A collapse in a hub of the "Chung Nam Network" has wiped about HK$2bn off the balance sheets of at least 11 listed companies, many of which never announced that they had invested in it. We piece together an ugly jigsaw and call on the SFC to investigate and HKEX to wake up and require announcements.

The Joint Global implosion
30 September 2016

There's been an implosion in an unlisted hub at the heart of what we call the "Chung Nam Network", a galaxy of listed companies that investors would do well to avoid, wiping out about HK$2bn of value from the books of at least 11 listed companies. This is a complicated story involving scrutiny of dozens of corporate disclosures to piece together a jigsaw on which regulators should now act, so bear with us.

The birth of Joint Global

On 15-Sep-2015, 11 shareholders, including at least 9 listed companies as we will deduce below, agreed to pool their shareholdings of a Cayman Islands company called HEC Capital Limited (HECC), one of the unlisted hubs in the Chung Nam Network, injecting the shares into a new holding company in the Marshall Islands called Joint Global Ltd (JG). No announcements were made at the time by any of the listed companies involved, several of which we believe breached the Listing Rules by staying silent on the notifiable transactions. We know this now only because a few of the listed companies made disclosures in their subsequent annual reports. Incidentally, the Marshall Islands are better known for explosions than implosions, as a former US nuclear test site, including Bikini Atoll, after which the swimsuit was named. But we digress.

Note 18(ii) of the 2015 annual accounts of GT Group Holdings Ltd (GT, 0263) discloses that in Sep-2015, it agreed with 10 unnamed "independent third parties" to establish JG, swapping each share held in HECC for a share in JG. This deal completed on 2-Oct-2015, and GT's 36.5m shares were 12.98% of JG. The value of those shares was put at HK$215m or about $5.89 per share, the same as a year earlier.

Regulatory note: in our view, GT's acquisition of the stake in JG and the disposal of the stake in HECC should have been treated at least as a Discloseable Transaction under the Listing Rules, because HK$215m was more than 5% of GT's total assets at 31-Dec-2014 and possibly as a Major Transaction as it was about 25.4% of the 5-day average market capitalisation prior to the transaction date.

Note 20(b) of the 2015 annual accounts of Mason Financial Holdings Ltd (Mason, 0273) discloses that in Sep-2015, it swapped 12m shares (1.15%) of HECC for 4.27% of JG, valued at HK$90m. It had acquired the HECC shares by first, in Jul-2015, agreeing to paying HK$100m in cash to HECC for 12% of Gold Mountain Ltd (Gold Mountain) and then, the next month, agreeing to sell it back to HECC in exchange for 12m HECC shares valued at HK$90m, or $7.50 per HECC share, booking a $10m loss. Both transactions were undisclosed until the annual report.

HECC had purchased 100% of Gold Mountain, which had a forestry business, for HK$720m from China Innovative Finance Group Ltd (CIFG, 0412) in a transaction agreed on 21-May-2015 and completed on 5-Aug-2015. So it appears that in the middle of this, HECC had sought funding from Mason, the net result being that Mason put HK$100m into HECC.

Note 18(a) of the 2015 annual accounts of Dragonite International Ltd (Dragonite, 0329) states that on 15-Sep-2015, it pooled its interests in "Company A" with 10 other shareholders to set up "Company C" which would own 26.96% of "Company A". Dragonite had swapped its 2.40% of Company A for 8.89% of Company C. After Webb-site complained to the Stock Exchange about this cryptic description, Dragonite announced that Company A was HECC and Company C was JG. It also said that JG would own 281.2m HECC shares and that the issue completed on 2-Oct-2015.

Regulatory note: in our view, Dragonite's acquisition of the stake in JG and the disposal of the stake in HECC should have been treated as a Discloseable Transaction under the Listing Rules, because each stake was valued at HK$137.5m ($5.50 per share) which is more than 5% of Dragonite's total assets at 31-Dec-2014 and more than 5% of its 5-day average market capitalisation prior to the transaction. The late announcement made no admission of this. Once again, the for-profit Stock Exchange doesn't seem to care.

