Veto Lerado (1225) sale until they pay up
1 September 2014
We need your help! On 16-Jun-2014 Lerado Group (Holding) Co Ltd, (Lerado, 1225) announced the proposed sale of its main business, making children's strollers and car seats, to Dorel Industries Inc of Quebec, Canada (listed in Toronto, DII.B), which owns a number of juvenile products brands, for a price (subject to adjustment) of HK$930m. This would leave Lerado with a huge pile of cash and a small remaining business which would allow it to retain its SEHK listing, manufacturing what it calls "Medical products" but is actually powered and non-powered mobility aids and wheelchairs (web site here), and also a small plastic toy manufacturing business.
While the sale looks reasonable, it is currently ruined by the intention to hoard most of the proceeds, making it a bad deal for shareholders. As we explain below, Lerado would have post-deal net cash of about $1.39 per share, versus a current (29-Aug-2014) share price of $1.20, but proposes to pay out only $0.30 per share and squat on the rest, far in excess of its requirements. We urge shareholders to vote against the sale unless the board announces a distribution of at least $1 per share, which will still leave Lerado ungeared with about half its net assets in cash. Webb-site founder David Webb holds just under 8% of Lerado. The circular for the deal is here. The meeting in on 16-Sep-2014.
Net asset value and net cash
At 31-Dec-2014, Lerado had 753,482,724 shares outstanding. Since then and up to 31-Jul-2014, options were exercised at $0.77 per share for 6.520m shares, and there were 3.274m options outstanding at the same exercise price. For the purposes of our calculation of distribution, we will assume complete exercise of the options, increasing the outstanding shares to 763,276,274 and raising proceeds of HK$7.54m.
The circular (p15) shows that the Remaining Group's factory premises are in the books at $53.2m but are worth HK$127.9m at 30-Jun-2014, an uplift of $74.7m ($0.098/share). To its credit in the past, Lerado has revalued its premises annually - we wish all companies would do this, to give a clearer picture of the balance sheet. We expect the 31-Dec-2014 accounts to reflect this increase and any subsequent adjustment by year-end. The Remaining Group also has a head office in Central, HK worth HK$54.4m, the same as its 2013 book value.
Taking the share options and the revaluation of premises into account, and using the pro forma balance sheet from Appendix III of the circular (p46) here is the pro forma net asset value calculation:
These figures assume, as the circular does, that Lerado pays tax on the deal (in the PRC) of HK$76.36m, and transaction costs of HK$13.85m. Obviously there would be changes from the 2013 year-end position up to completion of the sale, but this is unlikely to make a material difference. On 29-Aug-2014, the day after the circular, Lerado announced interim results to 30-Jun-2014, with net profit of $11.3m and net assets down by $7.3m due to foreign exchange differences.
The terms of the disposal call for US$10m (HK$78m) of the proceeds to be held in escrow for any material claims that may arise until 30-Apr-2015. So a breakdown of the cash is as follows:
As you can see, Lerado would be stuffed with cash of about $1.39 per share, of which about $1.29 is not subject to escrow. Of this, they propose to distribute only $0.30 per share, or about HK$229m. This would leave them with a war chest of about HK$830m ($1.09/share).
In our view, this allocation is completely the wrong way around. The remaining business had turnover of just HK$140m in 2013, of which $29m was the Plastic Toy Business and $111m was the so-called Medical Business. Even allowing for the possibility of capital expenditure to grow the business, Lerado should be more than comfortable with $200m of cash and no borrowings. If a commercially justifiable large acquisition comes along, they can always go back to shareholders with a rights issue, or issue shares as consideration.
Allowing for the fact that $78m of the cash will be tied up in escrow, this would still only justify a retention of HK$278m, or $0.36 per share. This calls for a distribution of at least HK$1 per share, or $763m (assuming full exercise of options). Here is what the net assets would look like after that:
As you can see, a $1 per share distribution still generously leaves the group with 42% of its net assets in cash (and another 15% in the escrow account) and no debt. At current market values it could even double the size of its factory premises (spending $128m) and still have $90m cash left over, and it would only do that if its business was growing massively, which would be a nice problem to have.
