Cooking with Gas
4 March 2004
Grand Field Group Holdings Ltd (Grand Field, 0115) a group engaged in property development and investment in Guangdong, went public in 1999 by taking over the listing of Chintex Oil and Gas Company Ltd (Chintex), which was one of Hong Kong's longest suspended stocks.
Chintex was suspended from trading in Sep-89. It had invested in two oil refinery projects on the same site in Zhanjiang, PRC which were seized by order of the mainland courts in Mar-91, resulting in write-offs of HK$241m and leaving Chintex with no business. Chintex was once chaired by Chim Pui Chung (Mr Chim), a former Hong Kong legislator who went to jail for an unrelated forgery offence.
Grand Field took over the shell in a scheme of arrangement and gave Chintex holders 80 shares in Grand Field for every 2,000 shares in Chintex, leaving the former owners of Chintex with 2.1% of Grand Field. Grand Field then took over the listing, effective 13-Oct-99, over 10 years after Chintex was suspended.
Now we hit the fast-forward button three years to the subject of this article.
On 4-Jun-02, Grand Field announced that it had conditionally agreed on 30-May-02 to buy 75% of Sino Richest Ltd (Sino Richest) from 3 vendors, for HK$63m, to be satisfied by the issue of 315m shares in Grand Field at $0.2 each, representing 15.4% of the enlarged Grand Field. The shares were issued at a 33% premium to the market price of $0.15.
The shares were acquired from Ivan Wong Chi Keung (Mr Wong, 15%), and from two BVI companies - Worldgate Developments Ltd, owned by Mr Lin Xian Guo (Mr Lin, 30%) and Logistic China Enterprises Ltd, owned by Mr Zeng Qing Chun (Mr Zeng, 30%) respectively. The remaining 25% of Sino Richest would be held by Mr Zeng's company. Mr Wong is something of a deal maker and you will be hearing more about him in our next article.
So what did Sino Richest own, that made it worth so much? Well, not much. It was only incorporated on 3-May-02, less than 4 weeks before the agreement with Grand Field. On 25-May-02 it signed an agreement with a Chinese-named entity (no translation was offered in the announcement) to establish a joint venture to develop and construct gas pipelines in Chongqing, China. Sino Richest would own 80% of the JV, which was planned to have a registered capital of HK$30m. At 30-May-02 Sino Richest had unaudited net liabilities of HK$18,380.
The announcement contained absolutely no explanation of who Mr Wong, Mr Lin and Mr Zeng were, or why it was that Grand Field could not have entered into the deal on its own. Grand Field was, in effect, paying these men a $63m premium for the right to invest $18m in 60% of a gas project. That's a 350% finder's fee!
A condition of the deal was the obtaining of a valuation report valuing the JV at not less than $95m. The circular to Grand Field shareholders dated 8-Jul-02 contained a valuation report on the JV, assuming it had been fully invested, by B.I. Appraisals Ltd, signed by a William C.K. Sham (an unfortunate name in the circumstances), which valued the JV on a discounted cash flow basis at HK$106m. However, this report had so many assumptions that, in our view, it was worthless to investors. The assumptions included:
- assuming that the projections outlined in the Business Plan provided will materialize; and
- assuming that the projections outlined in the Business Plan provided are reasonable, reflecting market conditions and economic fundamentals.
The Business Plan was presumably provided by the vendors. Including these assumptions in the valuation was like saying "the numbers add up, provided that the numbers are real". At $106m, this valuation implied that Grand Field's 60% effective interest in the JV would be worth $63.6m, just a fraction above the consideration for the deal. What a coincidence.
But wait a minute. The valuation assumed that the business had been funded, whereas Sino Richest had in reality not yet contributed the HK$24m of capital needed to fund its 80% stake in the JV. The circular fudged this issue, but it is clear from subsequent disclosures that Grand Field was buying a shell which had not invested any money in the JV.
