Global Tech's Wreck
10 February 2003
As we've said before, when a Hong Kong company incorporates the words "Global" and "Tech" into its name, you can be fairly certain that it is neither global in scope nor possesses any great technology. Such is the case with Global Tech (Holdings) Limited (GT, 0143), a distributor of mobile phones to mainland China for the likes of Samsung and (formerly) Nokia. Pushing boxes is not high-tech.
GT was listed on 9-Apr-99 in an IPO of 100m shares at HK$1.80 per share (or $0.18 per share after a 10:1 split). The IPO represented 25% of the enlarged company, and included a secondary listing in Singapore, with 17.75% of the offer being placed there. The shares soared into the mobile stratosphere, reaching a high of $16 ($1.60 post-split) in Mar-00, when it was briefly worth $6.5bn. With the shares down to $11.25 in Sep-00, Deutsche Bank took them on a roadshow, sang the praises of the growing Chinese mobile market, and set a price target of $18.50 ($1.85 post-split). "One of the cleanest and most attractive China stocks we have analysed for some time" wrote their analyst, since departed. On Friday 7-Feb-03, the shares closed at $0.085.
At IPO, GT was chaired by Johnny Sze Tsang Fai (Mr Sze), and his brother, Timothy Ethan Sy Ching-tang (Mr Sy) was Vice Chairman. Their family trust owned 69.75% of the company, and a mystery "independent third party" held another 5.25% through a Bahamas company.
The first warning sign on GT was the very generous bonus arrangement for directors, which was clearly disclosed in the IPO prospectus. The bonuses were based on "profit after minority interests but before taxation and extraordinary items" (PAMIBT) and calculated as follows:
|Excess over $200m||15%|
This was subject to a cap at 10% of the PAMIBT. So did they stick to that? Take a look at the table below:
Note: as minority interests were always loss-making, we have excluded them from the calculation, since otherwise the directors would be rewarded for higher losses in the subsidiary, which clearly is not the intent.
As you can see, GT breached the bonus limit in the first two years. The only way to get the calculations below 10% is if you adjust PAMIBT to add back the bonuses before dividing the total into the bonuses - then you get 9.98% and 9.81%, but that is not what the prospectus said would happen. Either the prospectus was misleading, or the bonuses breached the contractual limit. The Stock Exchange does not appear to have noticed this.
Secondly, did you notice that we labelled the results for 30-Sep-01 as "Original"? That's because they were restated in 2002, to include a $120m write-off of goodwill on a 51%-owned loss-making subsidiary called Sino Media Group (SMG) Ltd (SMG, formerly known as Chinese Sports Program Syndicating Co Ltd). Even though the 2001 profit was restated and reduced by $120m, the directors didn't hand back their 15% of it last year. The actual results are as follows:
The acquisition of SMG was announced on 19-Jun-00, although a letter of intent had been announced as early as 27-Jan-00. Initially, the target was described as "an internet and network company", but 5 days and several newspaper stories later, GT came clean - it was a TV advertising company, which on 1-Oct-99 entered into an 8-year agreement effective from 1-Jan-00 with a PRC company called Tianjin Zhongti Film & Television Co Ltd (TZFT) to buy and re-sell advertising space on a daily evening programme known as China Sports Broadcasting Network, to be broadcasted via CETV-1, a state-owned TV channel. SMG would also post real time sports news on its own web site, and that was the feeble justification for the deal - GT planned to become a WAP mobile phone internet content provider.
SMG had net liabilities at 31-Mar-00 of HK$12.52m, and would have to pay a yearly fee for the advertising rights of RMB15m (HK$14.1m), escalating at 5% per annum. Despite the ink on the advertising deal being barely dry when negotiations began, the vendor, Mr Cheng Kwee Cheh (Mr Cheng), received new GT shares valued at HK$130m. The owner of the other 49% of SMG was not disclosed (perhaps it was TZFT). Mr Cheng was described as an "independent third party", and we know nothing else about him. Mr Cheng was also to receive $35m in cash if SMG ever listed on a stock exchange, but that never happened.
On 6-Jan-03, SMG was put into voluntary liquidation. The directors' report at 30-Sep-02 reveals that GT had loans receivable from SMG of $72m which were unsecured and interest bearing at HIBOR, or 2.02% p.a.. In the year to 30-Sep-02, GT wrote off $39.6m of receivables from the minority shareholders of SMG. In effect then, 100% of SMG's losses had been funded by GT, but until the write-off, the company had held out the hope of recovery from the minority shareholder, and boosted director's bonuses in the process. We wonder how realistic that hope was.