Dragonite subscribed its 25m HECC shares at $5.50 each on 16-Sep-2014, announced then as a Discloseable Transaction. Dragonite claimed that its 8.89% stake in JG "might facilitate [Dragonite] to be in a better position to have an influence over the corporate actions of [HECC]" - but it failed to say how this might be the case - for example, whether it has any representation on the board of directors of JG, or whether any decisions of JG require Dragonite's approval. We guess not.

Note 16(d) of the 2015 annual accounts of Rentian Technology Holdings Ltd (Rentian, 0885) discloses that on 15-Sep-2015, it swapped its HECC shares for shares in JG, converting 1.73% of HECC to 6.40% of JG, both valued at HK$95.464m. Incidentally, the number of shares is erroneously stated as 108m. It should be 18m. So the book value was about $5.30 per share. Note 11 (a) of Rentian's 2016 interim results states that in the first half of 2016, it disposed of its stake in JG to an "independent third party" in exchange for other unnamed HK-listed shares valued at HK$95m. Lucky them, depending on what they got in return.

Note 20(b) of the 31-Mar-2016 annual accounts of CIFG discloses that during the year, it subscribed 56.8m shares of JG for HK$340.8m, or $6 per share. Although described as a "subscription", this was in practice an asset swap of HECC shares for JG shares. Looking back, on 12-Jun-2014 in a Discloseable Transaction, CIFG subscribed HK$228m for 38m HECC shares, increasing its holding to 56.8m shares. Incidentally, that was the day after HECC had cut its stake in CIFG from 15.59% to 8.51%, thereby avoiding the connected transaction rules as its holding was now below 10%.

Regulatory note: in our view, CIFG's disposal of the HECC shares and the acquisition of the JG shares should have been at least a Discloseable Transaction under the Listing Rules, because the $340.8m value amounts to more than 5% of the total assets of CIFG at 31-Mar-2015.

Note 21(a) of the 31-Mar-2016 annual accounts of NetMind Financial Holdings Ltd (NetMind, 0985) refers only to "Company A" but we can be sure that this is JG. It describes the agreement in which it swapped its 23.8m shares in HECC for 8.46% of JG. It also states that subsequently (up to the year-end), JG issued 8.4m shares to a new investor, diluting NetMind to 8.22%. It also states that JG "purchased" another 47,138,400 shares of HECC "through borrowing", increasing JG's shareholding from 26.96% to 30.11% of HECC by 31-Mar-2016. This is consistent with an increase in the outstanding shares of HECC of the same amount, so the shares were probably new.

So that's 6 of the 11 original shareholders of JG identified: GT, Mason Dragonite, CIFG, Rentian and NetMind. We'll deduce 3 more of the founders below.

Note 10 of the 2016 interim results of Imagi International Holdings Ltd (Imagi, 0585) discloses that on 2-Mar-2016, it subscribed for 6.2m shares of JG for HK$45.198m, or HK$7.29 per share.

Note 4(v) of the 2016 interim report of National Investments Fund Ltd (NIF, 1227) discloses that on 14-Jan-2016, it entered into an agreement with JG which resulted in a holding of 0.78% of JG at a cost of HK$16.038m and the transaction completed the next day. We assume this is a subscription. It accounts for about 2.26m shares of JG.

The implosion

In its interim results for 30-Jun-2016, GT made a startling admission. It's shares in JG were now, in its view, not just worth less, but worthless, and GT has taken a full HK$215m impairment charge. Note 7 states:

"Taking into account the unaudited net asset value of Joint Global as at 30 June 2016, and other relevant factors, full impairment of the value of the investment in Joint Global was made as at 30 June 2016."

