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Our eyebrows were raised when all the representatives of PCCW resigned from the board of Hikari Tsushin International, of which PCCW owned 20%. All became clear a few days later as the Japanese parent sold a 51% controlling stake to a previously unknown investor whose intentions remain vague. The sale price was announced as $0.045, a 70% discount to NAV, triggering a general offer at that lowly price, but days later PCCW sold a 10% stake at $0.155 - what's going on?

Hikari's Strange Exit
30 December 2001

Two years ago, on 28-Dec-99 at the height of the internet bubble, Hikari Tsushin, Inc (HT) of Japan and Pacific Century Cyberworks Ltd (PCCW) of HK announced a joint subscription of shares in battery maker Golden Power International Holdings Ltd, which was renamed Hikari Tsushin International Ltd (HTI). HT invested HK$535.6m for 51% and PCCW invested $210.1m for 20% of the enlarged company, making a combined injection of $745.7m.

HT also subscribed a $93.42m zero-coupon note convertible at the same price as the share subscription and redeemable on 9-Mar-02.

After adjusting for a subsequent 4:1 stock split, the subscription price was $0.225 per share, based on the net asset value at the time, while the market price at the time was $1.006 per share, driven up by the sheer excitement of having PCCW and Hikari as new shareholders - what greater luck could a company wish for?

The change of control was completed on 10-Mar-00 and HTI changed its year-end from March to July, to match the year-end of HT. As a result, the latest accounts are for 16 months to 31-Jul-01. At the beginning of the period, before HT really got going, HTI had just $7.8m of investments. During the period, HTI acquired 16 long term investments at a total cost of $462m, of which 6 internet stocks came from HT for $185m in a connected transaction approved by shareholders. One short-term investment came on 9-Jun-00 from HT at a cost of $7.9m, being 0.36% of Korean Internet Auction Co. Ltd, just before its IPO. Only a tiny portion of these investments was sold, bringing in a small profit of $5.9m on a book cost of $7.5m.

However, by 31-Jul-01, the "fair value" of these investments was reduced by 57% or $268m, of which only $150m was taken as an "impairment loss" (i.e. recorded as a loss in the profit and loss account) and the other $118m taken direct to the investment reserve, by-passing the P&L.

Note to regulators

This highlights one of the farcical aspects of current accounting standards - directors are required to record long-term investments at fair value, but unless they think that an investment is "impaired" (in other words, the reduction in fair value is permanent) then they don't have to record a reduction in value as a loss - they can just hide it in the reserves. So a director can have two simultaneous and conflicting opinions, the first opinion being that an unlisted investment is worth "X" and the second being that it will bounce back and be worth "Y" in the future (in which case, it should be worth "Y" now). This allows directors to be very subjective in the amount of losses they record, based on their own optimism or clairvoyance of future prices. The concept of permanent or temporary losses should be abolished, and all reductions of fair value should be recorded as losses.

What was it worth?

OK, so we've got a battery business, a pile of internet investments, and a somewhat reduced pile of cash, but let's look at where we stand at 31-Jul-01, with investments stated at fair value:

	HK$m	$/share
Long term investments	202.2	0.0434
Cash, net of debt	234.7	0.0503
Other net assets	256.3	0.0550
Total net assets	693.2	0.1486

The bulk of "other net assets" represents the fixed assets of the battery-making business.

The Strangest Exit of 2001?

Here's what happened next. On Mon-3-Dec-01, HTI released an announcement dated Sat-3-Dec-01, stating that the 3 representatives of PCCW on the board of HTI, being Mr Francis Yuen Tin Fan, Mr Mico Chung Cho Yee and his alternate, Mr Hubert Chak, had resigned on Fri-30-Nov-01. The Webb-site.com eyebrows were raised. Why would the directors representing a 20% shareholder resign without replacements? Something was going on.

