In the first of a multi-part series, we delve into a transaction by the HK offshoot of Xinhua, the PRC's official news agency, and the people behind it.

Raking muck, Part 1
21 February 2012

Once in a while, its nice to stop thinking about the bigger picture and trying to make HK a better place, and instead roll up our sleeves, don several pairs of rubber gloves and rummage around in the organic fertiliser at the bottom end of HK's market, hopefully triggering a few investigations by the authorities to keep them busy, and reminding them of gaps in our regulatory system. This story is so long and complicated that we will break it into several parts. When complete, it will cover at least these 8 listed companies:

So pour yourself a coffee and let's get started.

Inno-Tech, Railsmedia & CNC buy into CNMHK from Vicky Yu

On 18-Feb-2011, Inno-Tech agreed, via its 100% subsidiary, Superior Luck Investments Ltd (SLI), to buy 19% of China New Media (HK) Co Ltd (CNMHK) from Win Today Ltd (Win Today), 100% owned by Vicky Yu Wai Yin (Vicky Yu) for HK$78m, of which $39m was in cash and $39m in convertible notes. Prior to this, CNMHK was 51% owned by COMG and 49% by Vicky Yu. CNMHK was a start-up:

"principally engaged in outdoor advertising in Hong Kong, specializing in advertising spaces in lifts and outer walls of buildings."

Inno-Tech put out a circular on 16-Jun-2011. This stated that CNMHK had outsourced the sales of advertising spaces to an agent, Easy Advertising Group Ltd (EAG), which had

"not yet procured any end customers for the time being".

Hardly a compelling story. CNMHK was only incorporated on 19-Jun-2009 and had net liabilities at 31-Dec-2010 of HK$1m, but the deal valued it at $411m, and Ample Appraisal Ltd (Ample Appraisal) gave it a value of $412m. More than ample, we would say. The financial adviser was China Merchants Securities (HK) Co Ltd. The deal completed on 13-Jul-2011.

The 18-month notes were convertible @$0.60 into 65m shares, equivalent to 68.38% of the existing shares, but on 6-Oct-2011 and 13-Oct-2011 Inno-Tech redeemed the notes early for $39m in cash. This was an odd decision, given that the notes were interest-free and the market price was well below the conversion price ($0.335 and $0.355 on the two dates) - why not keep free cash for 18 months?

On 26-Jul-2011, a second listed company, Railsmedia, agreed to buy 7% of CNMHK from Vicky Yu for HK$28.8m, of which $13m was in cash and $15.8m was a promissory note. The announcement mentioned that SLI owned 19% of CNMHK, but didn't disclose that Inno-Tech owned SLI, nor did a follow-up announcement. Simultaneously, Railsmedia launched a placing of 310m shares @$0.078 via Tanrich Securities Co Ltd (Tanrich Securities), raising $23.2m net, partly to pay for the acquisition.

Two days later, on 28-Jul-2011, CNC (then known as Tsun Yip Holdings Ltd) agreed to buy 17% of CNMHK from Vicky Yu for HK$70.04m, of which $25m was in cash and $45.05m as a 3% 3-year promissory note. The implied valuation of $412m was again supported by Ample Appraisal Ltd and the financial adviser was Athens Capital Ltd, signed by Ross Cheung Ting Kee. The deal completed on 11-Aug-2011.

As a result of the 3 deals, Vicky Yu had sold a total of 43% of CNMHK to the three listed companies for HK$176.84m, receiving $116m in cash (including the Inno-Tech note redemption), $15.8m of promissory notes from Railsmedia and $45.05m of promissory notes from CNC. COMG still owned 51% and she owned 6% of CNMHK. Bear her name in mind as we'll come back to it in part 2.

