ICG Asia, HK-listed subsidiary of Nasdaq-listed Internet Capital Group, last week announced a huge loss in its 2000 annual results, including a HK$1.02bn (US$130m) provision against its toys and properties business. Webb-site.com asks whether things are as bad as they look, and we query the implications of a put option over the toys and properties business which if exercised, could give the benefit of a $1bn discount to Hutchison Whampoa.

ICG Asia's HK Put Option
10 April 2001

Last week ICG Asia Ltd (ICG Asia), the HK-listed subsidiary of Nasdaq-listed Internet Capital Group, Inc(ICG), announced its annual results for 2000.


ICG Asia was once known as Harbour Ring International Ltd, until being taken over in a deal announced in March last year. It was then briefly named "ICG Asiaworks Ltd" until a possible naming confusion with iAsiaWorks arose. The original business, which the company still owns, was in toy manufacturing and property development and investment. Yes, this was the company that brought you Teenage Mutant Ninja Turtles a decade ago!

The ICG takeover was a classic "reverse listing" in which a deal was done to obtain a listing by injecting sufficient cash to obtain a controlling shareholding. The deal which introduced ICG as a shareholder was a hugely dilutive issue of new shares for cash at HK$0.30 each, a 67% discount to the net asset value per share of $0.90 as of 31-Dec-99, adjusted for a property valuation a month later.

Alongside ICG came Hutchison Whampoa Ltd (Hutchison) and Li Ka Shing Foundation Ltd (LKSF), the personal foundation of Mr Li Ka-shing, Hutchison's Chairman and ultimate controlling shareholder. LKSF is a company limited by guarantee in Hong Kong, so it has no issued shares.

Hutchison was already a 21.2% shareholder of Harbour Ring, and its participation in the share issue helped to reduce the dilutive impact of the subscription by ICG. Three weeks after the deal was announced, it was slightly reworked to establish a vehicle called Asian Employment Co Ltd (AECL) was set up to be 78% owned by ICG and 22% by Hutchison, and this in turn held 6.1% of the enlarged ICG Asia. The plan was to use these shares under options as an incentive for future employees of the group.

As a result, the ownership looked like this:

Name Before
the deal
the deal
ICG   50.1
Hutchison 21.2 13.7
LKSF   5.0
AECL   6.1
Dr Luk Chung Lam & Associates 37.4 11.9
Playmates Toys 12.9 4.1
Others 28.5 9.1
Total 100.0 100.0

Li Ka-shing was hardly diluted at all, indeed, because he has only about an 18% economic interest in Hutchison (via 36% of Cheung Kong (Holdings) Ltd which owns half of Hutchison) his economic interest in ICG Asia, including LKSF, actually increased from 3.8% to 7.5%. It is interesting to note that when Mr Li's indirect post-deal voting interest was disclosed under legal requirements, it did not include the shares issued to LKSF. Either he has no voting interest in the foundation, or it had already sold the shares.

In the above table, Dr Luk Chung Lam (Dr Luk) was the Chairman of Harbour Ring. Playmates Toys is another listed company which was also a major customer. Through Reading Investments Ltd, which Dr Luk controlled, he sold 110m shares (about 2% of ICG Asia) at $1.20 on 25-May-00, over 4 times the current price.

The total share subscription in the takeover was more than twice the number of existing shares in issue, and it diluted net assets per share by 46% to $0.49 per share. Nevertheless, in the dotmania surrounding the internet, the deal won speculative applause and the shares briefly traded as high as $9.20. Today they are back to  $0.255, down 97%. On top of the share issue, the subscribers also got 3-year warrants to subscribe yet more shares at $0.39 per share.

But what about those toy and property operations? Now we get to the interesting bit.

Toys and Property (T&P)

Clearly, ICG did not have much interest in the toys and property business - it is an internet B2B player. At the same time, any listed company which ceases to carry on any business besides holding cash would automatically be suspended on the Stock Exchange, so it was important for ICG Asia to carry on the Toy and Property (T&P Operations) at least until it had something else to do.

At the same time, the existing management (including the Dr Luk and his associates with 37.4% of the company) were needed to run the T&P Operations.

A BVI holding company called Shamrock Green Ltd (Shamrock) was then established and 50% held by Hutchison, while 25% was held by each of two companies controlled by Dr Luk. This company granted a put option to ICG Asia in respect of all the Toy Operation and the Property Operation (T&P) (in other words, everything except the cash reserves of Harbour Ring). The put option gives ICG Asia the right, but not the obligation, to sell the T&P Operations to Shamrock at a certain price (the Put Price) at any time up to two years after the deal completed on 4-May-00.

If the put option is exercised then Hutchison has a 14-day right to buy the other half of Shamrock at half of the Put Price, giving it the 100% of Shamrock and all the benefit of the deal.

So what is the Put Price? Watch carefully and you will see the magic. The deal was struck as follows. Before the subscriptions, but allowing for the existing employee share options, there would be 1,751,377,402 shares in issue. Multiply that by 30 cents, and then deduct $300m for the estimated net cash held by ICG Asia just before the deal closes. That leaves you with exactly $225,413,220. That's the Put Price.

