The Dilution Solution
1 August 2000
You didn't think the story was finished, did you? We explained in a previous article how independent shareholders of Pacific Challenge Holdings Ltd (PCH) had rejected a proposal by its largest shareholder, E1 Media Technology Ltd (E1 Media), to extract HK$170m of cash from PCH in return for a highly-valued Cents.com Ltd (which doesn't even own that domain). E1 Media had spent over $189m to buy 30% of PCH back in February.
E1 Media is an internet start-up incubator founded by Dr Lily Chiang (Dr Chiang), who is also an executive director and daughter of the founder of HK-listed injection moulding machinery maker Chen Hsong Holdings Ltd (Chen Hsong).
E1 Media was prohibited from voting on the Cents.com proposal as it was a connected party to the transaction. Voters against the proposal included the second-largest shareholder, Kistefos Investment A.S. (Kistefos), which owns 62.4m shares, or 26.12% of PCH.
We now know that privately-held Kistefos is 85% owned by Mr Christen Sveaas, one of Norway's richest investors. Kistefos was one of the founding investors of Pacific Challenge back in 1994.
The Dilution Solution
After the rejection of the Cents.com acquisition, what happened next was predictable. On 27-Jul-00, the board of PCH (which consists of 3 representatives of E1 Media and two independent non-executive directors) decided (Word format) that now would be a good time to do a placing of new shares with "independent third parties". Under the standard general mandate which PCH, like most HK-listed companies, obtained at their latest annual general meeting, the directors had discretion to issue shares equal to 20% of the existing issued shares, the maximum permitted by the Stock Exchange rules.
PCH proposes to issue a total 47.6m shares (equivalent to 19.93% of the issued share capital) at $0.67 per share. That compares with the $2.79 per share which E1 Media agreed to pay for their stake back in Feb-00.
What funding need?
You might wonder why PCH needs the money. After all, they still have at least $170m of cash on hand ($0.71 per share) which they had planned to spend on Cents.com Ltd.
They were also due to receive $29.3m for the 28-Mar-00 sale of the group's brokerage companies to a mysterious "independent third party" called Steppington Holdings Ltd. There has been no word on whether that deal was completed or who owns Steppington, which is not registered in HK.
So why do they want a relatively small $31m from this placing? The usual bland reasons are given:
"to enhance the capital base of the Company as well as to strengthen the cashflow of the Company... the Company has no present intention on the specific use of funds and as such, the net proceeds raised will be used as general working capital of the Company".
In other words, they don't need the money. You might also wonder why E1 Media is willing to be diluted at $0.67 per share when it paid $2.79 per share back in February. Even the net asset value of the company is around $0.93 per share (including the unaudited results to 31-Mar-00) and most of that is cash.
The New Investors
The placing is in two equal slices. Half is through a registered dealer called Get Nice Investment Ltd, to a person called Mr. Cham Wai Ho (Mr Cham). The announcement describes him as "an independent professional investor".
Our database tells us that a person called Anthony Cham Wai Ho was until 14-Jun-00 an Independent Non-Executive Director of Star Cyberpower Holdings Ltd, formerly known as Chung Hwa Development Holdings Ltd.
On a whim, we picked up the phone and called Get Nice, and asked to speak to Anthony Cham. It turns out that he is the Managing Director of sister company Get Nice Futures Company Limited. We asked him what he thought about the now-scrapped Cents.com acquisition, but he said he didn't know anything about it. Mr Cham clearly has confidence in the current management of PCH.
The second placee is Dr Pau Kwok Ping (Dr Pau), and he is described as "a director of a company listed in Hong Kong". Now which company could that be? Want to take a wild guess?
We'll tell you what PCH preferred not to mention. Dr Pau is an Executive Director of Chen Hsong Holdings Ltd, the company founded and still run by Dr Chiang's father. Dr Pau is 46 years old and has been with the group man and boy, since 1968 when he would have been only 14.
Dr Chiang is also an Executive Director of Chen Hsong, and both she and Dr Pau are directors of Chen Hsong Investments Ltd, which owns 67.35% of Chen Hsong. That company is in turn 84.42% owned by the trustee of the Chiangs' Family Foundation and the Chiangs' Industrial Foundation. Dr Pau owns 4.9% of Chen Song Investment. Dr Chiang owns 60% of E1 Media.
As a result of the placing, Kistefos would be diluted to 21.78%, while E1 Media would have 25.07% and the two new investors would have a total of 16.62%. So E1 Media and the new investors will have a combined total of 41.68% of the company, should they choose to vote together on specific future proposals.
We are not, of course, suggesting that any of the named parties are acting in concert. That is for the SFC to determine and not us. The SFC declined to comment on the case.
Speaking exclusively to Webb-site.com, Mr Erling Thiis, the Managing Director of Kistefos Investment A.S., said:
"We think the placing is very curious as there are no indications that the company needs any additional working capital. Furthermore we are surprised that the placing takes place at the point in time where the share price does not in any way reflect the real underlying value of the company. That, in our opinion, gives serious grounds for questioning the judgment of the board of directors."
We understand that Kistefos has instructed lawyers to object to the transaction with both the Stock Exchange and the SFC. You will not be surprised to learn that there is no formal process for objecting to a listing application - you just have to find someone at the Exchange who is willing to listen, and do it fast, since approvals of issues such as this are delegated by the Listing Committee to the Listing Division.
Loopholes are there to be exploited
We've talked about the problems with the general placing mandate in a previous article.
This case highlights again the way in which the placing mandate is open to abuse. If PCH wished to issue new shares for cash then it should have done so by way of a rights issue. That is what is known as "pre-emptive rights" and it prevents dilution of existing shareholders without their consent. So long as the Stock Exchange refuses to bring itself up to international standards on pre-emptive rights, investors will suffer dilution through placings such as this.
This is not Singapore, where the limit is 20% per year. This is not London, where institutional investors require a limit of 5% in 1 year and 7.5% in a three-year period. This is Hong Kong, where anything goes.
After each general mandate, the rules allow you to get another one, and then another. Yes, you can have as many mandates as you like in one year. Controlling shareholders can approve a new mandate in a general meeting every time their board exhausts the old one.
After the 20% placing general mandate has been exhausted (assuming that the Stock Exchange either doesn't wake up or can't smell any coffee), one of the first things that PCH is likely to do is to seek a new mandate.
Next, we predict that a new acquisition will be identified, and the consideration will be in cash.
The board might also turn their eyes to the share option scheme - don't you think the board should be incentivised with a raft of new share options? PCH has never granted any options under its existing scheme, so up to 10% of the company could be issued as options to the management, subject to a maximum of 2.5% per individual, and at a strike price of not less than 80% of market price.
Watch this space!
© Webb-site.com, 2000