Takeunder Code

Three recent "takeunders" of Beauforte Investors, China Internet Global Alliance and Tung Fong Hung have reminded investors how ineffective Hong Kong's takeover code is. In each case, a buyer has been willing to pay a substantial premium for a stake which, while under 35%, is clearly enough to achieve control without making a general offer. Webb-site.com urges the SFC to reduce the threshold for these "takeunder" transactions.

HK's Takeunder Code
18th December 2000

It's right up there as General Principle 2 of the SFC's Hong Kong Takeover Code (HKTC), just after General Principle 1:

What do we mean by "control"? That is where takeover codes differ. In the UK, where the code was first born, it is 30%. In Singapore, it is 25%. Malaysia, 33.3%. In Australia and Canada, it is 20%. Even the PRC apparently sets the level at 30%. But in Hong Kong, the HKTC says:

As a practical matter, control is demonstrated when a shareholder can achieve and maintain a majority representation in the boardroom. Another strong indicator of whether a person believes they are acquiring control by purchasing a stake is whether they are paying significantly more than the market price of the shares, since the market price reflects a discount for the lack of control. You don't buy shares in the market and expect to call the shots in the boardroom.

With that in mind, Webb-site.com takes you through three cases from the last three months which demonstrate clearly that the HKTC's 35% takeover threshold is too high. In each case, a "takeunder" has been achieved by one or more purchasers who buy more than 30% but less than 35% of the target, in each case at more than a 100% premium to market price, and in each case without making a general offer.

Case 1: Blown out by Beauforte

On 9-Oct-00 it was announced that The Wharf (Holdings) Ltd (Wharf) was selling 34.87% of Beauforte Investors Corporation Ltd (Beauforte) to Wonson International Holdings Ltd (Wonson).

The price of HK$298.15m, or about $29.20 per share, was a premium of 107% over the closing price of $14.10 on 5-Oct-00, and a premium of 39% to the consolidated net asset value of $21.07 per share at 31-Dec-99. Beauforte was essentially a shell, with most of its assets either in cash or invested in Wheelock/ Wharf group companies. These investments are believed to have been sold prior to the sale of Wharf's stake in Beauforte.

Adjust for the interim retained profit of $6.2m for the 6 months to 30-Jun-99, and you have net assets of $623.2m. Wonson's share of that would be $217.3m. So in round terms, it was paying an HK$80m control premium to net assets for Beauforte, which just so happens to be the amount of the deposit on the deal.

Wharf actually held 49.99% of Beauforte, and by completion of the sale of 34.87% to Wonson on 24-Nov-00, Wharf had placed out the balance of it shares to placees who were "independent of and not acting in concert with" Wharf or Wonson. All the directors (including the non-executive directors) of Beauforte resigned and were replaced with Wonson appointees.

Case 2: Close, but no CIGAr

In another recent takeunder transaction, on 29-Sep-00 it was announced that Mr Oei Hong Leong, who owned 46.27% of China Internet Global Alliance Ltd (CIGA), was selling 29.00% of it to two listed companies. 11.55% was sold to Hanny Holdings Ltd (Hanny) and 17.45% to Paul Y - ITC Construction Holdings Ltd (Pauly).

Hanny had also agreed to buy 5.90% of CIGA from a company called Namble Ltd, taking Hanny's stake to 17.45%, the same as Pauly, and the combined stake to 34.9%. A separate announcement from Hanny revealed that Namble was owned by Hutchison Whampoa Ltd (Hutchison), controlled by Mr Li Ka-shing. Some people never miss out on a deal.

Hanny and her sisters

If Hanny and Pauly sound like siblings, well they almost are. ITC Corporation Ltd (ITC) owns 21.14% of Hanny and 40.79% of Pauly. The SFC would almost certainly assume them to be acting in concert, so they had to stay under the 35% takeover threshold to avoid making an offer.

Hutchison held another 3.51% of CIGA, and Mr Oei held 17.27%. So each had sold the same 62.7% proportion of their shareholdings at the premium price. Completion of the sales by Mr Oei took place on 11-Oct-00 and completion by Hutchison was due on 16-Oct-00. The rest of Mr Oei's stake was placed out with third parties on 9-Oct-00 and Hutchison was to do likewise.

As a term of the deals, Mr Oei caused a board meeting of CIGA to take place on 11-Oct-00 at which 5 representatives of Hanny and Pauly were appointed to the board as executive directors, outnumbering the existing 3 executive directors. There are also two independent non-executive directors and Mr Canning Fok of Hutchison remains on board.

