Solstice Special
21 June 2000
For our Northern hemisphere readers, while away those bright summer evenings with a glance at Solartech International Holdings Ltd (never look directly at this stock - it may cause permanent blindness to fundamental valuation principles).
Solartech was listed on 12-Dec-96 and until recently had been doing a decent but unspectacular job of making power cords (the sort of thing you use to plug in your kettle), audio cables and telephone cords. Turnover was growing nicely, and although net margins were shrinking, the company remained profitable.
Solartech has done a string of placings under repeat general mandates since Nov-99 and spent some of the proceeds on dot-com acquisitions. For example, it paid HK$49m cash for yaso.com.cn and HK$43m cash for 51qq.com. Solartech also engaged in an trendy but pointless 10 for 1 stock split. We are not talking about HSBC here!
Then on 5-Jun-00 the company announced the acquisition of a 20% interest in a company called HK1186.com Ltd. The stock code on the Stock Exchange of Hong Kong for Pacific Century Cyberworks just happens to be 1186, but as far as we know there is no connection between the company and PCCW.
The business of HK1186.com is described as "the provision of online VCD/DVD wholesaling and retailing outlets and online cinemas and the licensing of copyrights to other web sites for online broadcasting." The company has another domain which is Goodtake.st. Both sites were launched as recently as Apr-00.
Prior to the Solartech investment, HK1186 was 56% owned by Mr. Wong Chak Wai. He is described as "the head of the marketing team of equity derivative products in a foreign bank since October 1997". The other 46% was owned by a company owned in turn by four individuals who have been business partners in film production, VCD/DVD distribution and copyright trading since 1997.
Solartech is paying HK$179.092m (US$23.0m) for a 20% interest in HK1186.com Ltd. This was done through two different agreements on 23-May-00 and 2-Jun-00. In the first agreement, Solartech bought a 6% interest in HK1186.com Ltd from Mr Wong for HK$54m in cash, valuing HK1186.com at $900m.
In the second agreement, Solartech bought a further 14% interest in exchange for 2.2 billion new shares valued at HK$0.05686 per share. The new shares represent 19.9% of the existing issued share capital - almost exhausting the 20% general mandate on the day it was granted, which explains why they did the deal in two stages. No mention was made of the intended acquisition when the general mandate was sought. The transaction gives the vendors 16.6% of the enlarged Solartech.
Valuations
Solartech said that the acquisition price "represents a 10% discount to the amount of HK$1 billion at which a firm of independent valuers valued the business of HK1186 as at 2 June 2000."
And how was this valuation arrived at? It is as reliable as the projections on which it was based:
"The valuation was arrived at by applying a multiplier of 8.5 to the revenue projection of HK1186 for the 12 months period ending in April 2001 which is estimated to be around HK$118m."
Note that is a multiple of revenue, not profit. Solartech says that "it is expected that HK1186 will begin generating a net profit around October 2000" but no word on how much.
There has been a growing trend in HK of listed companies coming up with "independent valuations" in an effort to rationalise paying ridiculous prices for internet acquisitions. In most cases, these valuations are based on future projections and either discounting cashflows for years into the future, or more often, applying multiples to projected turnover and citing "companies in the USA" with similar valuations. It's a case of the blind leading the blind. Often the role of the independent valuer is simply to apply a mathematical rule to the projections and then to disclaim any responsibility for the projections themselves (since these are made by the management of the target). That really makes the valuation pointless.
These valuations normally fail to take any regard of the costs of establishing the company being acquired - and that is a good indicator of the barriers to entry for would-be competitors. In this case, HK1186.com did not even commence business until Apr-00. Up to 22-May-00 it had an unaudited loss before tax of HK$460,000 and the unaudited net assets of its holding company (which had no other assets) were HK$3,560,000. In addition, there are shareholders loans of about HK$2,985,000. Add these figures up and you have the starting shareholders' capital of just HK$7.0m.
So let's see - invest HK$7m, and get a dot-com company worth HK$1,000m. Get HK$54m in cash and 17% of a listed company in return for 20% of your dot-com company. Nice work if you can get it.
Shareholders of Solartech have suffered huge voting dilution from this and other deals, none of which has been offered to existing minority shareholders. They have seen the share price soar to $0.44 on 11-Feb-00 then collapse by 91%, closing at $0.041 today.
If a shareholder owned 1% of Solartech a year ago, when the market price was $0.158 (split-adjusted) then he is now sitting on a loss of 74% and has seen his stake diluted to 0.45% of the company. There's no solace this solstice.
© Webb-site.com, 2000
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