25 May 2013
Yorkey Optical International (Cayman) Ltd (Yorkey, 2788) is a company suffering from corporate obesity - it is stuffed with cash, and has been since it listed in 2006, having consistently failed to execute its IPO investment plan or otherwise deploy the capital into its business.
At 31-Dec-2012, Yorkey had cash of US$113m (HK$878m) and no borrowings. The cash is worth HK$1.06 per share. Yesterday the shares closed at $0.65, a 39% discount to the cash. The market capitalisation is HK$538m (US$69.3m). The stock is also at a 55% discount to net asset value of $1.43 per share. 74% of the net assets are cash.
Now, after a change of control and the exit of a co-founder, Yorkey is seeking independent shareholders' approval to carry on dealing with its new 27.4% shareholder and using the cash to extend generous credit, putting the money at risk. With your help, we now aim to resolve this problem in the interests of all shareholders. Vote against the connected transactions, and demand a distribution of the surplus cash. We reckon they can pay out $0.81 per share and still have a comfortable contingency fund.
The dividend would benefit all shareholders, including the controllers. It would slim down Yorkey, deter its customers eyeing the cash pile and demanding more credit, and would dramatically boost the rate of return on equity.
Yorkey is engaged in the manufacture and sale of plastic and metallic parts and components of optical and opto-electronic products in China. Customers named in the IPO prospectus include Canon, Konica, Minolta, Nikon, Olympus, Pentax, Ricoh, Samsung and Toshiba.
Yorkey was founded in 1995 and prior to the IPO and pre-IPO subscriptions, it was 55% owned by Mr Cheng Wen-Tao (Mr Cheng), then CEO, via Asia Promotion Optical International Ltd (Asia Promotion, BVI) and 45% by Ability Enterprise Co., Ltd. (Ability Enterprise, 2374.TT), which is listed in Taiwan.
Yorkey listed in HK on 10-Feb-2006 after an IPO of 190m new shares (including 30m over-allotment) and 40m existing shares at $2.20. This raised gross proceeds for Yorkey of HK$418m (US$53.9m). The prospectus contained an investment plan for the proceeds, 90% of which was for equipment purchases and 10% for working capital.
In early 2006 just before the IPO, Taiwan-listed Asia Optical Co., Inc. (Asia Optical, 3019.TT) subscribed for 40m shares @HK$1.592, raising $63.68m (US$8.21m) and Fortune Lands International Ltd (Fortune Lands) subscribed for 120m shares @HK$0.32, raising HK$38.40m (US$4.95m).
Taking the pre-IPO issues and the IPO together, net of expenses, Yorkey raised US$65.4m. This added to a pre-IPO cash pile of US$43.6m at 31-Dec-2005, so at 31-Dec-2006, Yorkey had US$125.0m of cash and no borrowings. Six years later, the company has proven that it didn't need the money, which remains untouched. Fixed assets were US$27.9m in 2006 and $24.2m in 2012. Turnover was US$82.2m in 2006, peaked at US$124m in 2007 and was $92.8m in 2012. Net profit peaked at US$27.7m in 2007 (including $5.2m of interest on the cash) and was just US$0.06m in 2012.
After the IPO and the over-allotment, Yorkey was 29.16% owned by Asia Promotion, 23.86% by Ability Enterprise, 14.46% by Fortune Lands, 4.82% by Asia Optical and 27.71% by the public.
About Fortune Lands
Fortune Lands does not have a beneficial interest in the shares it holds. It is the trustee of the "Yorkey Employees' Trust", which was established by Yorkey to provide for incentives and reward to "Eligible Participants". Before the IPO, Mr Tawara Seiichi, an employee of Yorkey, was nominated to hold 100% of Fortune Lands. Mr Cheng loaned HK$38.4m to Fortune Lands to subscribe for the deeply-discounted shares. On 1-Feb-2010 Mr Tawara transferred Fortune Lands to Mr Chen Yao Tang, a senior manager (but not a director) of Yorkey who joined the group in 2005 and heads the mould technology department.
Fortune Lands sold 5m shares on 15-Jan-2007 in an off-market deal at $2.467 per share, and in a week of on-market sales from 27-Aug-2007 to 3-Sep-2007, sold another 2m shares, cutting to 113m shares where it stands today. The sales raised about HK$17.22m. The first two dividends in 2006 and 2007 produced another $19.79m, so Fortune Lands could have repaid its debt to Mr Cheng by 30-Jun-2007, although we have no way of knowing whether it did. As the person who funded the original purchase, he continued to disclose an interest in the shares held by Fortune Lands until 10-Mar-2011, the same day that he stepped down as CEO.
The prospectus (p144-149), outlines the terms of the Employee Trust, a points-based system (1 point per underlying share) which awards shares (and the income from them) to participants, with a 5-year vesting schedule. As there have been no further disposals of shares since 2007, it appears that this scheme is dormant. Either that, or each and every one of the participants have decided to leave their vested shares in the trust rather than sell them or take delivery of them. If the shares in the trust have not been fully allocated, then to whom do they belong when the scheme expires after 10 years in 2016? Were these shares really for employees?