You will notice that the net asset value before the deal was 90 cents per share, not 30 cents. In fact, audited net assets at 31-Dec-99 were $1,579m. Outstanding share options at that date had a subscription price of about $15m. In the shareholders' circular regarding the deal, ICG Asia's property portfolio was valued by FPDSavills (Hong Kong) Ltd at 31-Jan-00 at about $822m, implying a small deficit of $18m compared to book value.

This adds up to adjusted net assets of about $1,576m at 31-Dec-99. Deduct the estimate of $300m of cash, and you have net assets under the put option of about $1,276m. As an aside, the circular to shareholders on the deal said that:

"The combined net asset value of the [T&P] Operations extracted from the working schedules in the preparation of audited financial statements  of the Group for the year ended 31st December 1999 was approximately HK$712.3m"

but that is far less than the provision the company later made against the business, so we will assume the circular was wrong.

Compare our estimate of net assets under the put option with the Put Price, and you have a net asset discount of around $1,051m (US$135m, or 82%) excluding any goodwill value in the Toy Operations.

The independent financial adviser, Anglo Chinese Corporate Finance Ltd, wrote:

"The option price was not determined by an evaluation of the probable value of the Toy and Property Operations.

In our opinion, the option price should not be taken as the likely value at which the Toy and Property Operations are likely to be sold, if they are to be sold at all. Based on our assessment, the present value of the Toy and Property Operations is greater than the option price."

We totally agree. Any half-baked sale process ought to achieve a better price than 18% of net asset value.


Despite the huge disparity, ICG Asia included in its interim and final 2000 results a provision against the carrying value of the T&P Operations. They wrote:

"the Company has determined...to hold the [T&P Operations] for disposition.... In view of this determination and the lack of effective control and substantial long term restrictions on management, the Company has not included the T&P Operations in its consolidated results of operations after 4th May 2000. Accordingly the Company has made a provision of HK$1,018,148,000 to reflect the value of the [T&P Operations]." (emphasis added)

In plain English, that translates to "we are putting it up for sale, and writing off the difference between book value and what we think it can be sold for". We spoke with ICG Asia's CFO, Ms Rowena Chu, who confirmed that the provision was based on the Put Price. Presumably the difference between our estimate of $1,051m and the actual provision of $1,018m is accounted for by normal trading up to 4-May-00.

Given the huge discount that the Put Price represents, Webb-site.com finds it very unlikely that it would be in public shareholders' interests to exercise the Put. Hutchison would stand to receive the $1bn discount if the Put were exercised.

The worrying thing about this is that by making the write-down of the carrying value to the Put Price, ICG Asia is now in a position to exercise the Put without recording any loss or profit. Is this $225m figure really the board's best estimate of net realisable value of the T&P Operations, when the properties alone were valued only last year at $822m? Webb-site.com suggests that the provision was excessive and does not "reflect the value of the T&P Operations" as the company suggests.

In a vague and worrying reference, the resolution which sought shareholders approval of the ICG takeover said (in part) that approval was sought for

"the consummation of the transactions contemplated by the Option Deed"

Setting aside the fact that a piece of paper has no brain and cannot contemplate anything, it is surely wrong that this should be taken as approval of any exercise of the Put Option up to two years after its grant, when no decision had yet been made to exercise it. No transaction was "contemplated" by granting the option - only the right to transact as a last resort, underpinning the value of the T&P Operations. Indeed, rule 14.26(1) of the Listing Rules includes in "connected transactions" requiring independent shareholders' approval:

"the exercise by the issuer...of any option granted to it to acquire or realise assets, from or to a connected person".

There is no way that shareholders should be deemed to have approved a decision which the board has not yet made and which, if made at the time of the deal would have been so manifestly against their interests. So if and when the board decides to exercise the Put,  then the transaction should be subject to independent shareholders' approval. At the time of the ICG takeover, ICG and Hutchison were deemed to be acting in concert with respect to the Takeover Code. To avoid any suggestion that ICG might be repaying favours to Hutchison for facilitating the original deal, ICG should be required to abstain from voting its 50.1% stake on any exercise of the Put.

Management Services Agreement

Remember that reference to "substantial long term restrictions on management" of the T&P Operations in the results?

In conjunction with the ICG takeover, there was a Management Services Agreement which gives the previous management of the T&P the "exclusive right to manage and operate the [T&P] Operations". This was based on existing employment contracts and will be terminated by ICG Asia on the exercise or lapse of the Put Option. If the option lapses (on 4-May-2002) then after that, ICG Asia would regain full control of the T&P Operations and be able to decide which parts to sell and which parts to keep. Unless something has gone alarmingly wrong with the T&P Operations, this must be the best route.

An note on ICG

Shareholders should keep a close eye on ICG Asia to see just what value they achieve from the eventual disposal of the Toy and Property Operations. Not only that, but our US readers and shareholders of ICG itself should also be watching closely. Such is the fate of the parent (NASDAQ: ICGE), that its market cap has fallen over 99% to just US$432m at the time of writing. Therefore the discount in the Put Option of US$135m is now worth almost one third of this amount!

ICG Asia has not done very much with the $1,116m it raised from the subscriptions. By the end of 2000, it was sitting on net cash and equivalents of $1,306m (US$168m), or about HK$0.24 per share, so the 50.1% attributable to ICG is about US$84m, or 19% of ICG's market value.

© Webb-site.com, 2001

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