Nam Tai's Bids and Bounty
19 November 2005
NTEEP's brief history
Nam Tai Electronic & Electrical Products Limited (NTEEP, 2633) was listed on 28-Apr-04 after an IPO sponsored by HSBC. In the IPO, no new shares were issued and the parent, Nam Tai Electronics, Inc. (NTE, NYSE:NTE, incorporated in the BVI, with investor relations out of Vancouver, Canada) sold 200m existing NTEEP shares, being 25% of the issued shares, at HK$3.88 per share, raising HK$776m before expenses. NTE booked a gain of US$71.1m (HK$555m) on the sale in 2004, which helped offset an investment loss of US$58.3m on its then 9% stake in mobile handset maker TCL Communication Technology Holdings Ltd (TCLCT, 2618).
Incidentally, TCLCT is a disaster zone - it was listed on 27-Sep-04 in an introduction sponsored by Morgan Stanley and CICC and plunged into loss in the third quarter results published on 28-Oct-04. From a first-day price of $1.16, the shares have fallen 77.2% to $0.265 at the time of writing.
NTEEP owns 95.52m promoters' shares representing about 3.69%, of TCL Corporation (TCLC), acquired in Jan-02 for US$11.968m. TCLC owns 57.4% of TCLCT and 54.81% of TV maker TCL Multimedia Technology Holdings Ltd (TCLMT, 1070). TCLC has A-shares listed on the Shenzhen Stock Exchange (SZ:100), which currently trade at RMB2.00 each, off a 1-year low of RMB1.72, compared with net assets of RMB1.78 per share. In NTEEP's 3rd quarter results, published after the privatisation bid was announced, it said it will consider making a provision for impairment of the investment in the 4th quarter. NTEEP shareholders should not be too worried about this - because it is a non-core asset and because the market price of TCLC values the promoter's shares at RMB191m (US$23.6m), well above the book value. China is in the process of converting the multiple classes of shares in mainland-listed companies into a single listed class, so the promoters' shares are likely to become transferable in the end.
On 9-Mar-05, in its first sale after the IPO, NTE sold 20m NTEEP shares at $2.55 each to funds managed by Value Partners Ltd, raising $51m. The stock closed the previous day at $2.625. On 14-Mar-05 it sold a further 10m shares in the market at $2.60 each, raising $26m. NTE booked a gain of US$5.87m on the sale in its Q1 results.
On 8-Apr-05, NTEEP announced that it would buy Namtek Software Development Co Ltd (Namtek), 80% owned by NTE and 20% by its management, for US$26.7m in exchange for new shares in NTEEP valued at HK$2.55 each. NTE received 65.34m NTEEP shares, increasing its stake from 71.25% to 72.06%.
On 8-Aug-05, NTE began selling NTEEP shares in the market, over 4 days, as follows
|Date||Number||Aver. price $||Proceeds $m|
There's nothing more likely to shake investor confidence in a stock than the sight of the majority shareholder dumping shares for no apparent reason, and so it was that the stock slumped from $2.025 on 7-Aug-05 to a daily low of $1.14 on 14-Oct-05. NTE booked a US$2.295m gain on the sale in its Q3 results, which helped keep its EPS flat for the quarter. NTE also sold 6.006m shares in TCLCT on 11-Aug-05 at HK$0.389, and unloaded 150m shares at $0.38 on 31-Aug-05, cutting its stake to 3.32%. NTE booked a loss on those sales of US$1.421m.
NTE has not sold any NTEEP shares since then, leaving its current holding at 612.76m shares, or 69.50% of NTEEP. Overall, the gross proceeds of NTE's sales of 252.574m NTEEP shares from the IPO until now is $893.4m, or about $3.537 per share.
The NTEEP Offer
On 23-Oct-05, 16 months after selling NTEEP to the public at $3.88 per share, and with the shares having slid to $1.22, NTE offered to buy it all back at $1.80 per share, a 54% discount to the IPO price. The total cost of buying back the 252.574m shares it sold (excluding shares issued to the Namtek management for their 20% of Namtek) would be $454.6m, resulting in a net cash windfall of $438.8m before the expenses of the IPO and privatisation.
It is noteworthy that the average price of NTE's August sales of NTEEP was $1.791 per share, just a smidgeon below $1.80. So the privatisation bid is basically at the lowest price at which NTE has ever sold NTEEP shares, and about half the average price at which it sold them since and including the IPO.
