China Treasure's Love for Yanion
24 June 2003

China Treasure (Greater China) Investments Ltd (CTGCI, 0810) is what is known as a "Chapter 21 Investment Company" - a special type of listed company allowed under the Chapter 21 of the Listing Rules to be listed with absolutely no track record, compared with the normal 3 year track record requirement for main board listings. You cannot tell from the Stock Exchange trading screen that shares of Chapter 21 companies are different from any other main board listing - there is no special stock code for such companies, you are just supposed to know which ones they are. Go figure. At least on the GEM the stock codes all have an "8" on the front.

Amongst other restrictions, Chapter 21 companies are not permitted to invest more than 20% of their net assets in "investments issued by any one company or body" at the time of investment, and may not own 30% or more of another company or take management control of such companies.

The prospectus of CTGCI was published on 19-Feb-02 and it was listed on 28-Feb-02. 100m shares were issued to the public at HK$1.00 each, 70% by placing and 30% by public offer, raising $100m gross and $93m net of expenses. Prior to the IPO, an initial 3m shares had been issued at the same price. As a result, CTGCI had pro forma net assets at IPO of $96m, or $0.93 per share.

The Listing Rules for Chapter 21 companies require disclosure of individual investments in the annual report, including any investment that represents 5% or more of net assets and at least the 10 largest investments.

What they bought

It turned out that CTGCI had invested $18.89m in 4.91% of Yanion International Holdings Ltd (Yanion, 0082), which was the subject of yesterday's article on Webb-site.com. That represents 19.68% of CTGCI's pro forma net assets at IPO. The shares were all acquired by 30-Jun-02, as the same figure (but not the identity) shows up in the skimpy interim report.

In addition, CTGCI had invested $18.57m in 13% of unlisted Korning Investments Ltd (Korning), which in turn owns 60% of a "newly established Pharmaceutical Joint Venture" in Beijing. The investment represents 19.34% of pro forma net assets at IPO.

The only other unlisted investment was $18.00m in 19% of Modern Vocal Limited (Modern Vocal), which in turn owns 90% of a Sino-foreign joint venture in the PRC to "develop, manufacture and distribute internet telephone units and value-stored calling cards in the PRC". That investment represents 18.75% of pro forma net assets at IPO.

It may not have escaped your notice that these 3 investments are each just under the 20% limit in the Listing Rules for individual investments by Chapter 21 companies such as CTGCI. For normal listed companies, any transaction over 15% of net assets would be a "Discloseable Transaction" requiring an announcement and a circular to shareholders. Unfortunately, Listing Rule 21.13 for Investment Companies contains an exemption from the rules on Discloseable Transactions, so this means that no investment will ever need to be disclosed except in the annual report.

The Yanion connection

Now if you read yesterday's story on Yanion, then you will know that Yanion owns the remaining 87% of Korning and  60% of Modern Vocal, so they are both subsidiaries of Yanion. So now you can see that CTGCI has invested a total of $55.46m, or 57.8% of its pro forma net assets at IPO, in shares of Yanion or its subsidiaries:

Of course, nowhere in the CTGCI annual report does it mention that Yanion is the other shareholder of Korning and Modern Vocal. Nor does the report identify the vendor(s) of the stakes in Korning and Modern Vocal.

Now let's take a look at those prices. The acquisition of 13% of Korning values the company at HK$142.8m. But Yanion "only" paid $99.84m for 87% of Korning, so this implied a valuation of $114.8m. So for a minority stake in Korning, CTGCI paid 24% more per share than Yanion paid for a majority stake. Maybe part of the difference represents capital injected into Korning.

As for Modern Vocal, CTGCI's purchase of 40% implies a valuation of $94.74m on the company, while Yanion paid $13.5m for 60%, implying a valuation of $22.5m. So for a minority stake in Modern Vocal, CTGCI paid 321% more per share than Yanion paid for a majority stake.

Doesn't that seem odd to you? Is it a complete coincidence that the price of each minority stake just happens to be close to the investment limit for CTGCI of 20% of net assets?

Investment Managers

The interim investment manager of CTGCI was AsiaVest Investment Advisory Ltd (AsiaVest), owned by Andrew Nan Sherrill (Mr Sherrill), who resigned as an executive director of CTGCI on 4-Apr-03. The reason that CTGCI had an "interim" investment manager was that the intended manager, China Core Capital Management Ltd (China Core), was not yet licensed by the SFC at the time of the IPO. China Core took over from AsiaVest as manager of CTGCI on 1-Jan-03, having obtained its license on 20-Nov-02.

CTGCI has two independent non-executive directors. One, Mr Charles Chan Wai-dune (Mr Charles Chan), was also an INED of Yanion from  29-Nov-00 to 4-Jun-01, and as we explained yesterday, his firm, Charles Chan, Ip & Fung CPA Ltd (CCIF) claims a local connection with WorldVest Holdings Ltd (WorldVest), of which Mr John Kao Ying-lun (Mr Kao) is a Director and founding partner, while Mr Kao is also an executive director of Yanion. Three other directors of Yanion are directors of WorldVest Capital Ltd.

