The latest deal deserves attention from the SFC's corporate misconduct team. We also find improbably high profit margins which have now collapsed, a big receivables problem, and two changes of board, the latest after a character from our 2012 "Raking Muck" series reappears.

Blowing the whistle on Sinoref (1020)
12 November 2014

Sometimes it is just really obvious that a company is up to no good. This is one of those times. On 3-Nov-2014, after a recent board change, Sinoref Holdings Ltd (Sinoref, 1020) announced the conditional acquisition of 90% of Time Credit Ltd (Time Credit), a HK-based money-lender, from one Ms Lam Wai Ha, about whom we know nothing. The company claims that she is an independent third party.

The purchase price is HK$140m, valuing the whole of Time Credit at $155.6m, which compares with warranted net assets of HK$4m (or $3.6m for Sinoref's share), so the deal is priced at a ridiculous 38.9 times net asset value. Time Credit was incorporated on 30-Dec-2011 and made a net profit of $0.71m for the year to 30-Jun-2014, so the deal values it at a P/E of 219 times. The barriers to entry into this industry are almost zero, as the entity is lending money, not taking deposits from the public. Time Credit is one of hundreds of HK-licensed money lenders, and is currently awaiting the annual renewal of its license, which expired on 27-Aug-2014, according to this list.

The price of this transaction relative to both NAV and earnings is so ridiculous that it cries out for scrutiny from the SFC's nearly-new corporate misconduct team. Webb-site calls on them to investigate.

Licence renewal is a condition of the acquisition, but Sinoref has already paid out a HK$70m refundable deposit to Ms Lam, equal to half the purchase price. The rest is payable on completion, $37m in cash and $33m in a 2-year 3% promissory note. The other condition is that she grants a credit facility of up to $100m to Time Credit for at least 2 years, with repayment to be guaranteed by Sinoref. Both conditions must be fulfilled by 31-Mar-2015.

Sinoref has managed to obtain a valuation of HK$159m for Time Credit, based on unpublished cash flow projections, from a valuer incorporated last year, called International Valuation Ltd, but even if you could see the report, it would be meaningless, because the valuation assumes that "the financial projections provided by the Target Company are reasonable, reflecting market conditions and economic fundamentals". In other words, the valuer is not saying that the projections are reasonable. Indeed, nobody is. They just assume that they are.

Now we will recount the history of Sinoref, and how it has undergone two de facto changes of control, leading to the most recent board.

A brief history

Sinoref, by the way, is not in the business of money-lending. It is engaged in the manufacture and sale of "advanced steel flow control products" which are consumables (lasting a few hours) in the steel-making process. More recently it is also engaged in the manufacture and sale of paper converting equipment via an acquisition in early 2014, of which more below. Sinoref listed on 7-Jul-2010 after an IPO of 390m shares (32.5%), including 90m existing shares, priced at $0.76. The IPO raised HK$195.3m for Sinoref. The stock has a Webb-site Total Return of -40.97% from the first day of trading up to 11-Nov-2014.

Suspiciously-high profit margins collapse

Prior to its IPO, Sinoref recorded extremely high gross profit margins which peaked at 68.4% in 2010, the year of the IPO, and proved to be unsustainable. The margin declined to 55.9% in 2011, 47.4% in 2012 and then collapsed to 13.2% in 2013 and when negative to -10.8% in the first half of 2014. This was almost entirely due to a collapse in average selling prices, which peaked at about CNY41,900 per tonne in 2010, dropping to CNY20,900 per tonne in 2013 and CNY17,200 per tonne in 2014. Cost of sales per tonne rose gradually from CNY13,300 per tonne sold in 2010 to CNY19,100 per tonne in the first half of 2014.

It is questionable whether the high profit margins were ever real or were engineered, but they no longer exist - it is one reason that your editor doesn't buy IPOs, because if a company has been manipulating its margins to juice up its valuation, then it will not be able to maintain that for long without running into cash flow issues. If there is a money-go-round, then the music tends to stop quite soon after IPOs.