From 3-Oct-2007 to 21-Dec-2007, Yorkey repurchased 2.222m shares at an average of $2.117. There has been no change in the outstanding shares since then. It would not make much difference if they were to use the repurchase mandate now, because at current prices, blowing the full 10% mandate would only absorb about HK$53.8m (US$6.9m), just 6% of the cash. Besides, the free float limit is 25%, and the float is only 41.5%, so the most they could buy would be 16.5%.
On 5-Oct-2009, Asia Promotion and Ability Enterprise transferred 80m shares into a Taiwan Depository Receipt (TDR) offering in Taiwan at TWD 8.2 (about HK$1.97) per TDR. In the Webb-site CCASS Analysis System, we can see that the shares were transferred to Citibank N.A. as depository, 24.833m from Ability Enterprise on 5-Oct-2009 (from its custodian First Worldsec Securities Ltd) and 55.167m deposited by Asia Promotion on 6-Oct-2009. The TDRs began trading on the Taiwan Stock Exchange on 8-Oct-2009 (code 9188.TT). This cut Asia Promotion's holding to 22.57%, and Ability Enterprise to 17.45%.
Change of control
On 19-Nov-2012, Mr Cheng's Asia Promotion agreed to sell its 22.57% stake to Asia Optical, purportedly for US$18.55m or HK$0.77 per share, increasing Asia Optical's stake from 4.83% to 27.40%. While there is no evidence that Asia Promotion received anything more than that, this is an astoundingly low price given that the net asset value at 30-Jun-2012 was $1.46 per share including $1.05 of cash per share. Mr Cheng could, as the CEO (before stepping down) and largest shareholder, have simply caused the board to declare a dividend of $0.77 per share and received the same amount while keeping his shareholding intact.
The sale was completed on 8-Mar-2013.
Dividends paid in the 7 years since IPO total HK$0.884 per share, almost the same as EPS of $0.875, so the company has paid out about 100% of its earnings, but that is not the point. It is grossly over-capitalised. Even if it had genuine plans to invest the money in its business in 2006, those plans have not been executed, and with turnover dropping and net margins reduced to nearly zero, it doesn't need the money now either. The cash is just sitting in the bank earning a paltry rate of interest.
Being a listed company, Yorkey has the flexibility to call on the markets with a rights issue if it should need funds for a good project later, but for now, it should return the money to all shareholders and allow them to invest it themselves in other companies that really need the capital.
With an average turnover in the last 2 years of US$107m per year, we consider that a contingency fund of 3 months' turnover, or US$27m, should be more than adequate. Trade receivables at 31-Dec-2012 were US$16.6m, or about 65 days' turnover, which is not unreasonable, but we would not want to see that situation deteriorate as customers eye the cash pile and demand more credit.
So with a US$27m contingency fund, Yorkey has US$86m more cash than it needs. That's about HK$0.81 per share. As a Cayman company, Yorkey can pay distributions "out of share premium" - that is, it does not need to do anything legally complicated even though the money would be a return of surplus cash rather than accounting profits.
We call on Yorkey to immediately declare a distribution of $0.81 per share (including the pending $0.02 it has declared in respect of 2012).
Yorkey has for years been engaged in ongoing supplier and customer transactions with both Ability Enterprise and Asia Optical and their respective associates. If ongoing transactions with "connected persons" are large enough, then they are subject to approval by independent shareholders every 3 years.
Owning more than 10%, Ability Enterprise has always been a connected person of Yorkey. The previous agreement with Ability Enterprise was approved by independent shareholders (then including Asia Promotion and Asia Optical) and ran from 2010 until 31-Dec-2013. In the past, Asia Optical owned less than 10% of Yorkey, so was not a connected person until 8-Mar-2013, when it increased to 27.4%.
On 25-Mar-2013, Yorkey announced a renewal of transactions with Ability Enterprise and a conditional agreement for transactions with Asia Optical, for a period ending 31-Dec-2015, bringing the two shareholders into synchronisation.
Unfortunately for investors in general, the Stock Exchange of Hong Kong (SEHK) has relaxed the thresholds for such transactions to require approval. In 2010, it was 2.5% of revenue or HK$10m, whichever was greater. Now, it is 5% of revenue, so Ability Enterprise does not need your approval this time around, while Asia Optical does.
The agreements include generous credit terms of up to 120 days for Asia Optical and its associates. That is a lot more than the average 65 days in the accounts, and in effect it allows Yorkey to use its cash pile to make interest-free loans to its largest shareholder in the form of extended credit. Yorkey says that Asia Optical was the largest customer in the past and is still one of the top 3 customers, and this is a reason for longer credit. To the contrary, in our view this is a reason for prudence, because if Asia Optical gets into financial difficulties, we don't want it causing large write-offs at Yorkey. Given the influence that Asia Optical has over Yorkey, if Asia Optical does get into financial distress, then it will lean on Yorkey to extend the credit period.
Who can vote?
For starters, Asia Optical cannot vote, as it is a party to the agreement.