We didn't have to wait long to find out what. The day after the announcement, on 4-Dec-01, HTI's stock was suspended pending a possible general offer for the company. Rule 7.1 of the Code on Takeovers and Mergers (Code) states that except with the consent of the SFC Executive, the directors of an offeree company (in this case, HTI) should not resign until the first closing date of an offer. By resigning the day before the possible offer was announced, the PCCW guys avoided being locked in during an offer period, or having to give a recommendation on whether to accept the offer.

On 7-Dec-01 HTI announced that a company owned by Mr Daniel Wong King Shiu (Mr Wong) had bought HT's 51.04% stake in HTI for $0.045 per share, or about $107.2m in total. He had then agreed to place 17.04% of this through Kingston Securities and Kingsway Securities at the same price (the Placing), leaving him with a 34% stake in HTI for a net price of $71.4m. The Placing is conditional on the consent of the SFC Executive under Rule 21.2 of the Code because it involves the offeror selling during an offer period.

As this is more than the 30% threshold, it triggers a mandatory cash general offer for HTI at $0.045 per share, apparently the highest price Mr Wong (and any parties acting in concert with him) paid in the last 6 months.

A discount for control?

But wait! Look at that table above. Mr Wong has acquired control of HTI for what is apparently less than its net cash per share, as of 31-Jul-01! In other words, HTI could have distributed all its net cash to shareholders, and HT would have received more money and still owned 51% of the remaining assets and a listed vehicle.

Mr Wong has paid a discount of some 70% to net asset value. Not only that, but the average market price in the ten market days prior to suspension was $0.1336, so we are told that he has paid a 66% discount to market price (which is the price of a minority share) for a controlling stake. Normally, one would expect a premium for a controlling stake.

Now you might be wondering what happened to PCCW in all of this, with its 20% stake, or 933.6m shares, unchanged since the original subscription. Well, on Mon-17-Dec-01 there was a spike in the trading volume which forced HTI to announce that PCCW told them it had disposed of exactly 500m shares (10.72% of HTI) at $0.155 per share, taking its remaining stake below the 10% legal disclosure threshold.

Note: However, during the offer period, PCCW will have to disclose dealings under Rule 22 in HTI so long as they stay above 5%, as that makes them an "Associate" under the Code.

The buyers of PCCW's stake were not disclosed and are presumably independent. The sale price was a reasonable 8% discount to the previous Friday's close of $0.169. On the Monday of the sale, market volume totalled 945.6m shares, and the price collapsed to $0.10, falling further to close on 28-Dec-01 (the last day before this article) at $0.081.

One cannot help but wonder if everything meets the eye here - a substantial shareholder who recently had directors in the boardroom of HTI is able to sell 10.72% at $0.155 per share but a controlling 51% stake passes hands two weeks earlier for just $0.045? And if PCCW was able to sell its 10.72% stake to independent investors at $0.155, then why is Mr Wong willing to sell 17.04% in the Placing at only $0.045?

Was HT really so desperate that it was willing to sell control of HTI for a 70% discount to net asset value?

Who is Mr Wong?

A search of the internet reveals nothing on Mr Wong. This is his big break! The announcement says that he has "over 10 years of experience in securities business as an investor and dealer". So we checked the SFC's registered person list - there is a Wong King Shiu who was licensed as a Securities Dealer's Representative on 30-May-97, but he is not currently working for a dealer, and unfortunately the register does not show historic changes so we don't know who he worked for. The announcement says he is aged 42, was "engaged in the catering industry" for over 7 years after graduating from Haking Wong Technical Institute, and thereafter "taught in a local technical institution for 4 years before starting his own business as a restauranteur". So he sounds like a former chef. He is currently an investor "focusing on listed securities in Hong Kong" - well he's certainly focusing now!

There is a standard paragraph on the "intentions of the purchaser", variations of which we have seen in many other deals, which basically tells you nothing about why they want the listed vehicle and rules nothing in or out.

We're not gamblers, but we'd be happy to bet that you haven't heard the last of this deal. At the very least, HT of Japan owes its shareholders an explanation as to why it sold control at such a low price, and long suffering HTI minority shareholders in Hong Kong would like to know why the offer price is so low.

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Hikari's Strange Exit 30 December 2001