The creation of CNC

CNC was listed as Tsun Yip Holdings Ltd on 30-Aug-2010 after a placing at $0.128 per share (split-adjusted). It was in the business of waterworks, drainage and site formation for the public sector in HK. Less than a year later, it had begun to morph. Notably, before doing this, it had lost all 3 of the INEDs it floated with. Mr Sung Lee Kwok resigned on 16-May-2011, Mr Lim Hung Chun resigned on 18-Jul-2011 and Lo Ho Chor resigned a week later, in each case "due to his other business commitments which require more of his dedications" and in each case a new INED was appointed the same day.

On 2-Jun-2011, there was a strange appointment of then 29 year-old Mr Hui Chi Kwong (CK Hui) as an Executive Director. From graduating in 2006 until then he was an insurance salesman with AIA. He got a 3-year contract with CNC, admittedly at only $360k per year, but why? The company said "It is believed" (presumably by the board) "that his established network would be helpful for the business development of the group". What, in drainage and waterworks contracts with the government? How so? What exactly are we missing here?

On 8-Jul-2011 CNC launched a best-efforts placing via Emperor Securities Ltd of 198.4m shares (using the full 20% general mandate) @$0.173, an 19.2% discount to the 5-day average (20% is the maximum under the Listing Rules) raising $33.3m net "for the Group's general working capital and further business development." The placing completed on 21-Jul-2011. A week after that, CNC agreed the deal with Vicky Yu, the initial payment of which was $25m, absorbing most of the placing proceeds.

On 6-Sep-2011 CNC agreed to buy Xinhua TV Asia-Pacific Operating Co., Ltd (XTVAPO, HK) for HK$700m from 3 vendors: 70% from China Xinhua News Network Co Ltd (CXNN, HK, 100%-owned by Xinhua News Agency), 5% by APT Satellite TV Development Ltd (100% owned by APT Satellite Holdings Ltd, 1045) and 25% from (wait for it) Proud Glory Investments Ltd, a BVI shell owned by "Dr Lee Yuk Lun" (YL Lee). The price was payable as to $93m in shares @$0.196 (which would all go to CXNN) and $607m in 5% 3-year bonds convertible @$0.196. The circular was filed on 20-Nov-2011 and includes another ample valuation by Ample Appraisal at $701.2m. The deal completed on 9-Dec-2011.

The deal structure avoids triggering a takeover offer: the shares allotted to CXNN are 28.5% of the enlarged company, and the bonds cannot be converted if doing so would trigger a general offer.

XTVAPO is a start-up with no revenue from incorporation on 22-Dec-2009 to 30-Jun-2011. At that date, it had net liabilities of HK$6.8m, and issued share capital of $0.01m. On 5-Sep-2011, CXNN granted broadcasting rights of its TV programmes to XTVAPO for the Asia Pacific region (excluding PRC) "on an exclusive basis" for 10 years from 1-Sep-2011, for a fee of HK$1m per year for the first 5 years and HK$3m per year for the second 5, a total of $20m. The licence can be yanked if there is a change of control of CNC.

Why this TV distribution right should be worth any more than what XTVAPO is paying for it is anyone's guess, but by buying the shell which owns it, they are paying $700m for it. Amazingly, the market seems to say it is worth even more. None of the bonds has yet converted, but when they do, there will be about 4762m shares in issue. The stock closed on Monday (20-Feb-2012) at $1.09, implicitly valuing CNC at $5,190m when the bonds are converted. YL Lee's bonds alone (which cost him almost nothing) are worth HK$973m at that price, plus the interest.

By comparison, on 8-Jul-2008, before the placing, CNC had a market value of $210m. Add $33m for the placing and you've got $243m. So the market has added about $4,947m for what is essentially just a start-up TV distribution company. Anyway if you enjoy a bit of the-world-as-China-sees-it, you can watch CNC World online in English here or in Chinese here and there's an iPad English App and iPad Chinese App with streaming live TV. The web sites and apps are not mentioned in the circular, so we assume they are not part of the deal, only satellite and cable TV rights.

