Toxic Offer

Great Wall Cybertech has kicked off the bad governance year with a proposed toxic "open offer" of 4 new shares for every existing share held, at an 85% discount to market. Either you take it up or get massively diluted. In response to this, the share price crashed 41% today. We first criticised this style of offering in 1999 and the Stock Exchange has yet to close the loophole. We tell independent shareholders how to STOP this deal.

Toxic Offer
2nd January 2002

Oh dear, if today is anything to go by, it looks like 2002 will be just as bad as 2001 for minority shareholders. Great Wall Cybertech Ltd (GWC), whose key products appear to be TVs and losses, has staked its claim to the first bad governance event of the new year, on the first trading day, by announcing a proposed open offer to existing shareholders of 4 new shares for every existing share. The new shares are offered at $0.01 each, an 85% discount to the previous market price of $0.066. The shares crashed 41% to $0.039 in response. Better rename it Great Fall Cyberwreck.

We wrote a detailed article in 1999 which explains what an open offer is and why they should be banned, unless the discount is minimal (10% or less). The points in that article, which compares open offers with the fairer "rights issue" method, are just as valid today as they ever were, and we won't repeat the detail here.

In an open offer, shareholders can either do nothing, or take up their entitlements. They cannot sell those entitlements like they can in a rights issue. Therefore, if the offer is at a large discount to the market price, part of the value of their shares in effect has been transferred to those entitlements, which are then worthless unless they are taken up.

Take GWC's offer as an example: shares were trading at $0.066, but 4 new shares are offered at $0.01 each. Therefore the average theoretical "ex-entitlement" (TEEP) price of 5 shares is $0.0212 per share. That makes the entitlements worth $0.0112 per new share (the difference between the subscription price and the market price), or $0.0448 per old share. That is the value that is transferred to the entitlements.

So if a shareholder fails to take up his or her entitlement, then he simply sees his existing shares drop to the TEEP price, a loss of $0.0448, or 68%, and his percentage shareholding is diluted by a factor of 5. By comparison, in a rights issue, the shareholder can sell the rights in the market, theoretically recovering the $0.0448 of value which they would otherwise lose from the dilution.

Even worse, in this case, the net asset backing of the company at 30-Sep-01 (believe it or not) was $0.75 per share. The issue price is at a 98.7% discount to that, so the net asset backing per share will drop by 79% from $0.75 to $0.158 per share.

No excess entitlements

Unlike some deep-discount open offers, which are bad enough, the GWC offer is made worse by the fact that shareholders cannot apply to take up more than their entitlements of the new shares, thereby absorbing the excess created by those people who fail to take up their entitlements. There will always be some shareholders who are uncontactable, or are foreign-registered, or simply on holiday. They "snooze and lose" which is unfair, but this reallocation of shares is a mechanism which at least means that underwriters only get the stock if there is truly no demand for it amongst those shareholders who hear about the offer.

But GWC has no such reallocation. Instead, the lucky underwriter, First Securities (HK) Limited, gets all the excess entitlements at just $0.01 each. We wonder what they will do with the shares.

The controller

The controlling shareholder, Vandor Profits Limited (VPL) has 30.1% of the company (just above the takeover threshold) and will take up their entitlements, maintaining their stake. Incidentally, the announcement contains a circular definition which fails to spell out the name of VPL. It also bizarrely warns that the company "will not offer fractions" of shares, ignoring the fact that all entitlements will be whole numbers in a 4 for 1 issue!

At the last disclosure, on 12-Jul-00, VPL was 76.64% owned by Macross Profits Limited which in turn was 60% owned by Wu Shaozhang (Mr Wu), the Chairman of GWC, and 40% was acquired by China Everbright Holdings Company Limited (CEHC), which is owned by the PRC Government. That 40% stake came from Chen Weixiong (Mr Chen), a director of GWC, who no longer has a holding. Although this represents an effective sale of shares by a director, Mr Chen did not disclose the price at which he sold his stake.

The accounts state that Mr Wu, CEHC and Mr Wong Kwok Wing (the Vice Chairman of GWC) own all of VPL, which suggests that Mr Wong owns some or all of the remaining 23.36%.

STOP THE DEAL!

The good news is, under Listing Rule 7.24(5), as the offer involves an increase of more than 50% (in fact, 400%) in the share capital, it must be conditional on approval by shareholders in general meeting, with any controlling shareholder (that means VPL) abstaining from voting. So this is one occasion on which your vote can count.

The bad news is that there is no requirement to conduct a poll on such voting (counting each share as 1 vote) so investors must specifically demand a poll to get one. So if you are a shareowner of GWC, we urge you to tell your broker or custodian, to tell HKSCC Nominees Ltd to vote AGAINST the proposed open offer and demand a poll on that resolution. The shareholder' circular and notice of meeting has not yet been posted but the provisional date of the meeting is 28-Jan-02.

By voting against, you will send a clear message to GWC that this behaviour cannot be tolerated. If they want to issue new shares, they should make a normal rights issue and allow everyone the opportunity to either take up or sell their rights.

By the way

That HK$64m they are trying to raise as working capital wouldn't go far anyway. GWC's 50% owned associated company Qingyaun Rowa Electronics Co Ltd (QRE) and its affiliates owe GWC, as of 30-Sep-01, $709m, the bulk of which is trade receivables and more than 90 days overdue. In other words, GWC has been supplying its associate and not getting paid that often. In addition, GWC has been issuing guarantees over QRE's and other associates' borrowing, totalling $298m utilised credit at 30-Sep-01. That adds up to a billion dollars worth of potential trouble.

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Toxic Offer 2nd January 2002

No excess entitlements

The controller

STOP THE DEAL!

By the way

Toxic Offer
2nd January 2002