China Core is owned as to 37.5% by Mr Brian Chen Wen-Suei (Mr Chen), 37.5% by Robert Ma Kam Fook, who is a director of both China Core and CTGCI, and 25% by Michael Chan Yan Ming, who is Managing Director of CTGCI.

The other director of China Core is Mr Gary Ma Ming Fai. He is also Chairman and largest shareholder of GEM-listed Xteam Software International Ltd (Xteam, 8178). And guess what - one of the independent non-executive directors of Xteam is Mr Cheng Shu Wing, who is a director of WorldVest Capital Ltd and an executive director of Yanion. What a small world!

Mr Chen Again

Wait a minute, doesn't Mr Chen's name seem familiar? As you may recall from yesterday's article, he was the "independent third party" who sold 87% of Korning to Yanion for US$12.8m (HK$99.84m), when Korning had no assets besides an agreement to enter into a pharmaceutical joint venture. He was presumably also the independent third party who sold the other 13% of Korning to CTGCI.

As Mr Chen owns more than 10% of China Core, that makes him a connected person of China Core, which became the investment manager of CTGCI on 1-Jan-03, and hence he is now a connected person of CTGCI under Listing Rule 21.13.

However, as China Core didn't formally take over management of CTGCI from AsiaVest until 1-Jan-03, Mr Chen was not connected to CTGCI at the time of the acquisition of the Korning stake.

Adding the $18.57m cost of CTGCI's stake in Korning, and assuming none of that was for new shares, it appears that Mr Chen received a total of $118.4m for selling 100% of Korning to the two listed companies.

Other holdings

OK, so about 58% of CTGCI's net assets have been sunk into the Yanion group. Now what else did they buy? Well, only two debt securities. They invested $13.5m in a 4% convertible loan note in a company called Info Quality Development Ltd "principally engaged in design, advertising and promotion business in PRC", convertible into 30% of the equity and maturing 31-Dec-04.

The other investment was $15.60m in something called the Maximus Global Strategy Fund which is "a short term high yield income fund administered by Commerzbank International Trust (Singapore) Ltd". There was no mention of who manages this fund (normally the administrator just handles redemptions, subscriptions, valuation and so on), and we can find no reference to it on the web.

CTGCI may be diluted in Korning

It's not mentioned in CTGCI's annual report, but in Yanion's annual report, note 35(b) states:

"On 20 November 2002, the Group advanced HK$10,853,000 to Korning...to meet its capital contribution obligation to its indirect subsidiary... Huayi. The minority shareholder of Korning, an investment company not connected with the members of the Group and its directors, did not choose...to make their share of capital contribution at the time. The Group considers that, under the terms of the Korning shareholders' agreement, it has the right to subscribe for an additional 6.55% of the shares in Korning as a result of the above contribution and has requested for Korning's shareholder approval. However, the minority shareholder of Korning is of the view that its legal obligation to contribute funds to Huayi has yet to expire as the deadline for capital contribution has been extended...As at the date of this report, the applicable provisions of the shareholders agreement were being reviewed by the parties and their respective professional advisers. Decision for approving the issue of any additional shares by Korning to the Group was pending."

Of course, the problem is that at 31-Dec-02, CTGCI's investment in Korning already represented 20.8% of CTGCI's net assets, so under the Listing Rules, CTGCI cannot invest any more money in this single investment unless its net assets go up. In our view, even if the investment in Korning made sense, it was reckless of CTGCI to invest so close to its 20% ceiling in Korning while it knew that based on its current capital base it would not be able to keep up with capital commitments to Korning and would be diluted unless it could raise additional funds or grow its net assets in time.

Sponsor and lawyers

Guess who sponsored CTGCI? Dao Heng Securities Ltd, which was also the placing agent for all six placings by Yanion in 2000-2002 and is listed as Yanion's financial adviser in its annual report.

The legal advisers to the sponsor and underwriters of CTGCI were Siao, Wen and Leung, who are also the legal advisers to Yanion listed in its 2002 annual report.

Shareholders

On 1-Apr-03, when the disclosure threshold in HK was lowered from 10% to 5%, it was rather like the tide going out, as the following holdings in CTGCI were revealed below the old threshold:

Unfortunately, we don't know who owns the first five companies, even though if anyone owns one third or more of a corporate shareholder then they are required by law to disclose an interest. The disclosure forms do, however, provide us with the name of several directors, from which we can glean the following information.

1. A director of Big Draw Ltd is Lo Wai Leung, and we don't know anything about him/her.
2. A director of First Deals Trading Ltd is Yu Ho Wing, and we don't know anything about him/her.
3. A director of First Pink Ltd is Chan Tak Hung. A person of that name is the Chairman of Digital World Holdings Ltd (0109), a company which featured in another horror story last year as part of the "Styland network".
4. A director of First Win Trading Ltd is Jerry Yip Wai Leung, who is also a partner of J. Chan Yip, So & Partners, one of the two legal advisers to CTGCI listed in its 2002 annual report. Mr Yip is also an independent non-executive director of Styland Holdings Ltd (0211), a company which was at the centre of several of our stories last year. He is also an INED of Global Green Tech Group Ltd (0274), which employs a financial controller who was once an executive director of Styland..
5. I-Deluxe Assets Ltd does not list any director in its disclosure.
6. B & D Investments Ltd names Benson Ng Bing Sun as a 97% shareholder, but Mr Ng has not filed any separate disclosure of his interest. Three other directors are named, each surnamed Ng and holding 1%.
7. Joel Lazare Hohman is a non-executive director of CTGCI.