We're calling CNC a bubble. We should add that from a technical perspective, the stock ownership looks highly concentrated: of the stock in CCASS, 74.0% is held in the top 5 accounts and 86.7% in the top 10 accounts. When those bondholders start converting, watch out for the flood of stock.

About YL Lee and YF Lee

YL Lee, who has 25% of this deal, is Chairman and CEO of Rising Development Holdings Ltd (1004). We don't know where the doctorate is from, but he was upgraded from "Mr" to "Dr" in the 2011 annual report. He is a member of the Beijing CPPCC (a powerless municipal consultative body), and a part-time member of HK's Central Policy Unit (who knows how they pick them?). He owns a BVI company called Pico Zeman Asset Management Ltd, which as its name suggests, is nearly invisible online, but there is a probably-related firm called Pico Zeman Global Asset Management Ltd, which has a web site and is registered with the HK Confederation of Insurance Brokers.

YL Lee is or was also Chairman of Pico Zeman Securities (HK) Ltd (PZSHK), a small broker that has done a few placings and has a web site which, how can we put it, needs a bit of work. He is also Chairman of Volk Favor Food Co Ltd (Volk), a private HK company incorporated on 13-Mar-2007 with no web presence that we could find, but we did find another chap, Herman Lee Yuk Fat (YF Lee), who also claims to be Chairman of PZSHK and Volk. Maybe they are brothers and share the roles.

There are also two snappily-named bodies, The Wanchai and Central & Western District Industries and Commerce Association Ltd (WCWDICA, incorporated 16-Apr-2009) chaired by YL Lee, and on the other side of the harbour, The Association of Industries and Commerce of Yaumatei Tsimshatsui Mongkok Ltd (incorporated 9-Oct-2008), chaired by YF Lee. The bodies paid a joint visit to HK Baptist University last June, and a joint visit to the United Front Work Department of the Communist Party of China Central Committee in Jan-2011. You can thank WCWDICA for sponsoring the HK Chinese New Year fireworks in Jan-2012.

Since 26-Nov-2010, YF Lee has been an ED of CYTM, of which YL Lee was an NED from 2-May-2008 to 17-Dec-2008. CYTM is part of what we call the "Chung Nam Network" of companies to avoid.

YL Lee is married to Clarea Au Suet Ming (Clarea Au), who is the 75% shareholder of CL Group (Holdings) Ltd (CL Group, 8098) which listed on GEM last year. Despite controlling it, she does not sit on the board. CL Group owns Cheong Lee Securities Ltd (Cheong Lee Securities), which she acquired in 2007 and of which she is one of the largest broking customers. She and her associates accounted for 93.1% and 57.0% of its transaction value in the years to 31-Mar-2009 and 2010 respectively. In the second year, she and her associates had transaction value of $229.4bn (yes, billion) or about $918m per day.

Cheong Lee Securities has also done a number of placings including at least 6 for Inno-Tech and 6 for CYTM. You can safely avoid any stock on that list.

We don't know what exactly the contribution of YL Lee to the CNC deal is, but it appears that he gets a 25% carried interest in the start-up for almost zero investment. For a state-owned news outlet (and in China's case, a propaganda unit), Xinhua is behaving remarkably:

Imagine, if you will, the BBC engaging in such activity - teaming up with an AIM-traded company and injecting a start-up company, in return for 29.9% of the voting rights, and giving a 25% piece of the deal to your humble editor. Nice work if you can get it. Do our country's leaders in Beijing really approve of what Xinhua is doing? Interestingly, in its own coverage of the transaction, Xinhua says that Tsun Yip dealt with 3 shareholders of XTVAPO, namely "CNC Limited Co., APT Satellite Company Limited (APT) and Ao Rong Investment Corporation". The first two are basically correct, but we've never heard of the third one. Apparently it is a double translation of Proud Glory Investments Ltd (English to Chinese and back again). But why did Xinhua not mention YL Lee?