Meanwhile, in the interim results of Mason at the same date, Note 7(a) records an impairment of HK$84.521m against its $90m investment in JG, reducing it to $5.479m, or about $0.457 per share. It states:

"The investment has generated substantial losses and the directors are of the opinion that the probability to recover fully the investment would be remote. An impairment loss of HK$84,521,000 has been recognised in profit or loss in view of significant and prolonged decline in the carrying value of available-for-sale financial asset."

Dragonite in its 2016 interim results states that its $137.5m stake was impaired by HK$126.074m "with reference to the latest available financial statements" of JG, reducing it to $11.426m, also about $0.457 per share.

NIF, in Note 4 of its 2016 interim report, states that the net assets attributable to its 0.78% stake in JG are HK$1.763m, but it has reduced the fair value to $1.100m (about $0.49 per share), implying a loss of 93.1% in less than 6 months since it subscribed to JG.

Oh dear. That means that the other shareholders of JG will need to write off all or most of their investments too.

Enerchina's stake in HECC

One HECC shareholder that did not inject its shares into JG is Enerchina Holdings Ltd (Enerchina, 0622), which holds 83,333,333 shares of HECC in its books at cost of HK$500m, or $6 per share. In Note 11(i) of Enerchina's interim results at 30-Jun-2016, there was no change in the book value, and the HECC stake had been diluted only slightly from 7.99% at 31-Dec-2015 to 7.56% at 30-Jun-2016. From this, we can deduce that HECC has not been on a share-issuing binge in the half-year, with outstanding shares only increasing by about 5.7% from about 1043m at 31-Dec-2015 to 1102m at 30-Jun-2016.

So unless Enerchina has got its accounting wrong, we can assume that HECC's net asset value per share has not been materially impaired during the half year.

Two more probable JG holders

Enterprise Development Holdings Ltd (ED, 1808) is probably another victim of the JG implosion. On 8-Oct-0214, it subscribed HK$48m for 8m HECC shares at $6 each. The 2015 annual report, note 17, records unlisted equities at cost but doesn't say what they are. We suspect by then ED had swapped its HECC shares for JG shares, because the interim report at 30-Jun-2016 uses nearly identical language to GT in Note 11:

"Taking into account the unaudited net asset value of the particular investee as at 30 June 2016, and other relevant factors, full impairment of the value of the investment in the particular investee was made at 30 June 2016".

So we'll make ED the 7th of the original 11 shareholders of JG that we have identified.

Regulatory note: the only difference between the ED and GT statements is the replacement of the words "Joint Global" with "the particular investee". That's because ED never admitted to having swapped its shares in HECC for shares in JG, which should have been a Discloseable Transaction under the Listing Rules because $48m was more than 5% of ED's total assets at 31-Dec-2014 and more than 5% of ED's market capitalisation prior to the asset swap.

We can also infer that Hao Tian Development Group Ltd (HTD, 0474) is another casualty of the JG implosion. On 18-Sep-2012, it subscribed HK$30m for 5m HECC shares at $6 each, then on 22-Jul-2013 it bought 45m shares at $6 each for HK$270m from Ristora Investments Ltd (Ristora, of which more below). HTD booked these at $272m, presumably including fees, taking the total book value of the 50m shares to $302m. Although the investment was not named in subsequent reports, nothing changed in the "unlisted equity securities" until the HTD annual accounts at 31-Mar-2016, where we see in Note 21 an impairment loss of $265.178m, slashing book value from $302m to $36.822m or $0.73644 per share. Assuming Enerchina is correct that HECC is not impaired, HTD probably holds shares in JG rather than HECC.

So that makes HTD the 8th of the original 11 shareholders of JG.

Regulatory note: if HTD swapped its 50m shares of HECC for 50m shares of JG on 15-Sep-2015, then this should have been a Disclosable Transaction under the Listing Rules because $302m was more than 5% of HTD's 5-day average market capitalisation.

When did the implosion occur?