Despite the difficult market for manufacturers in general, who are challenged by elevated plastic prices, other raw material cost increases, rising labour costs, the appreciation of the RMB and electricity shortages, NTEEP has increased turnover by 4.3% in the first 9 months of this year, with operating profit up 6.5% and EPS up 2.8%. This is not a distressed company. The Offer values the stock at just 8.85 times 2004 earnings, and meanwhile NTE is trading on a P/E of about 16x, almost double the rating. Furthermore, NTEEP had net cash at 30-Jun-05 of HK$0.236 per share, so excluding that, NTEEP's core P/E is even lower.
You can see why NTE would make such an offer, but that is no reason to accept it. The shares traded above the Offer Price as recently as 9-Aug-05 without any privatisation bid on the table, and there has been no major change in the prospects of NTEEP since then.
NTEEP has 3 "independent non-executive directors", but 1 of them, Warren Lee Wa Lun, is a director of Yu Ming Investment Management Ltd (Yu Ming), which by an amazing coincidence has the job of advising NTE on this offer, so he is conflicted out of serving on the independent board committee which advises minority shareholders. However, that didn't prevent him from giving an opinion in the offer document, on behalf of Yu Ming, recommending shareholders to accept the offer. The other two INEDs are Thaddeus Beczak, former Chairman of the Stock Exchange Listing Committee and a member of the Advisory Committee of the SFC, who has been on NTEEP's board since the IPO, and Charles Chan Tit-hee, an accountant, who joined the board on 1-Nov-04. They have called the offer "fair and reasonable" and recommended investors to accept it.
The actual independent financial adviser is Platinum Securities Co Ltd (Platinum), which also considers the offer fair and reasonable. This is the same adviser which in 2002 said that a privatisation bid for Paul Y.-ITC Construction Holdings Ltd (now PYI Corp Ltd, 0498) at a 90% discount to net asset value was "fair and reasonable" (the privatisation failed) and in the same year said that the privatisation bid for Henderson Investment Ltd was fair and reasonable. Shareholders rejected it. Platinum's Managing Director Liu Chee Ming is a member of the SFC's Takeovers and Mergers Panel.
J.I.C. Technology Offer
On 23-Oct-05, the same day as the NTEEP offer, NTE also announced an offer to privatise its much smaller HK-listed subsidiary, J.I.C. Technology Co Ltd (JICT, 0987) at $0.55 per share. The offer for the 28.4% NTE doesn't own will cost $119.2m.
JICT was first listed under separate ownership in 1994 as Albatronics (Far East) Co Ltd (Albatronics) and was almost bust in 1998, when NTE first came onto the scene. They injected capital but not enough to prevent Albatronics from going into liquidation, and finally it was resurrected in 2002 when the current business was injected and shareholders of Albatronics got 1 share in JICT for every 90 Albatronics shares they held. Since then, it has been successfully growing its business in monochrome LCD displays for calculators, clocks, phones and the like. Customers include Uniden Hong Kong Ltd. JICT produces about 10 million LCD panels per month.
Value Partners has also been involved in JICT, and on 25-Nov-04, their funds purchased 28m shares from NTE at $0.75, raising their stake to 32.168m shares, or 9.12% of JICT. Then on 29-Dec-04 NTE sold 100m shares in the market at $0.80 per share, which made room for them to convert the remaining preference shares they had held since the restructuring, without reducing the free float below 25%. As a result, they held 71.63% of JICT, and Value Partners was diluted to 4.21%. NTE booked a gain of US$6.25m on the sales in Q4 of 2004.
For the 9 months ended 30-Sep-05, JICT's turnover gained 17.8%, net profit gained 22.9% and EPS was 4.21 cents. Extrapolate that for the full year, assuming no major seasonality, and you get EPS of 5.6 cents. That puts the offer on a prospective 2005 P/E of 9.8x. The shares last closed above the offer price on 15-Aug-05, just 3 months ago.
Having played a large part in the collapse of NTEEP's share price, NTE's Offer is cheeky and opportunistic. It puts NTEEP to the unnecessary expense of paying advisers and documenting a response to an offer which should not have been made. Ultimately it is the shareholders of NTEEP, including the minority shareholders, who bear this expense. We recommend that shareholders do NOT accept the offer. We think NTE's offer should be viewed more as a cry for attention - by making the offer after trashing NTEEP's share price through its own sales, it has brought attention to the stock, but in the process, brought its treatment of minority shareholders into question.
Shareholders should ignore the possibility of future sales of NTEEP by NTE, which would dilute NTE's earnings, and instead focus on the valuation of the stock. Unless there is something they are not telling us about the business or an urgent need for cash, it makes no sense for NTE to continue selling shares. On the face of it, NTE does not need the money - it had group cash of US$155m at 30-Jun-05, including NTEEP (US$26.8m) and JICT (US$3.4m). The only bank debts were a modest US$11.3m, almost all within JICT. And since 30-Jun-05, NTE's own cash has been boosted further by its sales of NTEEP and TCLCT.