One of the big problems with the kind of bonus plan adopted by GT is that it does not allow for loss-making years in the formula. There is no "make-good" provision that requires them to recover previous losses before the bonus share kicks in again. Hedge fund managers are well-used to this "hi-on-hi" formula, but it seems that GT is not. Their formula incentivises the directors to "manage" profits, and encourages them to defer recognition of losses in order to boost bonuses, and then throw the problems all into a single loss-making year. Despite mounting receivables and inventory, GT did not make any major provisions until the year to 30-Sep-02. Then it made a massive $257m write-down of inventory and a $210m provision for bad and doubtful debts. It also wrote off $57.4m for long-term investments.
We cannot judge whether these provisions were excessive, but because of the lack of a "make-good" in the bonus formula, management had an incentive to make excessive provisions for both inventory and debt in a single loss-making year, since any recovery if that inventory is sold or debts repaid later may increase the future profits and hence bonuses.
Another company which has used a similar bonus structure with a pattern of massive profits followed by similarly massive losses since its IPO is Regent Pacific Group Ltd (0575). Enough said - that disaster epic will have to wait for another article.
The IPO prospectus said that the 4 executive directors had entered into service contracts for 3 years from the date of listing on 9-Apr-99 (terminable by 6 months notice) and were entitled to "fixed" salaries totalling $3.384m, or an average $0.85m per director. The next table shows that the "basic salaries and allowances" ran to a lot more than that, and increased 297% over 3 years. No explanation for the extra allowances over the salaries, or the sharp increase in 2002, was ever given. It is being economical with the truth to say that salaries are "fixed" if you are going to supplement them with increasing additional allowances.
No directors' bonus was payable last year because of the $235m loss. In case you were worried about how the directors would make ends meet, you will be pleased to see that the loss included a "commitment fee" for 3 directors totalling $41m. Yes, they are committed alright. The breakdown of this figure between directors is not given, but the highest paid director last year received total remuneration of at least $38.5m. It's a fair bet that this is Mr Sy.
Not only that, but the old contract expired on 9-Apr-02 and the new contracts for the 3 directors who have survived since IPO includes a combined "fixed salaries" of $25,126,080. Again, no breakdown is given, but that's an average of $8.38m per director, an increase of 886% over the previous $0.85m per director.
But wait, there's more. The bonuses are now unlimited. There is no longer any formula, no cap, and the bonuses will be determined "in the sole discretion of the board".
The total executive directors' remuneration in the 4 years since the IPO is $212.4m, equivalent to 27.4% of the total net profits attributable to shareholders of $775.9m.
This case demonstrates all too clearly why the latest proposals from the Stock Exchange on disclosure of directors pay on a "no names" basis are grossly inadequate. We need to go much, much, further than that. The commitment fees in this case are simply a way of making up for the absence of the massive bonuses received in previous years. It is a clear abuse of minority shareholders' money, and a clear conflict of interest for the directors who control the company to determine their own pay in this fashion.
The Listing Rules should require that minority shareholders' approval be obtained for such massive variations in compensation plans. We have previously proposed that any new profit sharing or similar scheme, and any annual increase of more than 20% in an individual director's total compensation, should be approved in advance by minority shareholders.
In case you were wondering, the two "independent non-executive directors" of GT since the IPO are David Ip Man Tin (Mr Ip) and Michael Tai Ah Lam (Mr Tai). Mr Ip has been an INED of King Pacific International Holdings Ltd (0072) since 6-Sep-01. Mr Tai has been a director of Haywood Investments Ltd (0905) since 11-Dec-01 and became Managing Director and CEO on 1-Jun-02.
China Tax Trouble
"Regarding an article appearing on the Hong Kong Economic Times on 15 January 2002 in relation to the detention in Guangzhou City of a member of the Company's senior management due to certain taxation issues, the Board is not aware of the sources of such article but wishes to confirm that none of the directors of the Company is involved in the alleged investigation"
The stock closed unchanged that day, but the shares soon began to slide again, including a 21.4% fall on 23-Jan-02 to $0.385 before the stock was suspended at lunch-time. A week later, the company announced that it was negotiating a possible placing of new shares (which never happened) and almost in passing, mentioned that they had seen an article in Ming Pao on 24-Jan-02 in relation to
"the detention and investigation of a member of the Company's senior management... due to breach of certain relevant rules; and... the avoidance of customs duties by the Company by parallel importing Samsung mobile phones into the PRC..."
But not to worry, the Board wished to state that:
"none of the directors or senior management of the Company is involved in the alleged detention and investigation..."
