We warn investors of a bubble in the stock of China Strategic, the 80% owner of the proposed buyer of Taiwan's Nan Shan Life Insurance, partly financed by a massive note issue convertible into 78bn shares at $0.10 each. We publish the placing list and analyse the names in the deal. Finally, we warn investors to avoid 7 companies in the "Chung Nam network", which has lost HK$6.2bn in 5 years.

China Strategic bubble
13 November 2009

There's been much excitement this week about the proposed acquisition by Primus Nan-Shan Holding Co Ltd (PNS) of 97.57% of Nan Shan Life Insurance Co Ltd (Nan Shan), a Taiwanese life insurance company, from American International Group, Inc. (AIG) for US$2.15bn. According to the announcement dated 10-Nov-09, PNS is owned 80% by China Strategic Holdings Ltd (CSH, 0235) and 20% by PFH Holdings Ltd (Cayman), which is the general partner of PFH GP, L.P., which in turn is the general partner of PFH Partnership Holdings, L.P. (Primus Investor), which is an affiliate of Primus Financial Holdings Ltd (Cayman). That complexity probably has something to do with US tax.

Two unnamed Taiwanese commercial banks are expected to provide NT$ debt financing to PNS of up to US$700m equivalent (50% each), of which US$640m will go to the purchase price. That leaves CSH paying US$1,205m for its 80% stake in PNS, and Primus Investor paying US$301m for its 20%.

Bubble warning

CSH intends to raise HK$7.6bn (US$980m) net through a placing of notes convertible into 78bn shares at $0.10 each, and HK$3.96bn (US$511m) net through a placing of 40bn shares at $0.10 each, raising a total of US$1,491m. The placing agent is Kingston Securities Ltd (Kingston Securities).

So CSH should have about US$286m left over after paying for its stake in PNS. It will also issue options over 7.1bn shares at HK$0.10 each vested in 5 tranches over 4 years (with 20% up front), the bulk of which (6.4bn) goes to 2 directors. When exercised, these would bring in HK$710m (US$92m).

The shares of CSH took off on the news. At the end of April they closed at $0.098. On Wednesday they reached a high of $1.00, closing at $0.81, and yesterday (Thu-12-Nov) they closed at $0.71. Upon completion of the deal, exercise of all the options and conversion of all the convertible notes, there would be about 128.8bn shares in issue, which at last night's price values CSH at about HK$91.4bn (US$11.8bn).

Prior to the deal, at 30-Jun-09 CSH has net equity of HK$406.6m and convertible note liabilities of HK$518.1m, so assuming full conversion, adjusted equity was HK$924.7m (US$119m). So taking the fully converted equity, plus the proceeds of the placings and share options, CSH would have combined equity of about US$1,702m (HK$13.2bn) or about HK$0.102 per share.

Keeping in mind that AIG's sale of Nan Shan was the outcome of a competitive process, it seems unlikely that the company is worth significantly more than they PNS is paying for it. But let's be generous, and say that it is worth 1.5 times its net assets, which at 30-Nov-08 were NT$83.4bn (by comparison, Manulife (0945) trades at 1.45 times its 31-Dec-08 NAV). So that would make Nan Shan worth NT$125.1bn (US$3.88bn), and 97.57% worth US$3.79bn, and that's US$1.64bn, or 76%, more than PNS is paying for it. So 80% of that belongs to CSH, or US$1.31bn (HK$10.17bn) or about HK$0.079 per share. Even then, that only stretches CSH's value to about $0.181 per share. So even with a generous valuation, we see a downside of 75% from last night's price. With the deal not certain to complete, it should be trading even lower than that.

We say that's generous because Nan Shan has ongoing issues with its 34,000 agents, as well as a reported potential need for capital to buttress guaranteed-return policies. Nan Shan, which in addition to agents has 4,000 employees, was third largest last year in terms of premium income, which suggests that there are 2 other firms with at least as many employees/agents. Take into account smaller firms and there might be 160,000 people in Taiwan, or about 1 in 60 members of the Taiwan workforce, who do nothing but sell insurance to the other 59. The finance and insurance sector employs 415,000 people in total, according to the National Statistics web site.

Who's in the deal?

The placing list for the share placing is not known, but the convertible note issue was launched back on 20-Aug-09. The 78bn underlying shares (which will be about 60% of the fully-diluted company) are so massive relative to the existing shares that almost all the placees of the note issue have a discloseable "derivative interest" in at least 5% of the existing issued shares. So we have been able to piece together the placing list from filings, and here it is:

Running down the list, with some gaps (updated 16-Nov-09):

We have no information on Daisy Wong Fung Kwan, Viola Mak Siu Hang, Bryant Zhang Yu Tao, Hui Yick Fu or Yan Chi Ping. If you know who any of them is, or have more information on any of the other subscribers, please tell us.

A bit of trivia: Mr Lam married Betty Chong Yuet Wah, a cousin and sister-in-law of Li Ka Shing. She is the daughter of Mr Chong Ching Um, the founder in 1935 of Chung Nam Watch Co Ltd. He was the father of the late Amy Chong Yuet Ming and uncle of Li Ka Shing, who married cousin Amy. In 1989, Mr Lam and his wife founded Qualipak Manufacturing Ltd, which made packaging boxes for watches. In 1994, they sold it to Unisouth Holdings Ltd (now Willie International Holdings Ltd, Willie, 0273) for HK$136m in cash. Mr Lam was MD of Willie from 19-Jul-95 to 20-Jan-99, when he stepped down to chair Qualipak International Holdings Ltd which was spun off and listed on 30-Apr-99. After asset injections and a change of control, this became C C Land.