The price on the deals with Hanny and Pauly was $0.80 per share, for a total purchase price on the 34.9% stake of HK$1,278m, of which 50% was deferred as a promissory note for 6 months bearing interest at 7.5% per annum. The price represents a premium of 119% to the market price of $0.365 per share on 26-Sep-00. It was close to CIGA's unaudited net tangible asset value of $0.84 per share at 30-Jun-00.

CIGA has had something of an identity crisis this year, starting the year as China Strategic Holdings Ltd, then catching the internet wave and renaming itself to CIGA, and shortly to be renamed back to its old name. Like an excited electron, it jumped briefly into a higher energy state before losing a significant quantum of value and falling back to its ground state.

Case 3: Tung Fong Hung

Close on the heels of the CIGA deal, ITC announced on 10-Nov-00 that it had sold its 33.98% stake in Tung Fong Hung (Holdings) Ltd (TFH) to a company called Mainland Talent Developments Ltd, which is owned 50% by Ms Karen Lo Ki-yan and 50% by Ms Cindy Yau Shun Tek.

The price was HK$180m, or about $0.743 per share, a premium of 207% to the closing price of TFH of $0.242 on 8-Nov-00. A look at the accounts shows that net tangible assets of TFH at 31-Mar-00 were $0.550 per share. So the price was a 35% premium to net asset value, or in dollar terms, a premium of HK$47m above net assets.

As a term of the deal, all the existing directors of TFH resigned on 13-Nov-00 and the purchaser appointed its own representatives instead.

At the same time, TFH sold a 49% interest in Tung Fong Hung Investment Ltd (TFHI) to CIGA for $44.1m. As you have already learned, CIGA was by then was in aggregate 34.9% owned by Hanny and Pauly. CIGA also granted TFH a put option to sell the balance of 51% of TFHI for $45.9m at any time in the next 2 years. The price was based on a 5.3% discount to net assets of TFHI.

TFHI is the intermediate holding company of TFH's principal subsidiaries engaged in Chinese medicine, food supplements, health products, pharmaceutical business and internet business. TFHI accounted for 94% of the turnover of TFH in the year to 31-Mar-00 and was loss-making. The rest of TFH's business is mainly property investment.

The deal essentially allows TFHI to remain under its existing management because CIGA retains the right to appoint 2 out of the 4 directors, and to approve any changes to the board, amongst other things. At the same time, TFH can claim to have a continuing business through 51% subsidiary TFHI (unless and until it exercises the put option) which helps to maintain its listing.

What it all means

Three cases in three months, and we could tell you of many more in this and previous years. If you still doubt that anyone can control a company with less than 35%, then remember that Mr Li Ka-shing did exactly that with Cheung Kong until earlier this year, as did Hutchison with Hong Kong Electric until moving through 35% a few years ago, and as does Henderson Investment with Hong Kong and China Gas (currently 33%).

34.9% has been demonstrated time and again as a large enough block to justify a substantial control premium. If a buyer thought they were getting only fleeting control, with directors likely to be replaced against their will, then they would not be willing to pay that premium in the first place. Clearly then, the HKTC's idea of control is way out of line with the realities of the market.

We believe that the risk of outside interference to a controlling shareholder only really becomes significant below 25%, with a more subjective element between 25% and 30%. Above 35%, it is very rare to have any outside interference with the way you run a company. Therefore at the very least, the HKTC should lower the threshold to 30%, in line with the UK and the mainland, and see how it goes for a couple of years before considering a further reduction to 25%.

We can always expect that some people will simply fail to disclose all their shareholdings in order to avoid making an offer when they have bought control of a company. While that may involve the offence of lying to the regulators, it is easy to do and difficult to detect. But that same group of people would be just as likely to hide shareholdings above 35% at present, so that is no argument for maintaining the threshold at a level which bothers nobody. It is an argument for better enforcement.

Transition provisions

Whenever a threshold is moved, the question of what to do with people between the old and new thresholds arises, in this case between 30% and 35%. The answer is simple - any subsequent increase in a holding between these levels, where that holding existed prior to the new threshold taking effect, must give rise to a takeover obligation, just as it would if the person had gone through 30% for the first time.

If such a transition provision is not put in place, then we would see a rush of substantial shareholders increasing their stakes from below 30% to just above it prior to the threshold reduction from 35%, in order to avoid ever passing through the new 30% threshold and having to make a bid.

Out of Control

When you are an investor in a company, and control changes hands, you expect to be paid for it. You don't expect to see larger shareholders rewarded for cutting you out of the deal, taking all the control premium for themselves. If that premium were spread amongst all shareholders, it would certainly be lower in percentage terms, but it would also provide the equal treatment that Hong Kong must strive for if it wants to mature into a world-class market. It is time to move beyond the lip-service approach to takeover regulation.

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HK's Takeunder Code 18th December 2000