Trade receivables - another red flag

Sinoref's trade receivables have ballooned since IPO. At 31-Dec-2009, the last full year before listing, trade receivables were CNY46.5m on turnover of CNY156.9m. Nearly all of it was less than 90 days old based on the "goods delivery date". Four years later at 31-Dec-2013, it had trade receivables of CNY172.4m on turnover of CNY186.4m. In other words, it had not been paid for most of what it sold that year. Of the total due, CNY78.0m was more than 180 days old. At 30-Jun-2014, it had trade receivables of CNY 208.0m, after making an impairment charge of CNY25.9m on doubtful debts during the half-year. Of the total receivables, CNY96.0m was more than 180 days old.

First change of control

Only one of the original executive directors (the Chairman and CEO Xu Yejun (Mr Xu)) and one 82-year-old INED have remained at Sinoref since the IPO. The founding shareholders, including Mr Xu, have sold their holdings starting in Sep-2013. Based on the large discounts to market prices at which they sold, they seemed to be in a remarkable hurry to get out. But then, 2013 was the year in which the profit margins were collapsing. Here's how the first change of control panned out:

As a result, there were 4 new directors in a 7-man board that looked like this, and control had effectively changed. Now you must be wondering, what's the connection between Sinoref and Sino Splendid (apart from the "Sino" bit), that resulted in them having 3 senior people in common? Left unsaid was that Sino Splendid is controlled by one Mr Chen Ying Zhen, who bought the controlling holding on 13-Jan-2013 at the tender age of 24. His father, who guaranteed that transaction, is one Mr Chen Hong, presumably the same man who bought the stake in Sinoref. As you will see though, he didn't hold Sinoref for long. But first, let's talk about the fund-raising.

Placings

Since the IPO of Sinoref, there were no changes in outstanding shares until this year, when Sinoref has issued shares for cash twice. On 10-Jan-2014, it launched a placing of 200m shares (16.67% enlargement, 14.29% of enlarged shares) at HK$0.38, an 18.5% discount to the 5-day average price, raising $75m net. The subscription completed on 20-Jan-2014. On 25-June-2014, Sinoref launched another placing of 110m shares (7.36% enlargement, 6.86% of enlarged shares) at HK$0.57, a 19.7% discount to market, raising $61m net. The subscription completed on 7-Jul-2014. Both placings were via China Investment Securities International Brokerage Ltd. The combined net proceeds were HK$136m.

On 24-Jul-2014, Sinoref signed a 60-day MoU for a possible acquisition from Mr Chen, at a price to be determined, of Brilliant King Global Ltd, which held a 65% interest in a company which "supplies and installs parapets" along the roads of Chongqing. With its history, crash barriers are something Sinoref could definitely use.

On 13-Aug-2014, Mr Chen opened a short position in 205.012m shares, and it appears that China Construction Bank was on the other end of that, perhaps holding a call option. It claimed an interest of 410.024m shares but that was 205.012m beneficial and 205.012m security interest, so they were probably double-counting the same shares. As you will see below, this eventually resulted in Mr Chen selling out.

On 22-Sep-2014, the MoU with Mr Chen was extended to 150 days of signing, or 21-Dec-2014.

On 29-Sep-2014, Mr Xu sold 130m shares (8.10%) at $0.51, close to the closing price of $0.50, to a company held by one Calvin Ng Hang Fai (Mr Ng). We know nothing about him.

Hello again, Mr Jiang

Ten days later, on 9-Oct-2014, Howard Jiang Qi Hang (Mr Jiang) bought 205.012m shares (then 12.78%) at $0.30 off-market, just 25 days before the announcement of the acquisition of Time Credit by Sinoref. Mr Jiang bought his shares in Sinoref either from Mr Chen or via CCB, both of which ceased to be interested in the same number of shares. In the Webb-site CCASS Analysis system we can see the shares moving from CCB International Securities Ltd to Tanrich Securities Ltd on 13-Oct-2014.

Mr Jiang has featured in Webb-site Reports before on 11-Mar-2012, in Part 6 of our epic "Raking muck" series. Then, he was involved with a company called China Outdoor Media Group Ltd (COMG, now National United Resources Holdings Ltd, 0254). On 28-Dec-2009 Mr Jiang sold to COMG an almost empty company for HK$1242m in shares and convertible bonds. The total goodwill in the acquisition was $1247m, and COMG wrote it all off by 30-Jun-2013. As we said in our article, based on average market prices over the period of his sales of shares and bonds up to that point, Mr Jiang had raised about HK$1.812bn, retaining a 27.67% stake at the time. On 18-Sep-2013, Mr Jiang sold his remaining 27.12% holding in COMG to Mr Yang Fan for HK$150m, taking the total estimated proceeds to about HK$1.96bn. Meanwhile COMG is left with a worthless business.