Shopping list not credible
The circular does include a $668m puffed up shopping list, namely $200m for expansion of the Medical Business (if and when the existing premises, of unspecified size, become too small), $280m for potential investment or acquisitions for the Medical Business (none has been identified), $120m for "investment opportunities in other business sectors" and $68m for working capital. This is only arrived at by taking the net proceeds of the sale, deducting the $299m proposed dividend and then allocating the remainder to this list. It also completely ignore the other net cash of $168m the group already has.
This is not a group to which you would want to write a blank check in the hope of some wonderful deals. Since listing in 1998 their deal-making has included a HK$21.1m investment in 2001 for 8% of a company which was developing genetically-engineered cows (yes, really). The investment was written down by $9.7m in 2004 - still, there's no point crying over spilt milk. Also in 2001, they bought a 30% stake, still held, in Weblink Technology Ltd, a maker of fibre-optic connectors now in the books as the "associate" at $5m. Incidentally Sandmartin (0482), another Taiwanese-controlled company, owns 51% of Weblink.
Although they were small punts, neither of these investments had anything to do with the core business of strollers and car seats. Lerado also engaged (against our repeated advice at AGMs) in a 5-year frolic of retailing of children's products which was shut down in 2012 after cumulative segment losses of HK$127m on sales of $269m. Lerado repeatedly told us at AGMs for over a decade that its existing cash pile was needed for potential acquisitions, but it never made any and instead the hoard just diluted its return on equity and then got depleted by the retailing mess.
The skillset of manufacturers has almost no application to retailing, as we keep trying to explain to the board at AGMs of Kingmaker Footwear (1170), another Taiwanese-controlled firm which is still blundering around in the retail space (run by the Chairman's daughter), detracting from its strong core manufacturing business. Kingmaker calls its retail brand "Fiona's Prince" but we call it "Fiona's Frog". No amount of resuscitation is going to turn it into a prince. They will, eventually, shut it down, after burning through more of shareholders' money.
Keep the business or give us the cash
Although the Lerado disposal, at close to net asset value for a currently-difficult business, looks reasonable, this is more than offset by the fact that the board proposes to hoard the proceeds. If shareholders approve the deal in its current form, then they would be left with a cash shell with a small residual business, and the shares would be weighed down by this, likely trading below net cash per share. If you don't believe us, then look at fellow Taiwanese-controlled Yorkey Optical (2788), or Porky Yorkey as we call it.
And this is why Lerado's shares currently (29-Aug-2014) are at $1.20, below the pro forma net cash of $1.39 before dividends.
We can and must act on this. The Lerado directors between them hold only 33.02% of the issued shares. Webb-site founder David Webb holds just under 8%, so if another 25% votes against, and nobody else votes in favour, then the deal would be vetoed. We would rather keep a good (and clearly saleable) business, with management still incentivised by their holdings, than end up trapped in a cash shell.
Unless the board announces an increase in the Proposed Special Dividend to at least HK$1 per share, David Webb will vote against the disposal, and we urge all shareholders to do likewise. The meeting is on 16-Sep-2014. Vote AGAINST now, and send a message to management. If they change their mind, then they can announce the increased dividend, send out a short supplementary circular, and delay the meeting date to allow shareholders to change their vote in light of the new information.
Launching a public campaign was not our first choice. It seldom is. We reached out privately to the Board, when the deal was announced and again shortly before the circular was posted, advising them of our views, but they did not respond positively. Are you a shareholder? See our voting guide or contact us here.
© Webb-site.com, 2014
Organisations in this story
- KINGMAKER FOOTWEAR HOLDINGS LIMITED
- Lerado Financial Group Company Limited
- SANDMARTIN INTERNATIONAL HOLDINGS LIMITED
- Yorkey Optical International (Cayman) Ltd.