We know that Imagi paid $7.29 per JG share as recently as 2-Mar-2016, so either it massively overpaid, or the implosion appears to have occurred in the last 29 days of the first quarter, based on HTD's impairment at 31-Mar-2016. At the latest price of $7.29, the original 281.2m shares swapped by the original 11 shareholders of JG were worth $2050m, but at the apparent NAV of $0.457 per share at 30-Jun-2016, they are now only worth $128.5m. Nearly HK$2bn of value just vaporised.

Remember that when JG was formed, it held a 26.96% stake in HECC, so the whole of HECC was implicitly worth $7603m.

So how exactly did JG lose so much value? Join us as we investigate further.

First, we need to explain another unlisted network hub, Freewill Holdings Ltd (Freewill, Marshall Islands).

About Freewill

On 20-Jun-2014, Freeman Fintech Corporation Ltd (Freeman, 0279) and Mason (then known as "Willie International Holdings Ltd") pooled their HECC shares into a new vehicle, Freewill (presumably named after the two firms). At the time, Freeman and Mason owned 18.74% and 9.96% of HECC respectively, so the combined holding of Freewill was 267,113,988 shares (28.70%) of HECC, and Freeman and Mason owned 65.3% and 34.7% of Freewill respectively. The Freeman announcement is here and the Mason announcement is here.

On 2-Jul-2015, Skyway Securities Group Ltd (Skyway, 1141) subscribed 80m shares of Freewill for HK$440m. At the same time, Enerchina subscribed 38m shares of Freewill for HK$209m. Both deals, at $5.50 per share, were announced by Freeman. This implicitly valued the HEC shares at $5.50 each.

As a result, Freewill was now a 4-way hub, owned 45.29% by Freeman, 24.07% by Mason, 20.77% by Skyway and 9.87% by Enerchina. The announcements also disclosed that Freewill's unchanged number of shares in HECC had accreted to 29.04% (presumably due to a small share buyback by HECC) and Freewill also owned a HK money-lender, Longtop Enterprises Ltd (Longtop).

We pause to note that on 17-Jun-2015, National Investments Fund Ltd (NIF, 1227) borrowed HK$30m from Longtop, secured by 8.2m shares (0.89%) of HECC and 210 shares (5.11%) of Co-Lead Holdings Ltd (Co-Lead). On 28-Jul-2015, these shares were transferred to Longtop to settle HK$22.5m of the debt. This was disclosed in the 2015 annual report of NIF, notes 19 and 26.

Next, on 17-Jul-2015, China Opto Holdings Ltd (China Opto, 1332) subscribed 14.55m shares of Freewill for HK$80.025m, or $5.50 per share. Also, between 2-Jul and 17-Jul, Mason subscribed another 22m Freewill shares for $121m. So after this deal, Freewill was now a 5-way hub, owned 41.37% by Freeman, 27.20% by Mason, 18.97% by Skyway, 9.01% by Enerchina and 3.45% by China Opto, and it had raised HK$850.025m in cash. By this stage, Freewill owned 32.49% of HECC. It also held 16.49% of Cordoba Homes Ltd (Cordoba, BVI).

On 24-Nov-2015, Dragonite joined the party, buying 32,727,273 existing shares of Freewill for HK$180m ($5.50 per share) from HEC Development Ltd (HECD, BVI), which before that owned 116m Freewill shares. Previous filings show that HECD was 100%-owned by HECC, although this was not disclosed in the announcement.

Regulatory note: it is unclear how HECD acquired these Freewill shares and from whom, but they were issued by Freewill in Sep-2015, according to Note 18 of Mason's 2015 annual accounts. That note says that the resulting dilution of Mason's stake from 27.20% to 21.33% caused it a loss of HK$133.742m. That implies a huge discount of about $491.7m in the issue price of those 116m shares, or a discount of $4.24 per share relative to the net asset value of Freewill. According to Dragonite, at 30-Sep-2015, the unaudited NAV of Freewill was $6.34 per share. The SFC should investigate why this discount was granted and to whom.