Share movements before the CNC deal

Apart from one transfer between them, none of the management of CNC, who held 75% immediately after the IPO, bought or sold any shares until the CNC deal. The transfer between them is interesting in itself. On 13-Apr-2011, CNC announced that the former CEO, Peter Fung Chung Kin, had "disposed of" his entire holding of 111.6m shares (11.25%) to 2 directors in a 30:70 ratio, 33.48m shares to Martin Cheng Ka Ming (KM Cheng) and 78.12m shares to Eric John Chia Thien Loong (Eric Chia). A disclosure of interest shows that the shares changed hands at $0.049 per share. That is roughly equal to the net asset value per share of $0.046, but an 82% discount to the market price that day of $0.255.

Although the pre-IPO shareholders did not collectively sell shares, we can see in the Webb-site CCASS Analysis that the following movements of their shares took place, several months before the CNC deal:

In the midst of this share shuffling, on 12-Aug-2011, CNC granted 45m options, including 9.9m each to KC Kan, KM Cheng and Eric Chia, 1m to CK Hui (apparently he was not as valuable as the other EDs who happened to control the company) and 0.18m to Eric Chia's wife. The options were exercisable at $0.35 per share, after a 65% increase in the 5 weeks since the placing. Normally companies don't grant options after a rapid increase in price - they wait for better opportunities.

We are supposed to believe that this was not insider dealing - that despite the prior movements of shares into the custody of PZSHK and Cheong Lee Securities, firms which are linked to YL Lee and his wife, the directors knew nothing about the pending deal with Xinhua and YL Lee, and the company wasn't even being shopped around for a backdoor listing (shopping around would be price-sensitive in itself). On 18-Oct-2011, with the shares at $0.97 post-deal and the options intrinsically worth $27.9m, CNC announced that the options had been cancelled by mutual consent with all the grantees (including non-directors). CNC wrote "shortly after the above granting of the Share Options, an unique opportunity was available to the Company which ultimately concluded as the proposed acquisition". If only they had seen it coming.

Dealings by another party are also interesting. CYTM owns a small brokerage called GT Capital Ltd (GT Capital), and this page shows that it began holding CNC shares on 9-Jun-2011, increasing to 41.4m shares (4.17%) by 28-Jun-2011. There were no decreases, only increases. On 11-Jul-2011 CYTM bought 20m shares of CNC @$0.213, increasing its stake from 41.4m shares (4.17%) to 61.4m (6.19%), passing through the 5% disclosure threshold. So we can be fairly confident that the earlier purchases through GT Capital were for CYTM. If so, then they began buying after the shuffling of management shares into PZSHK and Cheong Lee Securities. According to the CYTM annual report, Executive Director YF Lee is "a member of the investment committee for a subsidiary of the company" and Chairman of PZSHK.

The 20m shares were bought through Chung Nam Securities Ltd (Chung Nam). Two days later CYTM bought another 22m shares @$0.215, again through Chung Nam, which had other client(s) in the stock. Chung Nam first received 17m shares in custody on 30-Jun-2011, a day on which PZSHK delivered 20m shares to the system. Chung Nam received another 30m on 14-Jul-2011 and 20m on 18-Jul-2011, by which time it was holding 109m shares, of which 42m were for CYTM and 67m for other client(s), we know not whom.

CYTM disposed of 35m shares on 30-Aug-2011 at $0.425, cutting below 5% before the CNC deal. Those shares didn't go through the market that day or (if that was settlement day) 2 days earlier - turnover was lower than that on both days. There was no decrease in the custody of GT Capital or Chung Nam. We don't know who bought the shares or through which of the two brokers, but obviously they did well if they held them until after the deal. Between 18-Jul-2011 and the deal, Chung Nam's custody holding increased slightly to 111.83m shares and GT Capital's position did not change.

We call on the SFC to investigate dealings in the shares of CNC prior to the announcement of the XTVAPO acquisition.

Now there's much more to come on the other companies mentioned at the top of this article, so stay tuned for Part 2.

©, 2012

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