Webb-site made a submission to SEHK, HK's for-profit regulator, arguing that Ability Enterprise should also be barred from voting in favour of Asia Optical's transactions, because it had simultaneously been granted a fresh agreement by Yorkey, and there was an obvious conflict of interest - we'll approve your agreement if you approve ours. SEHK should have allowed truly independent shareholders, i.e. the public float, to decide on this.
Webb-site also submitted that Fortune Lands, the trustee of the Yorkey Employees' Trust, should also be barred from voting, because it is too close to management. At the time of the IPO, 2 of the 4 directors of Fortune Lands were Mr Lai I-Jen and Ms Iris Wu Shu Ping, who are directors of Asia Optical. The other 2 were Mr Cheng (then CEO) and Mr Tawara, the employee nominee who owned it. If it exists to incentivise staff, then it presumably makes awards according to management recommendations based on performance of staff.
We have no way of knowing what SEHK did with our submission. When investors make complaints, it is very much a black hole approach - information goes in, but nothing comes out. The Exchange in theory has an "Aggrieved Party" procedure under Listing Rule 2B.15, where "any person" other than a listed issuer, its sponsor and authorised representatives, who is aggrieved by a decision of the Listing Division, can express his views in writing to the Chairman of the Listing Committee. The Listing Committee may decide to fully review the matter.
This rule is useless in practice, because after an investor files a complaint, she is not told what the decisions of the Listing Division are, let alone the reasons. As she is kept in the dark, she cannot know what to complain about. Meanwhile, after an investor complaint is made, the listed company can engage in a two-way discussion with the Listing Division to plead their case and negotiate an outcome. This is procedurally unfair to the complainant.
After repeated delays, the EGM circular was finally published on Wednesday. It states that Ability Enterprise and Fortune Lands can both vote. It discloses that the board of Fortune Lands no longer includes the Asia Optical directors, but is now 5 people, namely Mr Cheng (who sold his Yorkey shares to Asia Optical), Mr Chen (the Yorkey senior manager and nominee owner of Fortune Lands), Mr Nagai Michio (the new CEO of Yorkey), Alan Chiang Hsiang Tsai, and Wang Yi Chi, who are both also "independent" non-executive directors of Yorkey.
Both of those INEDs are also Professors at Feng Chia University, Taiwan, and amazingly, Prof Chiang specialises in corporate governance and financial statement analysis, so he ought to recognise a bloated balance sheet when he sees one, and he's been sitting on top of one since 2006. Webb-site reached out to both of them by e-mail, hoping for support, but did not receive any response. In HK, INEDs are elected by controlling shareholders and are seen but not heard.
Vote against the connected transactions
Shareholders should express their displeasure with the state of affairs at Yorkey by voting against the connected transactions and demanding a cash distribution.
The EGM is on Friday 7-Jun-2013, and voting cut-off at your broker or custodian will be well before that, so vote now.
It may seem counter-intuitive to vote against transactions which involve the core business, but there are larger issues at stake, and besides, Yorkey barely made a profit last year, so it can hardly be said that Asia Optical, which only accounted for US$13.8m of transactions (both sales and purchases), is crucial to its success. They can always come back and propose tighter credit terms and a distribution of the cash.
At the current share price, shareholders would be far better off if Yorkey simply shut down its business, distributed its cash and sold the listing shell. A clean shell typically goes for a premium of HK$200-250m over NAV, which in Yorkey's case would be a premium of $0.24-0.30 over NAV of $1.43.
The public float of Yorkey is 41.5%. Ability Enterprise and Fortune Lands have 31.1% between them. So to defeat the proposal, we need to get at least 31.1/41.5 = 74.9% of the public shares to vote against. Some of those shares (originally 80m shares, or 9.66% of Yorkey) are in the TDR programme. We don't know how difficult it is to vote those - we hope that the TDR depository, Citibank, will do its job properly, have regard to its fiduciary duties, and seek voting instructions from TDR holders in Taiwan.
Webb-site founder David Webb holds over 4% of Yorkey, below the 5% disclosure threshold. Templeton Asset Management Ltd holds 6.99% at the last disclosure on 20-Feb-2013. With SEHK allowing Ability Enterprise and Fortune Lands to vote, we have an uphill struggle to muster the remaining public vote. If you buy the shares, then make sure you vote them - we don't want people just buying for the discount and then sitting on the sidelines hoping that someone else will do the work.
We did reach out to management by e-mail several weeks ago, inviting them to seize the initiative to slim down the balance sheet with a special dividend (think of it as corporate liposuction) and remove the possibility of the cash being raided through connected transactions, in which case we would vote in favour and say nothing publicly. All we got in response was a load of nonsense - for example, after shrinking headcount from 3837 to 2688 in 2012 (in line with falling turnover), they claimed that they needed US$30m to buy land to expand factory facilities. They also ear-marked US$35-45m for "searching appropriate strategic partners to conduct M&A". There has been no M&A in 7 years, but if they really had a good deal, shareholders would finance it in a rights issue. Capital commitments at 31-Dec-2012 were just US$0.3m.
Even if we lose this vote, a message will be sent by investors that the company should shape up from its corporate obesity and lose the excess weight by distribution.
© Webb-site.com, 2013
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