We issue a bubble warning on Imagi (0585), up 616% in 4 days on turnover of 185% of the company. The confusing timetable, with a 10:1 consolidation yet to come, has likely contributed to more chaos than we have seen since Asian Citrus. The market price implies a valuation of 33.2 times book value, or a premium of HK$17.3bn (US$2.23bn). We think a discount would be more appropriate, for the characters involved.

Imagi bubble
14 April 2010

Investors should beware of a bubble in the share price of Imagi International Holdings Ltd (Imagi, 0585). The company is in the middle of a reorganisation; since last Friday (9-Apr-2010), the stock has been trading ex-rights, even though the rights issue is still conditional on shareholders' approval at a Special General Meeting to be held on Friday (16-Apr-2010). There is also a 10 to 1 consolidation (a reverse stock split) due to take effect on Monday (19-Apr-2010), if approved at Friday's SGM. The circular is here.

What some investors may not understand is that the rights issue is 4 new shares at HK$0.07 for each consolidated share held. That's equivalent to 4 pre-consolidation shares at $0.007 for each pre-consolidation share. Tonight (14-Apr-2010) the stock closed at $0.242, so the rights issue is at a 97.1% discount to the current, ex-rights share price. Adjusting for the rights issue, the stock has risen from $0.0338 last Thursday (the day before it went ex-rights), up 616% in 4 trading days. Turnover in the stock has been extremely heavy, with 6.67bn shares traded in 4 days, equivalent to about 185% of the current issued share capital. We haven't seen this much chaos since Asian Citrus. We did suggest to the Stock Exchange last Friday that they require the company to clarify the basis of the rights issue, but they haven't.

If you are confused by having two different ex-dates, then maybe that's the intent. As we have said before, allowing trading ex-entitlements, including dividends, rights issues or other distributions, before the distribution has even been approved by shareholders, is a recipe for disorderly and unfair markets. In our opinion poll last September, 85% of respondents agreed that this should be abolished, but it hasn't happened yet. They should have gone "ex" both the rights issue and the consolidation on the same day.

The rights issue is expected to comprise about 1.44bn shares, raising $100.8m gross. In addition, Idea Talent Ltd (Idea Talent, BVI) will subscribe 1.88bn consolidated shares at HK$0.07, raising $131.6m gross. Idea Talent is 60% owned by Francis Leung Pak To, who was MD of Peregrine Investments Holdings Ltd until it imploded in 1998, and 40% owned by Mico Chung Cho Yee, an executive director of PCCW Ltd since before it was PCCW. Mr Leung is also now back in business with Larry Yung Chi Kin, the hapless former Chairman of CITIC Pacific Ltd until it almost blew up in 2008 over forex losses, the police investigation of which is ongoing. Mr Yung, through CITIC Pacific, was one of the early backers of Peregrine.

Idea Talent may also subscribe up to 988m consolidated shares at $0.07, called "Top-up Shares" in the circular, within 45 days of completion of the main deal, such that its post-deal holding (including any shares it receives as a rights issue sub-underwriter) reaches a majority 52.5%. That would raise $69.16m (not $79m as stated in the circular). As if that wasn't enough, Idea Talent will also have an option to subscribe another 1.5bn shares at $0.08 within 1 year after completion of the first share subscription, raising $120m.

There are also a bunch of "Core Creditors" who have lent money to Imagi. Two of these are Cayman funds: the Trophy Fund (and its wholly-owned subsidiary Goodyear Group Ltd) and the Trophy LV Master Fund. Both are "managed" by Trophy Asset Management Ltd (Cayman), which is owned by Kenneth Hung Kam Biu (Mr Hung). The two funds are also "advised" by Winnington Capital Ltd (HK), which is owned 50% each by Mr Hung and his wife, Jocelyn Chu. The third creditor is Fortunate City Investment Ltd (FCI, BVI). FCI was wholly-owned by Mr Hung but he disposed of it to a secret "independent third party" in Nov-2009.

The creditors are owed a total of HK$241m, which will be settled by paying them US$9m (HK$69.75m) in cash plus 790m shares plus an option to subscribe 400m shares at $0.08 for 1 year after the subscription completes, raising $32m. The two Trophy funds hold about 18.2% of Imagi between them, but they have agreed not to take up any of their rights, nor to sell their rights, so these will be available for excess applications. Given the massive discount, there is likely to be a heavy over-subscription of those.

Bubble wrap

Let's wrap this up. If all of the Top-up Shares are issued, and all the options granted to Idea Talent and the Core Creditors are exercised (which is likely if the consolidated share price stays above $0.08), then there will be 7,358,759,190 consolidated shares in issue (p44 of the circular). At the current price of $2.42 per consolidated share, that implies a market value of HK$17.81bn. By comparison, the pro forma net tangible assets, shown in Appendix II of the circular, will be $318.8m, plus the proceeds of the Top-up Shares and Options, making $540m, or about $0.073 per share. So the market is implying 33.2 times book value, or a premium of HK$17.27bn (US$2.23bn). Given the huge destruction of shareholder value at Peregrine and PCCW, we think a discount to net asset value for the incoming management would be fairer than the premium. That suggests an eventual 97% downside from the current price.

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