In all the froth surrounding SABMiller's unsolicited bid for Harbin Brewery, media have overlooked the management's possible HK$110m payout under put-options from SABMiller triggered by the offer, and the $131m profit by the unknown parties who have flipped an option to Anheuser-Busch.

Harbin Secrets
6 May 2004

Hong Kong may or may not be on the brink of its first major contested takeover in years - the last one we can recall was a brief tussle in 2000 between Singapore Telecom and PCCW over Hong Kong Telecom, but that doesn't really count given that Cable & Wireless had majority control of HKT.

Yesterday SABMiller plc (SABMiller), which controls 295m shares (29.42%) of Harbin Brewery Group Ltd (HB), announced a $4.30 per share bid for the company, or 36.7x last year's EPS. We haven't seen such a generous offer since DBS Bank forked out for Dao Heng. Yesterday's bid was a swift reaction to an announcement that Anheuser-Busch Companies, Inc. (A-B) had conditionally acquired 291.5m shares (29.07%) stake at $3.70 per share.

The Real Deal

In fact, it's not that simple. That's just the version you read in the press, so let's dig a little deeper. Back on 22-Mar-04, HB announced that a BVI company called Global Conduit Holdings Ltd (Global Conduit) had conditionally agreed to buy the same block of 291.5m shares at $3.25 per share from another BVI company controlled by the Harbin Municipal Government. The owners of Global Conduit were not disclosed, but it said that nobody owned more than a 20% voting interest in the shell.

It turns out that all the shares of Global Conduit were held by another BVI company, Capital Select Enterprises Ltd (Capital Select), the owners of which are unknown. This manoeuvre avoided disclosing the beneficial owners of Global Conduit when it was sold. Then on or before 2-May-04, without ever putting up the money to actually complete the purchase of the HB stake, Global Conduit was conditionally sold by Capital Select to A-B. The HB announcement of 4-May-04 says that the "effective transfer price" is $3.70 per HB share. But, you will note that A-B has not actually acquired the HB shares, just "the right of Global Conduit to complete the purchase".

It appears that whoever owns Capital Select have managed to make a profit of $0.45 per share, or a total of $131.2m, without ever putting up the purchase money. That's not small beer! The purchase by Global Conduit from the Harbin Government remains subject to approval by "the relevant PRC authorities" and the issue of a legal opinion by the Government-owned vendor of the validity of the transfer. It is not known whether A-B's purchase of Global Conduit was conditional on these same approvals, or whether A-B has taken over the risk of the deal failing.

It remains to be seen whether the Government will grant all the necessary approvals, given that SABMiller now has an offer on the table at $4.30 per share, a 32.3% premium to the conditional sale price of $3.25 to Global Conduit. If Harbin Government can find a way to get out of the sale to Global Conduit, then they would be crazy not to use it and collect $4.30 instead, an extra $306m.

We call on HB to disclose full details of the beneficial owners of Capital Select and Global Conduit and the conditions of the purchase of Global Conduit by A-B. The only things that we know so far are based on filings under the SFO, which show that Philip Kan Sung Chee (Mr Kan) owned 20% of Global Conduit. Mr Kan is a partner of law firms Lo & Lo and its joint venture with UK firm Stephenson Harwood, Stephenson Harwood & Lo. The filings also show that a Mr David Lee Sun (Mr Sun) is a director of Capital Select and that both Mr Sun and Mr Kan are directors of Global Conduit. We know nothing else about Mr Sun.

Management's Pay-out

Back on 27-Jun-03, when SABMiller agreed to invest in HB, it set up a 95% subsidiary, Gardwell Ltd (Gardwell) to hold the shares. The purchase price was $2.29 per HB share, for a total of $675.6m. The vendor was an obscure Dublin-listed fund called China Enterprise Development Fund Ltd, major shareholders of which at the time of the HB IPO were University of Richmond, Fidelity and the manager of the fund. We could not find any trace of the fund last night on the Irish Stock Exchange web site - apparently it has been delisted.

Gardwell was structured like a leveraged Management Buy-Out (MBO) vehicle, with just $100m of equity, of which SABMiller put in $95m and $5m was subscribed by Advent Strategic Ltd (Advent), another BVI company owned by 5 directors and the CFO of HB. Presumably the remaining $575.6m was debt finance, perhaps funded by SABMiller.

As a performance incentive for management, SABMiller granted Advent put options, that is, the right to sell the 5% Gardwell stake back to SABMiller in tranches of 2.28% and 2.72% between the 1st and 3rd anniversary of the deal, for a total of $55m, "subject to certain performance criteria (i.e. the share price performance of [HB]". It is not known what share price targets were set. Now here's the punch:

"The exercise of the Put Options will be accelerated and, in certain circumstances, the consideration increased by 100% if: (i) SABMiller...announces a firm intention to make a general offer for the shares in [HB]..."

We don't know what the "certain circumstances" are, but now that SABMiller has indeed announced a general offer for the shares in HB, it appears that the Put Option has become exercisable, and management gets a pay-out of up to $110m (being a 100% increase over the $55m). That's a pretty decent return on their $5m investment less than a year ago, which itself was funded by the exercise of pre-IPO options.

But strangely enough, in protesting that the offer by SABMiller was "wholly unsolicited and was made without any prior discussions with the Board", the board omitted to mention that the offer had just triggered a potential windfall from SABMiller for 5 of the directors and the CFO of HB. If the put price is $110m, then the payouts are:

Advent stake Maximum
put value $m
Peter Lo 27% 29.7
Li Wentao 23% 25.3
Fu Hui 19% 20.9
Peter Jeva Au 18% 19.8
Bao Liusuo 10% 11.0
Lam Pong Sui 3% 3.3
Total 100% 110.0

A pay-out of $110m would imply a value per HB share of about $9.41, which is extremely unlikely to be achieved in the current market, so they would almost certainly exercise the put if they can. Even if the payout is $55m, that would imply an HB price of $5.68, again far more than the already frothy bid.

We call on HB to disclose full details of the put options, to confirm whether or not they have become exercisable, as the wording of last year's announcement suggests, at what exercise price, whether they have been exercised by management, and whether the exercise is in any way subject to the successful outcome of SABMiller's bid.

This story clearly isn't over, but we would not bet on a higher offer from A-B, given the frothy price already on offer from SABMiller. Depending on the detailed terms, management may also find it harder to collect on their put option if they spurn SABMiller's offer. Even if Global Conduit manages to complete the purchase from the Harbin Government, on balance we think A-B's most likely move would be to accept the $4.30 on offer, which is about 4 times the book value of HB's net assets.

For once, the clear winners in all of this are the public investors, who have seen a healthy return on the IPO price of $1.56. If you hold the stock, with the market now at $4.90 (lunchtime 6-May-04) and a 2003 P/E of 41.8x, you would be well-advised to take your profits. Don't depend on the big boys fighting it out.

© Webb-site.com, 2004

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