1.08 raised HK$108m, but a massive $19.6m of that, or 18%, is being spent on the IPO expenses. Sponsor BNP Prime Peregrine, which receives 4% plus an undisclosed financial advisory fee and a documentation fee, is taking $2.7m of its fee in shares at the IPO price.
The high expenses are partly a consequence of an even more ambitious original indicated pricing range of $1.55-$2.00 per share for 248m shares rather than the 100m finally placed at $1.08.
Conclusion
What can we say? iSteelAsia has been put together by its founders for minimal outlay and with maximum creativity. The outlay was an investment of US$500,000 (HK$3.9m, fees for the web site) and a capitalised shareholder's loan of HK$2m, plus the transfer of VSC's trading business (which was tagged at HK$3.5m). That all adds up to a net outlay (after repaying other shareholders' loans) of HK$9.4m. Not exactly a high barrier to entry, is it?
This outlay has been converted into 1,280m shares worth HK$1,011m at the current price of $0.79. If the Nasdaq market hadn't hit a rut, it might have been $2.56bn at $2.00.
The Fab Four have effectively purchased 266.24m shares, now with a market value of $210m, from VSC one day before the float, for the grand sum of $1.59m, and without consulting the independent shareholders of VSC. One of the Fab Four is even an independent non-executive director of VSC.
We can't help wondering if the listing division of GEM was comatose when this one wafted past its nose.
© Webb-site.com, 2000
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