On 10-Oct-2014, the day after Mr Jiang's purchase of Sinoref shares, there was another big board change at Sinoref. Ronald Sin Kwok Wai (Mr Sin) was appointed as ED, and Sam Li Yik Sang and Tong Yiu On were appointed as INEDs, while Steve Tsui Siu Hang (an INED since the IPO) and Mr Wong both resigned as INEDs. Mr Sin Was Financial Controller and Company Secretary of China National Culture Group Ltd (0745) from 24-Dec-2010 until 7-Aug-2013. While he was there, that company, then called "China Railsmedia Corp Ltd", also featured in our "Raking Muck" series in 2012, along with COMG.

On 22-Oct-2014 Mr Zhao resigned, and on 28-Oct-2014 Mr Ho resigned, completing the exit of 3 of the 4 directors appointed when Mr Chen was a shareholder. That just leaves Mr Chow.

On 24-Oct-2014, Mr Xu sold his remaining 200m shares (12.77%) off-market at $0.27, a 38% discount to the closing price of $0.435 and far less than he had accepted less than a month earlier. No buyers have disclosed interests, but the same number of shares was deposited into CCASS on 29-Oct-2014 with 3 brokers.

Then on 3-Nov-2014, the acquisition of Time Credit was announced, which as we said above, extracts $140m for $3.6m of net assets in return.

On 10-Nov-2014, Sinoref appointed Ms Yip Sum Yu, aged 24, as NED, saying that she is "a consultant of an investment company". We know nothing about her.

The net result is that currently the only two disclosed shareholders of Sinoref are now Mr Jiang, with 13.09%, and the mysterious Mr Ng, with 8.10%, while the 7-person board includes 2 original directors, one person (Mr Chow) appointed during Mr Chen's shareholding period, and 4 people appointed since Mr Jiang bought in.

An excellent opportunity to miss a profit guarantee

There's one more aspect of Sinoref worth mentioning, from Mr Chen's era. On 7-Mar-2014, Sinoref announced the acquisition of Accurate Trade International Ltd (BVI) from Rainbow Phoenix Holdings Ltd (BVI) for CNY55m, payable in new Sinoref shares at HK$0.62 each. The deal completed on 16-Apr-2014. The vendor was owned by one Evelyn Chua Go. She and her spouse, Mr Hu Jianzhong, also known as Eduardo V. Go, were the guarantors. The underlying subsidiary is Accura Machinery & Manufacturing (Taicang) Co. Ltd (Accura Machinery, PRC), a loss-making company which makes "paper converting equipment and other relating equipment". Prior to the acquisition it was held by Great Wall Machinery & Manufacturing (Philippines) Inc, which has an outdated web site here still showing the Accura name, and another site here.

Accura Machinery made net losses of CNY1.93m for 2012 and CNY1.89m in the first half of 2013.

In the interim report for the 6 months to 30-Jun-2014 issued on 12-Sep-2014, Sinoref said (p8):

"In view of the profit guarantee (the "Profit Guarantee") of the Accura Group of not less than RMB10 million for the year ending 31 December 2014 pursuant to the sale and purchase agreement in relation to the acquisition of Accurate Trade by the Company, the Directors consider that the acquisition will provide an excellent opportunity for the development of future business of the Group and broaden its revenue base.

However, CNY10m of the acquisition price is subject to the Profit Guarantee, and in Note 22 on page 45 of the same report, you will see that the directors contradict their rosy outlook with the following:

"As at the acquisition date, the directors were of the opinion that the profit guarantee would be met and that 20,456,000 shares would be issuable under the contingent consideration share arrangement. However, as at 30 June 2014, based on the latest forecast, the directors are of the opinion that profit guarantee will not be met and adjustment to the contingent consideration is considered necessary. It is estimated that the Company will be required to issue 17,392,000 new shares as the Tranche B Consideration Shares."

In other words, they already expected it to miss the profit forecast, making around CNY8.5m for the year. The Stock Exchange should require the company to explain the contradiction and whether they still expect that many shares to be issued or whether the outlook has deteriorated further.

© Webb-site.com, 2014

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