At 24-Nov-2015, Freewill owned 32.99% of HECC.

At 31-Dec-2015, Mason's share of the net assets of Freewill was $485.872m, or about $4.236 per Freewill share.

Note 14 of Freeman's 31-Mar-2016 annual accounts shows that the net assets of Freewill were $2,222.1m, or about $4.054 per Freewill share.

Skyway - the 9th JG member

From the Freewill analysis, we can infer that Skyway is probably the 9th victim of the JG implosion as follows.

On 30-Jun-2014 Skyway subscribed HK$228m for 38m shares (then 3.92%) of HECC at $6 per share. This added to 3m shares that it subscribed on 22-Jan-2013 (see note 22 of the 2013 annual accounts) at the same price, making a total book cost of $246m for 41m shares (then 4.23%).

The Skyway annual accounts at 31-Mar-2016 made an impairment charge of $327.782m on two unnamed investees.  The available-for-sale investments in Note 20 are Freewill (book cost $440m) and either JG or HECC (book cost $228m). We know from Freeman that the NAV of Freewill had declined from Skyway's subscription price of $5.50 to about $4.054, so if that is what Skyway used to assess its stake in Freewill, then the impairment on Freewill would be $115.68m. That leaves an impairment of $212.102m on JG or HECC, slashing the book value to $33.898m or $0.827 per share.

Regulatory note: if Skyway was one of the 11 shareholders who agreed to swap its shares in HECC for shares in JG on 15-Sep-2015, then at $228m this should have been a Discloseable Transaction under the Listing Rules, being more than 5% of total assets and more than 5% of market capitalisation.

Freewill and JG ownership

In the 6 months to 30-Jun-2016, according to Mason's interim results, Freewill issued another 35.4m shares to several investors. Mason's 20.01% share of net assets of Freewill was booked at $448.102m at 30-Jun-2016, implying NAV of $3.907 per Freewill share and $2239m for 100% of Freewill. Meanwhile, in Enerchina's interim report for the same date, it booked an impairment loss and reduced the value of its 38m Freewill shares to $4.20 per share.

Note 10 of the 30-Jun-2016 interim results of Imagi discloses that on 2-Mar-2016, it subscribed 7.5m shares of Freewill for HK$37.725m, or $5.03 per share.

Note 4(vii) of NIF's interim report at 30-Jun-2016 discloses that on 14-Jan-2016 (the same day it invested in JG and in 2 other companies in the network) it entered into an agreement with Freewill which resulted in a 0.54% stake at a cost of HK$15.95m and the deal completed the next day. We'll assume that is a subscription. The stake amounts to about 3.1m Freewill shares.

Webb-site calculates that there were 573,063,988 Freewill shares at the end of that period. So in summary, at 30-Jun-2016, the holders of Freewill were:

Name % of Freewill
Freeman (0279) 30.44
Mason (0273) 20.01
HECC 14.53
Skyway (1141) 13.96
Enerchina (0622) 6.63
Dragonite (0329) 5.71
China Opto (1332) 2.54
Imagi (0585) 1.31
NIF (1227) 0.54
Others 4.33
Total 100.00

So now you see there were two hubs holdings HECC shares: JG, which held 30.11% at 31-Mar-2016, and Freewill. Based on the NetMind and Enerchina data, we calculate that Freewill's stake, if unchanged since 24-Nov-2015, would have been diluted to about 24.50% at 31-Mar-2016.

From the above analysis, Webb-site calculates that there were 289,600,000 JG shares at 31-Mar-2016 and it was owned as follows:

Name % of JG
CIFG (0412) 19.61
HTD (0474) 17.27
Skyway (1141) 14.16
GT (0263) 12.60
Dragonite (0329) 8.63
NetMind (0985) 8.22
Rentian (0885) 6.22
Mason (0273) 4.14
ED (1808) 2.76
Imagi (0585) 2.14
NIF (1227) 0.78
Others 3.47
Total 100.00

So, again how did JG implode, while apparently leaving HECC relatively unscathed?

