Webb-site Reports

M-chip Golden Resorts (1031) is seeking shareholders' approval on 17-May-05 to sell a stake in an associate to a BVI company for HK$52m, or a P/E of 0.63. Meanwhile across the ocean, Nasdaq-traded China Energy Savings Technology (CESV) says that on 1-Feb-05 it completed the purchase of the same stake, in exchange for shares worth HK$731m, from the same BVI company. Who's telling the truth, and why is Golden Resorts selling for so little?

Golden Resorts and CESV
8 May 2005

It's not often we write about stocks on Nasdaq, but here's a story which straddles the Pacific Ocean.

On 19-Jan-05, HK-listed Golden Resorts Group Ltd (GRG, 1031), then known as Medtech Group Co Ltd, announced that it was jumping onto the Macau bandwagon. At the same time, it said it had conditionally agreed to sell a 35% stake in Starway Management Ltd (Starway) to a BVI company called Sky Beyond Investments Ltd (Sky Beyond), owned by a Mr Li Hing Sing, for HK$52m (US$6.67m) in cash, or HK$2m more than they had paid for it. Does that sound alright so far?

Wait till you see what's really going on...

Background

GRG had not held this stake for long. On 9-Jun-04, GRG conditionally agreed to buy 35% of Starway for HK$50m (US$6.41m) in cash from Eurofaith Holdings Inc. (Eurofaith), of which 50% was owned by Mr Cheng Ming and 50% by Mr Sun Li. Starway owns Shenzhen Dicken Industrial Development Ltd (SDID), a PRC company "which is a manufacturer of energy saving products". The price was approximately equal to 35% of the audited net asset value of Starway of HK$142.4m at 31-Mar-04. The deal was documented in a circular dated 13-Aug-04. Shareholders approved it in EGM on 30-Aug-04 and it was completed on 14-Sep-04. Shareholders seemed to like the deal - the stock went up 80.8% on the news. Based on 2003 earnings of Starway, the P/E was just 2.0.

What GRG didn't mention when it bought into Starway was that on 9-Mar-04 a tiny US Over-The-Counter company then called Rim Holdings Inc (Rim) executed a non-binding letter of intent to buy 100% of Starway in a reverse takeover, as announced on 23-Mar-04. Further details were given in a filing on 12-May-04. The vendor was named as Eurofaith. A definitive agreement was executed on 3-Apr-04, according to the quarterly results filed on 19-May-04. However, in a filing dated 7-Jun-04, two days before the GRG announcement, Rim said the reverse takeover had been scrapped on 29-May-04.

However, as of 16-Jun-04, the existing controllers of Rim agreed to sell 8,888,224 shares of Rim to a BVI company called Best Development Co Ltd (BD) for US$225,000 in cash. In fact half of the shares went to BD and half to a Mr Zhu Jie. The beneficial owner of BD was Mr Li Shilong. Rim agreed to sell its existing business to the departing chairman in exchange for cancellation of some shares, and as a result the shares acquired by BD and Mr Zhu Jie amounted to 50.1% of the outstanding shares of Rim, giving them majority control.

Then as of 29-Jun-04 Rim agreed to buy 50% of Starway from Eurofaith for US$120m (HK$936m), payable in convertible notes. Of course, you can put any nominal price you like on it when you are swapping paper for paper in an empty shell. The price was based on a P/E of 10 times a forecast profit of US$24m in 2004.

A 20:1 stock consolidation effective 25-Aug-04 reduced the outstanding shares to 887,048. The next day, Eurofaith converted the note and received 11,153,669 shares in Rim, which the board renamed China Energy Savings Technology, Inc (CESV). Of these shares, 6,900,000 (55.9% of the enlarged capital) were transferred to a BVI company called New Solomon Consultants Ltd (New Solomon), which at 9-Jan-05 was 55% owned by Mr Sun Li, who you will recall owned 50% of Eurofaith. Mr Sun is the Chairman and CEO of CESV.

On 17-Nov-04, CESV acquired an additional 15% of Starway from Eurofaith in exchange for 3,346,100 new shares, or the same exchange ratio as it had paid for the first 50% of Starway. As a result, Starway was 65% owned by CESV and 35% owned by GRG. Up to this point, things look relatively normal.

The independent accountant

The GRG shareholders' circular to approve the purchase of 35% of Starway included an accountant's report by K.W. Poon & Co. Guess what - Mr Poon Kam Wah (Mr Poon), presumably the proprietor of that firm, was appointed as CFO of CESV on 17-Sep-04. So barely a month after his firm had signed an accountants' report on Starway, he became CFO of its parent.

The Starway accounts

The Starway accounts appear on their face to show a remarkably successful business. The company makes and sells energy-saving electrical equipment, including a microprocessor-controlled transformer, which adjusts the voltage to fluorescent lighting, dropping it down from mains voltage after the tubes are fired-up. They also make a product for sewing machines to save power while the motors are idling. You can get a better explanation of the principles by looking at the web site of another provider, Ilumalite, or this one at Globalight. A detailed description of Starway's business is also contained in a document filed by CESV on 20-Aug-04. That also contains an independent auditor's report, not by Mr Poon's firm but by a Florida firm called Webb & Company (no relation to your editor!).

There are a few things in the Starway accounts which give us pause. The US filing says that Starway makes its own products, and the 2003 results in the HK filing showed that they had a cost of sales of HK$137.2m, but inventories at the year end were only $4.9m, or about 13 days cost of sales including only $3.6m of finished goods, and zero work in progress. That's remarkably low for a manufacturer, even bearing in mind that the cost of sales includes other items such as labour and depreciation.

