Open letter to the board of Ming Fai (3828) from David Webb
19 October 2016
To the current Directors of
Ming Fai International Holdings Ltd (Ming Fai, 3828)
As you know, I have previously written to you twice privately, commending you on the decision to dispose of our company's main investment property through open tender. The disposal will be effected by the sale of the company which owns it, Chartered Properties Ltd (CPL), so the transaction sensibly avoids 8.5% double stamp duty and instead incurs 0.2% stamp duty on the shares of CPL. You announced the proposed sale on 29-Aug-2016 and you have posted a circular dated 14-Oct-2016, convening an EGM on 3-Nov-2016 to consider the sale. I will be voting in favour of the sale.
The consideration for the disposal is HK$263m in cash.
In my private letters, I also urged you to declare, or announce an intention to declare, a special dividend to distribute the proceeds of the disposal. I gave you fair warning that if you did not do so in the circular, then the next letter would be public, so that other independent shareholders can add their views. You failed to seize the opportunity to make this your own initiative.
Unfortunately, all that you say about "use of proceeds" in the circular is:
"The proceeds of the Disposal will be partially used for repaying the bank borrowing of the Property. The net proceeds to be received by the Vendor from the Disposal will improve the overall cash position of the Group for general working capital purpose as well as for possible future opportunities that may arise. However, the Directors have not identified any target for acquisitions or any concrete investment plan as at the Latest Practicable Date."
As I explain below, hoarding cash is not an "improvement" in the cash position - our company is already overcapitalised, bloated with net cash far in excess of what is needed for the core business. Having too much equity drags down the rate of return on equity (profits divided by equity) and depresses the share price as it traps idle cash.
The risk of burning the cash on unsuccessful new businesses beyond your area of expertise and excellence also depresses the share price, particularly given that Ming Fai has a proven track record of losing money in new non-core businesses. In over 25 years in the HK market, I have seen so many successful entrepreneurs list their business on the Stock Exchange and then make the mistake of assuming that they must be good at everything. Expertise in one field is not expertise in another. I hope you have learned from these mistakes, as that is what makes us all stronger.
If you return surplus capital to the market, then the market will repay that trust. Just look at some of my other investees and you will see how this works. For example, Alco Holdings Ltd (0328), of which I own more than 9%, sold its former premises in Zung Fu Building on 29-Dec-2015 and has since then distributed a total of $0.90 per share in dividends. The stock has returned 68.2% since 29-Dec-2015 (the day of the announcement) when it was trading at $2.30, and closed yesterday at $2.90.
Ming Fai's core business, the basis on which all shareholders at the IPO invested, is the supply and manufacture of quality amenity products and accessories to the hotel, hospitality and travel industries. This continues to be the value driver of the company, generating revenue of HK$1678m in 2015 and a segment profit before tax of $136.4m, compared with revenue of $846m in 2007, the year of listing.
Unfortunately, in 2010 you embarked on an adventure into cosmetics and retailing, acquiring a mainland-based company called All Team Group Ltd and its brand "7 Magic" for RMB150m in cash and RMB100m in new shares. This business failed to deliver, resulting in the cancellation of half the new shares in 2012 and an impairment of HK$339m of goodwill and intangible assets in 2015. This segment, including a separate HK brand called "everyBody Labo" generated an operating loss of $27m in 2015 and $43m in 2014. You should terminate this business.
Also in 2010, you also established a laundry plant in Changshu City, Jiangsu with the goal of enhancing hotel relationships at an investment cost of HK$78m. That didn't work out either, losing HK$2.8m in 2010, $15.0m in 2011, $23.4m in 2012, $20.7m in 2013 and $12.7m in 2014 when it was terminated.
Our company's interim accounts at 30-Jun-2016 show net tangible assets attributable to shareholders of HK$1104m, including the property held for sale at $250m. At that date, we had cash and cash equivalents of HK$328.220m and bank borrowings of HK$50.768m, including the small mortgage loan of $22.713m against the property held for sale. So the net cash position was $277.5m. Net of expenses, the sale will produce a gain which you estimate at $10.633m, so the net proceeds should be about $260.6m. Accordingly, net assets will increase to about $1115m and net cash will increase to about $538.1m, or 48.3% of net tangible assets.
At 30-Jun-2016 there were 705,739,697 outstanding shares and 34,796,000 outstanding share options exercisable at $0.62 per share, all of which were vested and some of which have since been exercised. When fully exercised, the subscription proceeds would be about $21.6m, increasing net cash to $560m and net assets to $1137m, and there will be 740,535,697 shares in issue, a 4.93% dilution. It is inevitable that the special dividend will cause the holders to exercise all the options to receive it, so we must allow for that.
Fully diluted then, the net tangible assets per share are $1.535 and the net cash per share is $0.756. These compare with yesterday's closing share price of $1.05. The sale proceeds of $260.6m (net of expenses) are $0.352 per fully diluted share. This is the minimum that should be distributed. This will trigger the option subscriptions which almost match the mortgage loan repayment. The retention of HK$300m of net cash is more than adequate for our core business as it allows for substantial variations in working capital from receivables and payables. The net cash would still amount to 34% of remaining net assets of $876m, so there is a strong case for doing more than the minimum.
Share award scheme
Incidentally, recognising how dilutive share options can be, I am pleased to see that on 23-Sep-2016 you announced a share award plan pursuant to which existing shares can be acquired in the market and held by an independent trustee, who will not vote the shares, until the shares are vested to the employees.
Long-term share awards are a much better way to motivate staff. Shares always have immediate upside potential, whereas options can lose their incentive effect if the market price drops substantially. The cash spent can be a deductible employment expense for tax purposes, and existing shares do not cause any dilution of the share base. The cash outlay also focuses the board's attention on the real cost of the incentive. However, this only works if you also stop using the share option scheme (which expires on 2-Nov-2017 anyway), so please don't grant any more options, don't renew the share option scheme, and don't issue new shares into the share award scheme, just buy existing shares in the market.
As you know, I am the second-largest shareholder of Ming Fai, owning almost 10%. I know that several other significant investors have already expressed their concerns to you. The current directors and their associates combined hold 33.32%. At the 10% level, I would be entitled to requisition an Extraordinary General Meeting as and when needed, and in any event I can nominate candidates for election at any AGM. If you, as a board, don't declare a special dividend, then I will have to nominate new directors (including independent directors) who will. I hope that will not prove necessary, because I do believe in your ability to develop the core amenities business successfully, and I am only trying to add value for all shareholders, including the directors.
David M. Webb
© Webb-site.com, 2016