Ownership changes in HECC

What we can tell you is that the stakes in HECC have been shifting in the last few months and JG has disposed of part or all of its holding in HECC.

The trail of evidence is as follows. On 29-Feb-2016, Imagi announced a deal in which it would issue 1.9bn new shares (16.01%) to HECC in exchange for 455.5m shares (0.62%) of HengTen Networks Group Ltd (HengTen, 0136). HECC duly filed a disclosure of interest in the Imagi shares at that date, but there were no shareholders with 1/3 or more of HECC who made filings of a deemed interest.

However, effective 7-Mar-2016, that changed, when Easy Rider Investments Ltd (Easy Rider) made a filing disclosing an interest of 57.57% in HECC and hence an interest in the same Imagi shares. A filing at the same date shows that Karen Lo Ki Yan (Ms Lo), via her wholly-owned company, Ristora, owned 55% of Easy Rider, while another filing shows that Freewill owned the other 45% of Easy Rider. So apparently, Ms Lo and Freewill had pooled their stakes in HECC.

The next day, 8-Mar-2016, there was some movement, perhaps a dilution, which resulted in Easy Rider's stake in HECC reducing from 57.57% to 55.08%, shown in this filing.

The next change came on 25-Apr-2016, when Easy Rider's stake in HECC jumped to 84.23%, an additional 29.15%, as shown in this filing. We already know from Enerchina's accounts that HECC's outstanding shares only grew by about 5.7% in the first half of 2016, so this additional stake must have come partly or entirely by acquiring existing HECC shares. Furthermore, since Enerchina owns 7.56% of HECC, and Easy Rider now owned 84.23%, that only leaves 8.21%, so JG must by then have disposed of most or all of its stake.

Also by that date, Ms Lo's stake in Easy Rider had increased from 55% to 70.97%, while Freewill was reduced from 45% to 29.03%. So Freewill's attributable stake in HECC barely changed, from 24.79% on 8-Mar-2016 to 24.45% on 25-Apr-2016. It seems likely that Ms Lo injected funding into Easy Rider to purchase the HECC shares (or equivalently, injected the shares) in exchange for new shares in Easy Rider.

We know from Schedule 1 of a subscription agreement dated 18-Sep-2012 that Ms Lo, via Ristora, then held 151.25m HECC shares. On 22-Jul-2013, Ristora sold 45m HECC shares to HTD for HK$270m, cutting her stake to 106.25m shares. That would be about 10.2% of HECC at 31-Dec-2015, if she still held them.

Ms Lo is the spouse of Eugene Chuang Yue Chien, who according to Tatler is the "Chairman Emeritus and Founder" of HECC.

Back to JG

The question that the SFC should be investigating is how did JG lose so much money so fast? Who were its directors? Given that Enerchina regards its HECC shares as unimpaired, did JG sell the HECC shares for less than they were worth, or did JG make some other atrocious investment(s) that eroded the NAV of JG and forced the sale of HECC, and to whom were the shares sold? The above analysis shows that directly or indirectly, Easy Rider ended up acquiring JG's shares in HECC and JG ended up nearly worthless.

The other scenario is of course that HECC has indeed lost value itself, in which case Enerchina needs to make an impairment provision.

Given the opacity of this network, that is as far as Webb-site can go with public data. It is time for the SFC to step in and use its statutory powers of investigation on JG and its listed corporate shareholders. They should also be looking at the apparent dilution of Freewill at a massive discount, which damaged its listed corporate shareholders.

Meanwhile, the Stock Exchange should get off its backside and get the listed companies in the "regulatory note" boxes above to make the proper announcements about their asset swaps, and sanction them for failing to have done so.

© Webb-site.com, 2016

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