The market appears to agree that this offer is likely to fail. The shares are trading at $1.55, 13.9% below the $1.80 offer price. NTE has said that the offer is final, and that means under the Takeover Code it cannot be increased. In order to succeed, NTE needs acceptances in respect of 90% of the shares held by independent minority shareholders, which means that if holders of just 2.87% do not accept, than the offer will fail.
Given the good growth exhibited by JICT, the relatively low prospective P/E being offered, and the fact that the shares traded above the offer price only 3 months ago, we recommend shareholders do NOT accept the offer. Our recommendation is strengthened by the fact that NTE is making such a low bid for NTEEP - this should give investors the confidence to believe that the same approach is being employed with JICT. In the Offer Document, Asian Capital (Corporate Finance) Ltd (ACCF), the independent financial adviser, wrote:
"any enhancement in future profitability of JIC could lead to an increase in JIC's share price, and may even lead to a revaluation of JIC in terms of a higher price earnings multiple. In that respect, if the privatization is successful, Disinterested Shareholders will not be able to enjoy the benefit of such revaluation."
"the Industry and JIC's prospects appear to be positive"
Despite saying this, ACCF advised shareholders to accept the offer.
Bounty for Brokers
The story gets worse, though. On 14-Nov-05, the day the Offer Documents were posted, NTE announced that it would offer to pay a bounty of 1% "brokerage commission" to any dealers who tender valid acceptances on behalf of their clients, on condition that the offer succeeds. As far as we know, this is the first time this has happened in Hong Kong. The SFC has approved it, but we think that they were wrong to do so and have set a dangerous precedent by allowing this. Your humble editor is a member of the SFC's Takeovers and Mergers Panel and has conveyed this opinion to the SFC.
At one stroke, the SFC has removed the possibility of any brokers giving their clients independent advice on the privatisation which is untainted by the offeror's financial incentive, unless of course the broker is so noble as to decline the commission. How many brokers do you know who would do that? It's one thing for an offeror's contracted adviser to solicit acceptances, or to contract another firm to conduct a lobbying campaign, but that is something which is a limited contractual arrangement rather than a general bounty offer which conflicts the entire brokerage community. Now apart from this web site and the media, where are investors supposed to get unconflicted advice on these privatisation bids? The wholesale elimination of unbiased advisers is is not in the best interests of the market.
To see how bad this is, consider a scenario in which the privatisation were conducted by way of a "scheme of arrangement" (in which the proposal goes to a vote and is binding on all holders) rather than a "general offer". Would it then be acceptable for the bidder to pay 1% to brokers whose clients vote in favour of the scheme, but nothing to those whose clients vote against? Surely this would corrupt the vote, and yet the end result is no different - if a scheme of arrangement were approved, then all the shares would be sold. And if the current offers are successful, then NTE will be able to compulsorily acquire the remaining shares. The end result of 100% ownership is the same in either type of privatisation.
If the arrangement was intended to compensate brokers for the cost of contacting clients and explaining the offer to them, without bias, then a fee should have been paid to all brokers who hold the shares for clients in CCASS accounts, regardless of whether their clients accept the offer, and regardless of whether the offer succeeds, so that the fee does not influence the decision. That is not the case - the bounty is only payable to those brokers who tender shares and only if the offer succeeds.
The terms of the commission payment also prohibit the broker from rebating any of this commission to the client, because this would result in the client receiving a net higher price for his shares than other NTEEP shareholders in breach of the Takeover Code, but in practice this will be very difficult to police.
So if your broker calls you up and tries to get you to accept the offer, bear in mind that he has a financial incentive to do so - a bounty at least 4 times as large as the typical 0.25% (or less) brokerage rate you might pay if you just sell your shares in the market at some future date. Indeed, if he doesn't disclose this commission, then as your agent, he is receiving a commission without your permission, which is against Section 9 of the Prevention of Bribery Ordinance (titled "corrupt transactions with agents"), so report your broker to the ICAC. This is no different in principle to a supplier who pays a secret commission to supermarket staff (who are agents of the supermarket) for persuading the supermarket to buy the goods. However, before you call the ICAC, look at the small print of your client agreement, and you may find that you have already consented to the broker taking commissions in this way.
In allowing this arrangement, the SFC did not impose any requirement that brokers must inform their clients that the broker will receive a 1% commission from NTE. So not only is the arrangement wrong in principle, but it also lacks transparency. You have been warned.
© Webb-site.com, 2005
Organisations in this story
- China Renewable Energy Investment Limited
- NAM TAI ELECTRONIC & ELECTRICAL PRODUCTS LIMITED
- Nam Tai Property Inc. (VG)
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