Veto COS Loans to CNOOC
26 October 2004
There they go again. In a circular dated 21-Oct-04, China Oilfield Services Ltd (COS, 2883) proposed a series of waivers from the Listing Rules on connected transactions with its parent group, which require the approval of independent shareholders. The existing waivers, granted by the Stock Exchange before the company listed in 2002, will expire on 31-Dec-04.
We don't think that separate listings of companies which are so dependent on their parents for business makes sense, but now that COS is listed, you have to deal with it as it is. Given the nature of COS's business, most of the waivers are necessary and we would have no objection to them if proposed separately. For example, most of its turnover comes from providing drilling and other services to its state-owned parent, China National Offshore Oil Corporation (CNOOC) and CNOOC's listed subsidiary, CNOOC Ltd (CNOOCL, HK:0883, NYSE:CEO).
However, COS has bundled all of these waivers into a single yes-or-no shareholder vote, and the bundle includes a highly offensive proposal to renew and enlarge the ability of COS to lend money to its parent group. This is disguised as an ability to "deposit" money with CNOOC Finance Corporation Ltd (CNOOCF), described as a "non-bank finance" company, which is 62.9% owned by CNOOC and 31.8% by CNOOCL.
You won't find any warning in the current circular, which we think is a material omission, but the risk factors section of the IPO prospectus of COS makes clear:
"Our connected transactions with [CNOOC Finance] will include deposits of our funds... This non-bank finance company has the authority to engage in a variety of finance and investment activities including investments in equity securities, debt securities and real estate as well as borrowings and guarantees. It may also engage in CNOOC intra-group lending. Our deposits will not have the protection of any security interest or guaranty from CNOOC."
Under the existing waivers, the maximum amount COS could lend to CNOOCF was 10% of the previous year's turnover. They came close to that limit, with the daily balance peaking at RMB255m during 2003. Now, COS is seeking to expand that 4-fold, with a cap of 40% of the previous year's turnover in each of the next 3 years, subject to limits of RMB1,048m in 2005, RMB1,177m in 2006 and RMB1,323m in 2007 (an increase of about 12% each year).
There is no excuse for this behaviour. China has a banking system. If a company has surplus cash which will be needed in the near term, then it should put it in a bank or buy government treasuries. If it has surplus cash with no foreseeable usage, it should be returned to all shareholders as a dividend, not siphoned off to one of them as a loan. Lending money to its parent is exactly what got Guangdong Kelon and numerous other companies into such a mess. It's not a question of whether the terms of the loans are fair and reasonable (they may even be better than bank interest rates). What matters is the unreasonable risk that COS is taking by mixing its funds with the parent group's, and you won't find that discussed anywhere in the circular.
If any of this seems familiar, it is because we warned about a similar transaction in April in which COS's sister company, CNOOCL, sought and obtained independent shareholders' approval for loans to CNOOCF. The timetable was so compressed that a number of ADR holders who contacted us did not even know about the meeting and had not received any notice from the depository. The vote was 92.3% in favour, but the turnout was only 21.9% of shares eligible to vote.
In a similar feat of timing, the CNOOCL circular was dated 8-Apr-04, the day before Easter, but not filed with HKEx until 13-Apr-04, the next working day, shrinking the effective voting period. This time, the COS circular is dated 21-Oct-04, the day before a 3-day weekend, but was not filed with HKEx until lunchtime yesterday, 25-Oct-04. The meeting takes place in Beijing at 10:00 on 5-Nov-04, and the central depository, CCASS, will stop accepting custodian instructions on Wednesday 3-Nov-04, and custodians in turn will set a shorter deadline for their clients. You have less than one week to vote, so vote now.
Vote against bundled proposals
As we said earlier, the proposed loans to CNOOC group are bundled with other proposals, which on their own would make sense. Do not be intimidated by this. If you veto the bundle as we recommend, then COS can still come back with unbundled proposals for the things they really need, such as providing drilling services to CNOOC. So vote AGAINST resolution number 2 at the EGM. If you need help with voting procedures, see our voting guide.
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