Our latest New Year bubble worth popping is Kuangchi (0439), HK's top-performing stock of 2014, valued at HK$32.03bn (US$4.13bn) or 16.1x NTAV.

Kuangchi the stratospheric stock
2 January 2015

Continuing our New Year bubbles theme, the next one worth popping is Kuangchi Science Ltd (Kuangchi, 0439), which was HK's top-performing stock in 2014, with a Webb-site Total Return of 2167%, closing at $5.26. Appropriately enough, it was renamed from "Climax International Co Ltd" during the year, because what follows next may be an anti-climax.

The hype surrounding this stock began on 13-Jun-2014, when Kuangchi announced a massive subscription of new shares. It was so large that in order to meet the free float requirement of 25%, part of the new shares had to be issued as unlisted non-voting "preferred shares" which are convertible into listed ordinary shares when the free float permits (after substantial shareholders sell down).

So Kuangchi issued 1667m ordinary shares and 2,683m preferred shares, a total of 4350m shares at HK$0.08 each, eventually raising $348m gross. We say "eventually", because the preferred shares were issued in two equal tranches partly-paid, with only $0.004 per share payable initially. The remaining $0.076 is payable on the first tranche within 6 months of completion, and on the second tranche within 1 year of completion. The subscription price of $0.08 was a 76.1% discount to the closing price of $0.335 before the deal, but close to the net tangible asset value of $0.082 per share at 31-Mar-2014.

The buzz behind the deal is that, under an "Outsourcing Technology Development Agreement" (OTDA) for a fee of HK$55m, Kuang-Chi Innovative Technology Ltd (KCIT) would:

"research and develop a near space civil flying apparatus with a volume of not less than 10,000 cubic metre[s], which shall be equipped with communications facilities to be used in the range from ground level to near space and shall be able to fly at no less than 20 kilometres above sea level"

This may sound exciting, but a large-volume "near space flying apparatus" is of course a helium balloon with bells on. As a measure of the difficulty involved, the agreement called for KCIT to complete the design and testing of the "scaled flying apparatus" (perhaps a trial balloon) by 15-Sep-2014, and by 30-Oct-2014, to complete the "research and development of the required materials for the flying apparatus", and by 31-Dec-2014 to "complete the testing of the flying apparatus and deliver" it to Kuangchi for a further test run.

On 22-Dec-2014 there was much celebration (the announcement says so) when Kuangchi officially opened the "Appollo Base" (or possibly, the Apollo Base - they can't seem to decide on the spelling) and there erected the "KuangChi Space House No. 1" which is 42 metres tall, covers 10,000 square metres in site area, and is "currently the greatest construction in the PRC.. in terms of height and scale, respectively". So forget the Shanghai Tower, which is 632 metres tall, or the National Grand Theatre which covers 12,000 square metres. This temporary air-supported hangar is something like the ones sold by Membrane Structures inc., or a larger version of the bubbles over swimming pools in the winter.

Then they "revealed for the first time" (revelations are like that):

"a disruptive novel space service platform newly developed by the Group, namely the "Cloud", as well as certain equipment and technology specifically developed for the "Traveller", the civil near space flying apparatus, and to be released at the KuangChi Apollo Base."

Ah yes, "The Cloud" or, if you look at the pictures, a giant silvery helium blimp without its tail fins.

A circular went out on 29-Jul-2014 and the deal completed on 22-Aug-2014. Prior to that, Kuangchi (then Climax) was 44.08% held by CEO Hans Wong Hin Shek, who resigned on completion, along with most of the board. He then held 638,981,013 shares now worth $3361m at the inflated market price.

According to the circular and details from a subsequent disclosure of interest, the main subscriber, with 68% of the placement, was New Horizon Wireless Technology Ltd (New Horizon), which is 51% owned by KCIT and 49% by Shenzhen Kuang-Chi Hezhong Technology Ltd (SKCHT). KCIT is a 60% subsidiary of Shenzhen Dapeng Kuang-Chi Technology Ltd (SDKCT), which is a 53% subsidiary of Shenzhen Dapeng Kuang-Chi Lianzhong Technology LLP (SDKCLT), of which Dr Liu Ruopeng controls 37.73%. He also owns 35.09% of SKCHT. Multiply all that and he has a 23.31% economic interest in New Horizon.

New Horizon would not have to put in cash though, because it was provided with a loan by Rosier Investments Ltd (Rosier, BVI) in 3 tranches. Tranche 1 was sufficient to pay the entire cost of its ordinary shares and the $0.004 part-payment on the preference shares. Tranche 2, 6 months later, was enough to pay up all but $45m of the Tranche-A Preferred Shares, and Tranche 3, a year after completion, was sufficient to pay up all but $10m of the Tranche-B preferred shares. It is probably not a coincidence that the only funds New Horizon would need to find is equal to the $55m that would be due to KCIT under the OTDA, plus interest on the loan at 6.5% p.a..

New Horizon has pledged 986m of its Kuangchi ordinary shares (that's 87% of its holding of ordinary shares) to Rosier as security for the loan. Rosier is owned (via wholly-owned offshore companies) by Johnson Ko Chun Shun (Mr Ko, 41.7%), Yu Nan (Ms Yu, 29.1%), Liu Shu Ling (Ms Liu, 14.6%) and Guo Shanling (Ms Guo, 14.6%). Webb-site Who's Who has no previous record of Ms Yu, Ms Liu or Ms Guo.

Apart from the 68% of the placement taken by New Horizon, the remainder was taken 9.33% each by Mr Ko and Ms Yu, 4.67% each by Ms Liu and Ms Guo, and 4% by Reorient Group Ltd (Reorient, 0376), which is 51.35% owned by Mr Ko, its Chairman. Reorient Financial Markets Ltd acted as a financial adviser to Kuangchi on the deal, along with Kingston Corporate Finance Ltd.

Like the planned balloons, the stock quickly inflated and took off to the stratosphere, reaching a high of $6.23 on 23-Sep-2014, and closing the year at $5.26. Along the way, on 12-15-Sep-2014, Kuangchi agreed with 26 unnamed suckers subscribers to issue 289.9m shares at $5.386 each, raising $1561m. The price was 67 times the New Horizon subscription price, but a 5.3% discount to the closing price on 12-Sep-2014. The subscription completed on 29-Sep-2014.

Including the preferred shares, there are 6,089,401,125 issued shares. At the 2014 closing price of $5.26, the company is worth HK$32.03bn (US$4.13bn). The interim report shows net tangible assets at 30-Sep-2014 were $1785m. To this we add the payments due on the preferred shares of $204m, making $1989m pro forma, or $0.327 per share. So the stock is trading at about 16.1x its net tangible assets per share.

In our view, Kuangchi shows all the characteristics of a bubble. Helium balloons, when they reach a high enough altitude, tend to burst, sending their cargo to the ground. If you are on board, now would be a good time to strap on your parachute and jump.

© Webb-site.com, 2015

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