Auditors removed

On 13-Nov-02, CTGCI sent a circular to shareholders in which they wrote:

"The Board has received a request from shareholders of the Company for the removal of Ernst & Young and the appointment of Deloitte Touche Tohmatsu as auditors of the Company."

Ernst & Young, who had been the auditors of CTGCI at the time of its listing, were duly replaced at the shareholders meeting on 2-Dec-02. Deloitte Touche Tohmatsu gave a clean audit report on the 2002 accounts. The shareholders who made the request were not named. How wonderful that the board was so co-operative.

By complete coincidence, over at Yanion, Ernst & Young disclaimed their opinion on the annual report for 2001 (issued on 12-Aug-02) and did not seek reappointment at the AGM.

Readers might consider, if Ernst & Young had continued as CTGCI's auditors, wouldn't they have recognised both Korning and Modern Vocal as being subsidiaries of Yanion, having been auditors of both listed companies, and started to figure out this story?

Remuneration both ways

Page 118 of CTGCI's prospectus states:

"no...remuneration or benefits in kind [are] payable by [CTGCI] to any Director in respect of the current financial year under any arrangement in force at the date hereof [19-Feb-02]."

While that may have been true at that moment in time, the annual report shows that after CTGCI was listed, directors received remuneration totalling $1.752m, or about 1.96% of net assets, including 1 unnamed director who received over $1.5m. There were only 4 other employees, who received $689,200 between them.

CTGCI has had 3 executive directors, being Mr Sherrill (since resigned), Managing Director Michael Chan Yan Ming (who owns 25% of China Core) and Robert Ma Kam Fook (who owns 37.5% of China Core and is a director of China Core).  So all of the executive directors are connected to the interim or current investment manager. The management agreements with AsiaVest and China Core involve a management fee of 2.5% and a performance fee of 15% of any increase in net asset value between one year and the next.

This highlights a number of problems with the Listing Rules:

• affiliates of investment managers (their employees, directors and shareholders) are also allowed to act as directors of the listed company. The management contract with the investment manager is treated as a connected transaction under Listing Rule 21.13, but the amounts paid to the same people as directors of the listed company are not. This is a huge loophole, and makes a mockery of any effort to define the management fees.
• day-to-day management of an investment company is delegated by the board to an investment manager (for example, in this case, investments over $5m have to be referred by the manager to the board), so the board should be part time non-executive, and not paid as if they were managing the business. That's what investment management fees are for.
• the board is supposed to oversee the work of the investment manger, so anyone involved with both has a conflict of interest if they have to approve (as directors) their own recommendations (as managers).
• investment companies are allowed to have share option schemes, which provide further scope for investment managers (as directors) to reward themselves over and above the management fees and performance fees they receive as managers. These option plans were designed for regular listed companies and do not belong in an investment company. If an investment manager wants to receive options, then it should be a term of the investment management agreement, which is a connected transaction.

Conclusions

CTGCI gives Chapter 21 investment companies a very bad name, but that's largely because the Listing Rules make it possible, and hence make all such companies inherently at risk of bad governance. CTGCI has funnelled almost 58% of its net assets into the shares of Yanion and it subsidiaries at questionable valuations, breaking the spirit if not the letter of the rule which prohibits placing more than 20% of net assets in "investments issued by any one company or body". No doubt they would argue that Yanion, Korning and Modern Vocal are 3 different "companies or bodies". By contrast, in the UK, Listing Rule 21.9(h) says:

"not more than 20% of the gross assets of the issuer...may be lent to or invested in the securities of any one company or group" (emphasis added)

The latest unaudited NAV of CTGCI is $0.769 per share at 31-May-03, but even at the current share price of $0.31, you would do well to avoid it.

© Webb-site.com, 2003

Organisations in this story

• CCIF CPA LIMITED
• China Castson 81 Finance Company Limited (BM)
• CHINA CORE CAPITAL MANAGEMENT LIMITED
• Crazy Sports Group Limited (BM)
• Siao, Wen and Leung
• SPDB International Holdings Limited
• WorldVest Holdings Limited

People in this story

• Chan, Charles Wai Dune
• Chan, Michael Yan Ming
• Chan, Tak Hung (1960)
• Chen, Brian Wen Suei
• Cheng, Shu Wing
• Choy, Milano Tak Ho
• Kao, John Ying Lun
• Ma, Gary Ming Fai
• Ma, Robert Kam Fook
• Sherrill, Andrew Nan
• Yip, Jerry Wai Leung (1957)

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