The all-or-nothing nature of the share alternative, now worth 23% more than the cash offer, means that CCASS, which holds almost all the public shares in IDS, cannot offer the share alternative to its participants. Webb-site urges Li & Fung and IDS to amend the scheme to allow registered holders to make partial elections for shares. Otherwise, if you snooze, you lose.

Li & Fung/IDS offer has sting
24 September 2010

Li & Fung Ltd (Li & Fung, 0494) is proposing to privatise Integrated Distribution Services Group Ltd (IDS, 2387) by way of a scheme of arrangement, as explained in this offer document of 14-Sep-2010. The offer is subject to approval by independent shareholders, requiring at least 75% of voted shares and a simple majority of the number of shareholders, with not more than 10% of all independent shares being voted against. Shareholders are offered HK$21 per share in cash, but can elect instead to receive 0.585 new Li & Fung shares for each IDS share. Li & Fung closed on 22-Sep-2010 at $44.10, valuing the share alternative at about $25.80, a 22.9% premium to the cash offer.

This article is not about the merits of the proposal, but about the bad way in which it is implemented. Under the current terms, shareholders who want the share alternative must elect for that in respect of all of the holding, rather than being allowed to tender some shares for cash and the rest for scrip. If no election is made, they will get cash.

This is a huge problem because, like most listed companies, almost all of the publicly held shares are legally registered in the name of just one shareholder, HKSCC Nominees Ltd (HKSCCN), the nominee of the Central Clearing and Automated Settlement System (CCASS) and is owned by Hong Kong Exchanges and Clearing Ltd (HKEx, 0388). Independent shareholders own 55.08% of IDS, and 51.93% is in CCASS as shown in the Webb-site CCASS Analysis system. Since HKSCCN cannot elect for shares in respect of only part of its holding, CCASS cannot make the share alternative available to CCASS participants, including banks, brokers, custodians and direct investor participants.

So to benefit from the full offer value, assuming that the scrip remains worth more than the cash, beneficial shareholders must withdraw their stock from CCASS and transfer it into their own names, pausing at the stamp duty office to get an exemption (if they can prove that there is no change in beneficial owner) and then taking the certificates and transfer forms to the registrar. While individuals living in HK are capable of doing this with some effort (and the assistance of their brokers who hold the stock), it may be harder for overseas individuals who cannot easily sign and handle the paperwork.

For institutional investors, the situation is worse, because most of their stock is held in CCASS by custodians. If a custodian has more than one client, then simply transferring the stock from HKSCCN to the custodian will not solve the problem - the shares will need to be transferred to their clients instead. Many of these clients may be offshore entities managed by offshore managers. Some custodians participants in CCASS may hold shares as a sub-custodian for an overseas master custodian, so they wouldn't even know who to transfer the shares to. The top 10 CCASS accounts hold 98.00% of the CCASS holdings.

By ignoring the effects of nominee shareholdings, Li & Fung has caused a huge amount of paperwork, made it very difficult for investors to elect for the more valuable share alternative, and penalised those who are unaware of the problem and leave their stock in CCASS or other nominee names. Li & Fung has in the past earned itself a reputation as one of the better-governed companies in HK, and this problem may have arisen due to an oversight. There was no mention of the problem in the offer announcement of 12-Aug-2010, but it appears in the offer document a month later (page 15), so it probably dawned on them in between. Their adviser, J.P. Morgan Securities (Asia Pacific) Ltd, should have known better from the outset.

However, it is not too late to change this. The shareholders' meeting is on 7-Oct-2010. Webb-site urges Li & Fung and IDS to amend the scheme to allow registered shareholders to elect for the share alternative in respect of any number of shares in their shareholding. If necessary, they should delay the shareholders' meeting to allow this. The amendment will then allow HSCCN to elect part (not all) of its holding for shares, and in turn this will allow CCASS to make the share alternative available to its participants, and nobody will have to withdraw their stock from CCASS. It will also protect investors who are unaware of the problem. Otherwise, they will be victims of "snooze and lose", receiving only the cash payment, currently at a big discount to the share alternative.

Such an amendment would not change the maximum value of the offer and is manifestly in the interests of all independent shareholders, particularly those who are unaware of the problem, so we expect that the SFC's Takeover Executive would consent to such a change.

If Li & Fung does not revise the scheme, then there will be a brief window after the shareholder vote, from 8-Oct to 18-Oct, for beneficial owners to withdraw their stock from CCASS, get the transfers stamped or exempted from stamp duty, and lodge them with the registrar. It would be interesting to see which CCASS participants have holdings in CCASS when the music stops, and are thus forced to receive the cash offer by default.

©, 2010

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