The day after that announcement, both Mr Sze and Mr Sy failed to show up for the company's Annual General Meeting, and their staff claimed that it clashed with another important meeting. Well after all, other shareholders are not that important, are they?
Six days later, Mr Sze resigned as Chairman and his brother Mr Sy was promoted from Vice Chairman to Chairman. The company also appointed Paul Tse Po Lau (Mr Tse) as an executive director, and he turned out to already own 2.3% of the company.
The trail fell cold until 24-Sep-02, when local papers quoted a report from state-run news agency Xinhua that Mr Sze had been arrested by Guangdong police on accusations of hiding RMB304m in sales and evading RMB51.78m in Value Added Tax and RMB53m of corporate taxes, a total of RMB104m (HK$98m).
In an announcement on 24-Sep-02, GT said:
"The Board also noted...articles...[in] today's newspapers in respect of the alleged involvement of the former chairman of the Company, [Mr Sze] in mistated sales and tax evasion by two of his privately controlled companies, Guangdong Foshan City Xinlingyu Telecommunications Equipment and Tianfu Telecommunications Equipment..."
the announcement also stated that GT "had sold mobile phones" to the two companies controlled by Mr Sze - which raises two interesting questions:
- Why were the sales of phones to Mr Sze's companies not disclosed as connected transactions?
- Doesn't this business amount to a breach by Mr Sze of his non-competition undertaking?
In the IPO prospectus (p46), both Mr Sze and his brother agreed not to compete with GT until:
"the earlier of the date on which he and his associate cease to be a controlling shareholder of the Company or Director or the securities of the Company cease to be listed n the Hong Kong Stock Exchange".
Quite clearly, Mr Sze still controls the Company through the family trust - indeed, it is a condition of one of the bank loans that the company remains at least 35% controlled by the brothers. So what was Mr Sze doing trading in mobile phones outside of GT?
It is most interesting to note that in the year to 30-Sep-02, there was a dramatic shift in the declared location of GT's sales. Take a look at this table:
Sales to the mainland plunged, while shipments in "HK, Macau and Taiwan" soared. This increase of over $3bn in non-mainland sales, equivalent to perhaps 2 million phones at wholesale prices, is very unlikely to be as a result of higher sell-through to end-users in HK, and it is likely that the phones found their way to mainland China, but the method is not clear. What was the scale of GT's dealings with Mr Sze's companies? Did he "introduce" any other third parties?
A large part of the loss for the year to 30-Sep-02 was due to a $210m provision for bad and doubtful debts. Does this have anything to do with the sudden change in geographic sales? Are any of these debts due from Mr Sze's companies, we wonder?
HK Tax Trouble
As if the investigation of Mr Sze wasn't enough, the latest annual report reveals that GT itself is in dispute with the Hong Kong Inland Revenue over the tax of "certain subsidiaries" from 1996/7 to 2002/2. The amount of disputed tax assessment was not specified, or the extent to which it exceeds the amounts previously provided for.
Breach of covenant
The accounts also show that at 30-Sep-02, the financial covenants and undertakings of a loan agreement were breached by GT, and the company was negotiating with the banks on this. GT had total banking facilities of $1,366m of which all but $16m was utilised. This is despite the fact that GT had cash and bank balances of $1,070m and "trading investments" (mostly unlisted debt securities) of $262m. However, trade payables (mostly for phones) had swollen from $757m a year earlier to $1,055m, all of which were "aged less than 30 days".
What do we have here? A company which:
- grossly overpays its directors and apparently breached a formula limit
- wrote off $210m in bad debts, $257m in inventory and $57m in long-term investments last year to 30-Sep-02
- restated and reduced 2001 profits by $120m without calling back the 15% bonuses from directors
- paid directors "commitment fees" of $41m in a year when bonuses were not payable
- topped up "fixed" salaries with increasing allowances, and then increased the salaries by an average 886% after 3 years
- has a controlling shareholder and former Chairman about to undergo trial for tax evasion, who appears to have breached his non-competition undertaking, and has been buying mobile phones from the company in unannounced connected transactions
- is in dispute with the HK Inland Revenue over taxes
- is in breach of financial covenants on a loan agreement
and the Stock Exchange has done nothing. If Hong Kong investors had class action rights and contingent legal fees, you would probably see shareholder claims for recovery from the directors, but we don't, and we won't.
© Webb-site.com, 2003
Organisations in this story
People in this story
- Cheng, Kwee Cheh
- Ip, David Man Tin
- Sy, Timothy Ethan
- Sze, Johnny Tsang Fai
- Tai, Michael Ah Lam
- Tse, Paul Po Lau