In the annual 10-K filing for the period to 30-Sep-04, CESV discloses that the products are sold under two types of contract - an up-front purchase by the customer, or a "Savings Sharing contract", where the customer is not required to pay anything up front but enters into a 5 to 7 year contract whereby it pays 70% of the total savings from the reduced electricity bill. The US filing (but not the HK accountant's report) include a table which shows the estimated value of these contracts stretching out to 2008. These amounts are of course booked as current revenue when the products are accepted by the customer. Having said that, cash collection has picked up strongly since the end of 2003, when they had just HK$164k in the bank, and by 30-Sep-04 they had a (US-audited) US$18.4m in cash, and at 31-Dec-04 an unaudited US$26.8m. Assuming that these are the genuine proceeds of genuine sales, and that customers will keep honouring their accounts for 5-7 years after installation, and that the future energy savings booked as current revenue have been correctly estimated, then business is going splendidly.

One Stake, Two Deals

Now here's the weird thing. On 1-Feb-05, CESV agreed to buy 35% of Starway from Sky Beyond in exchange for 7,807,569 new shares of CESV, at the same exchange ratio as the other 65%. In a filing dated 4-Feb-05, CESV said the deal had been completed on the day it was signed. Based on the closing price of US$12.00 per CESV share on 1-Feb-05, the 35% of Starway was worth US$93.7m (HK$731m). The deal was signed on behalf of Sky Beyond by a "Mr Li Qing Xing", whom we assume is the same as Mr Li Hing Sing, just a different English spelling. He gives the same address as Mr Sun Li's New Solomon.

But hold on a minute, how can this be? Shareholders of GRG have yet to approve the disposal of that 35% stake in Starway to Sky Beyond, and yet CESV says it has already completed the purchase of the same stake from Sky Beyond on 1-Feb-05. A GRG circular dated 29-Apr-05 convenes a shareholders meeting to approve the sale for 17-May-05.

It cannot have escaped your notice that GRG is selling the stake for HK$52m which CESV has agreed to acquire for HK$731m in stock, or about 14 times the price, handing an instant paper profit to Sky Beyond of HK$679m. Or to put it another way, Sky Beyond ends up with shares in CESV at an effective price of US$0.85 per share, a 93% discount. The GRG circular states that Mr Sun Li and Mr Cheng Ming, the owners of Eurofaith, are not connected with Mr Li Hing Sing, the owner of Sky Beyond.

According to a CESV announcement dated 5-Apr-05, Starway made net income of US$6.15m in the second quarter ended 31-Mar-05, and shareholder equity was US$50m (HK$390m). That implies that the net assets attributable to 35% would be HK$136.5m. So GRG is selling its stake for just 0.38x NAV. According to the circular, for the year ended 31-Dec-04, Starway made net profit of HK$236.4m. This means that GRG is selling in on a P/E of just 0.63. Yes, that is not a typo. It starts with a zero, as in less than one year's earnings.

On 21-Apr-05, CESV graduated to trading on the Nasdaq National Market System.

Now ask yourself this:

If CESV says it already owns 100% of Skyway, but GRG says that the sale of its 35% stake is pending its shareholders' approval, then how can both statements be true?
Why did Eurofaith sell 35% to GRG for such a low P/E in the first place?
Why is GRG selling it to Sky Beyond (which it claims is independent of Eurofaith) on a P/E of 0.63, assuming the earnings are real?
Why didn't GRG sell the stake directly to CESV for HK$731m in stock, rather than selling it to Sky Beyond for HK$52m in cash?

Familiar names

Some of the names at CESV are found in our database. Mr Dennis Yu Won Kong, the COO of CESV, was an executive director of China Nan Feng Group Ltd (CNF, 0979) from 11-Oct-00 to 27-May-03, back when it was known as "Prosper eVision Ltd". Mr Lee Kam Man, now a non-executive director and previously CEO of CESV, was also an executive director of CNF from 7-Nov-98 to 7-Dec-01. Ms Sim Lai Fun, an Executive Director of CESV, served as assistant to the Chairman of CNF from 1999 to 2001. From 2002 to 2003, she served as assistant to the Chairman of OTC-traded China Cable and Communications, Inc (CCCI). Gareth Tang Yau Sing, former Chairman and now President and CFO of CCCI, was an Executive Director of CNF from 29-Apr-99 to 11-Oct-00. The same people were involved in the Australian-listed parent of CNF called China Convergent Corp Ltd, which in Feb-03 sold a 49% stake in a Chinese Cable TV business called "Baoding Pascali Multimedia Transmission Networking Co Ltd" to Nova International Films, Inc in a reverse takeover, and that company was then renamed CCCI. China Convergent was delisted in Australia in 31-Aug-04 after it failed to pay its annual fees. CNF, which reached a scrip-adjusted HK$40 in Feb-00, now trades at $0.09.

This brings us to an amazing coincidence - it turns out that Starway, which now is the BVI holding vehicle for SDID, is a recycled company - it was once a wholly-owned subsidiary of CNF, and was used in Oct-98, just after incorporation, to buy a 95% interest in a power station in Heilongjiang for HK$190m, which it sold in Feb-00 for $200m in order to focus on its Cable TV investment. At some point after that, CNF presumably disposed of the then-empty Starway, because it ended up being reused on 15-Feb-03 by Eurofaith when it injected SDID into the shell.

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Golden Resorts and CESV 8 May 2005