The Chung Nam network

In 1995 Willie acquired stock and futures brokerages which it renamed Chung Nam Securities Ltd (Chung Nam Securities) and Chung Nam Commodities Ltd (Chung Nam Commodities) respectively, and a shell company which had already agreed to buy a seat on the stock exchange and is now a brokerage called Radland International Ltd (Radland). On 6-May-97 Willie sold 60% of Chung Nam Commodities to CU Investment (Holdings) Ltd (CUIH). They hadn't sold it for long. On 26-Nov-97 Willie agreed to buy Hennabun Capital Group Ltd (BVI, Hennabun), which owned CUIH, from a company which was 52.73% owned by Joan Huang Min Chuan, the mother of Henry Chuang Yue Heng (Henry Chuang), who was already a director of Radland. Henry Chuang became ED of Willie on 1-Apr-98 and Chairman on 25-Oct-99, where he remains. His brother, Eugene Chuang Yue Chien, has never been on any HK-listed boards.

We pause to note that in the PCCW vote-rigging case, the judge held that 132 persons in whose names single board lots were acquired through Chung Nam Securities, and 18 persons in whose names single board lots were acquired through Radland, did so as a result of a plan devised by a Eugene Chuang. The judge also held that a plan had been devised by Pollyanna Chu Li Yuet Wah to induce employees of Kingston Securities and Golden Resorts Group Ltd, their friends and relatives, and clients of Kingston to purchase one to three board lots of shares (a total of 175 shareholders) and to sign proxy forms in favour of the Scheme of Arrangement to privatise PCCW.

In 1998, Willie reorganised Hennabun, which became the holding company of Chung Nam Securities, Chung Nam Commodities and Radland. The reason we are telling you this is that Hennabun subsequently became a financial lavatory down which other listed companies flushed their capital by investing in its shares or convertible notes, and some of those listed companies are or were run by people named in the list above.

We consider Sinolink and Yugang to be on the periphery of this network, rather than in the core. Other peripheral companies which invested in shares or convertible notes of Hennabun included China Sci-Tech Holdings Ltd (0985), Beauforte Investors Corp Ltd (0021), Golden Resources Development International Ltd (0677), China WindPower Group Ltd (0182, then N P H International Holdings Ltd), China Investment Fund Co Ltd (0612) and Hanny Holdings Ltd (0275).

We're going to make this really simple for you. What we call the Chung Nam network currently includes Willie, Heritage, Forefront, two other companies we have not yet mentioned, Mascotte Holdings Ltd (Mascotte, 0136) and Freeman Corp Ltd (Freeman, 0279), and two Chapter 21 investment companies, Radford Capital Investment Ltd (Radford, 0901), and Unity Investment Holdings Ltd (Unity, 0913) which are both managed by CU Investment Management Ltd. Radford and Unity do very little but invest in other companies in the network, and there is a history of inter-dealing between these companies, even though at the times of most such transactions, they have not been "connected" within the meaning of the Listing Rules.

Freeman recently reacquired a controlling stake in Hennabun from Eugene Chuang in a deal which completed on 30-Sep-09. The circular dated 30-Jan-09 contains an accountants report (p157 of PDF) shows that Hennabun lost HK$516.1m in the 3 years and 9 months to 30-Sep-08. Note that we say "reacquired": Freeman first acquired control of Hennabun from Willie back in 2006 (before selling it to Eugene Chuang on 29-Jun-07), so there is another accountants' report in the acquisition circular dated 24-May-06 (p46 of PDF) which shows that in the 2 years ended 31-Dec-04, it lost HK$562.6m. So that means that in the 5 years and 9 months to 30-Sep-08, it lost a total of HK$1,079m. We don't know what they made or lost in the year which passed before completion of the acquisition.

The bulk of this track record was net bad loan provisions of $637.9m. It also made a loss of $195.5m in 2005 on disposal of subsidiaries which owned more loans. At least some of those loans were made to companies in which Willie said, in note 43(b) of its 2003 annual report, "a brother of a director" is also a director and/or substantial shareholder. Perhaps they were referring to Eugene Chuang, brother of Henry Chuang. At the end of 2004, two subsidiaries of Hennabun held loans in the amount of $291.62m, of which $200m had been guaranteed by "a director of Hennabun". During 2005, these and possibly other subsidiaries were disposed of at a loss of $195.5m.

The table below shows that the combined net loss of these companies in their latest financial year (Dec-08 or Mar-09) was HK$3,127m. Over the last 5 years, they have lost HK$6,201m (US$795m). We exclude Mascotte and Forefront before 2007 when they entered the network.

At any given time, large chunks of the stock in these companies (over 30% in most cases) is in the custody of Chung Nam Securities. The Webb-site CCASS Analysis system shows you the current holdings of Chung Nam Securities, including many of the other listed companies mentioned above. The losses are financed by repeated placings of shares and convertible notes (often with each other), and rights issues. The resulting dilution necessitates repeated consolidation (reverse split) of the shares. For example, Freeman has consolidated by 500,000 to 1 since 1998, and Heritage has consolidated by 1,000,000 to 1 since 18-Sep-01. It is difficult to conceive an easier way to lose your money than investing in the Chung Nam network.

© Webb-site.com, 2009

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