On 27-Feb-03, Grand Field announced that Sino Richest (which was now a 75% subsidiary) had not proceeded with the JV because the China party had "failed to transfer the ownerships of their assets" as their share of the capital injection, and consequently the JV's business license from the Chongqing Government "no longer had effect". Grand Field didn't put a date on this lapsing, but a later announcement revealed that the licence actually lapsed on 10-Sep-02 (three months after the licence was issued). Grand Field had been silent about this problem for over 5 months, even speaking optimistically about the JV in their interim results published on 19-Sep-02, when they wrote:
"the Chongqing JV is in a good position to bring substantial profit contributions to [Grand Field] in the future."
Why did they think that the JV was "in a good position" when its license had lapsed 9 days earlier? The strangest thing about the timing of this deal is that according to note 29 of the 2002 annual report, the acquisition did not actually complete until December 2002. So why did Grand Field go ahead, knowing that the business licence had already lapsed? Were they buying gas, or hot air?
In the 27-Feb-03 announcement, although the JV was now dead, Grand Field was still optimistic in disaster, and said it was liaising with local government officials in the hope of pursuing the piped gas business on its own in Chongqing. This turned out to be a pipe-dream.
On 28-Apr-03 the auditor of Grand Field, Charles Chan, Ip & Fung CPA Ltd (CCIF), thought they could smell gas, and issued a qualified audit report for the year ended 31-Dec-02. They wrote:
"the evidence available to us was limited: during the year [Grand Field] acquired a subsidiary [Sino Richest] and the acquisition generated goodwill on consolidation of approximately HK$63,006,000...Although the acquisition was based on independent valuation report, there were no financial due diligence procedures or audited financial statements at the date of acquisition. We have been unable to carry out any audit procedures to ascertain the fair value of the identifiable assets and liabilities of the subsidiary."
This is hardly surprising, because apparently the only thing Sino Richest owned was a contractual right to pursue a joint venture which was now dead and for which the business licence had lapsed before the year end, yet the directors of Grand Field had included the JV as an intangible asset in the accounts. Were they cooking with gas?
For this intangible asset, Grand Field had paid Mr Wong and his fellow vendors $63m in shares. CCIF said about the deal:
"we have not obtained all the information and explanations that we considered necessary for the purpose of our audit...and we were unable to determine whether proper books of account had been kept."
On 11-Aug-03, Grand Field announced that on 31-Jul-03 it had sold its stake in Sino Richest to Mr Zeng for $32m, and was no longer pursuing gas in Chongqing. The announcement did not specifically say whether this payment was in cash or some other kind, but said that "the sum" had been received by the Company. It booked a loss of $31m on the sale in the Jun-03 interim results.
Auditors replaced
The 2002 directors' report said that CCIF would be proposed for re-appointment as auditors at the AGM, and the Notice of AGM said the same thing (item 3, to re-appoint auditors), but something changed. In an announcement on 27-Aug-03, Grand Field said that Chu and Chu were appointed as auditors that day, "in accordance with the resolution in the Annual General Meeting held on 26th June, 2003". It is not clear what they meant by this - either the re-appointment of CCIF was voted down (which was not announced) or Chu and Chu were proposed instead (in which case, was notice given to shareholders?), or CCIF declined to be re-appointed at the AGM. We simply don't know. The Listing Rules still don't specifically require companies to announce the outcome of shareholder meetings, although in new rules from 31-Mar-04, they will have to announce the outcome if a poll is demanded.
Missing Disclosures of interests
As a side note, the 30-Jun-03 interim report names as shareholders Worldgate Developments Ltd and Logistics China Enterprises Ltd, each holding 126m shares, which they received when they each sold 30% of Sino Richest to Grand Field. But the report did not include any deemed holding by Mr Lin or Mr Zeng, if indeed they still own the two companies.
Coming soon...
This was not the first time Mr Wong had sold a tropical igloo. In our next story, we'll tell you about the connection between Mr Wong and Kwong Hing International Holdings (Bermuda) Ltd (1131), one of several listed companies with which he has done similar deals.
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