Webb-site Reports

China Vanguard (8156) bought an asset from its controlling shareholder at 6.5 times the price at which China Motion (0989) turned it down. Now it is struggling to redeem convertible bonds the target issued to Goldman Sachs and Evolution Capital. We also query a year-end HK$139m cash outflow to buy a company which was once owned by the controlling shareholder, with negative net assets. Finally we look at a pending acquisition by Aptus, its subsidiary.

China Vanguard's Grand Promise
10 December 2009

In a separate story today on the recent history of China Motion Telecom International Ltd (CMT, 0989), we mentioned that CMT had aborted the HK$240m acquisition of Grand Promise International Ltd (Grand Promise), from Best Delight Group Ltd (BVI, Best Delight) because of the "very limited information" available for due diligence, and that a disclosure filing shows that Best Delight was owned by Ms Cheung Kwai Lan (Ms Cheung).

Ms Cheung is the Chairman and controlling shareholder of China Vanguard Group Ltd (China Vanguard, 8156, formerly B&B Group Holdings Ltd) and its subsidiary Aptus Holdings Ltd (Aptus, 8212). We wrote about them in our article B&B and Aptus on 22-May-06, warning of a bubble in both stocks. Since then until yesterday (9-Dec-09), China Vanguard (bonus-adjusted) has dropped 73.1% from $1.60 to $0.43, and Aptus has dropped 86.2% from $2.50 to $0.345. Hoo-hah!

Grand Promise owns Birdview Group Ltd (HK, Birdview), which owns 49% of a sino-foreign equity joint venture with registered capital of RMB100m, which has "exclusive authorisation" from the "Cultural Market Development Centre" under the administration of the Ministry of Culture of the PRC, "to develop and operate a nationwide karaoke content administration system". In other words, collecting copyright performance fees for songs and videos.

China Vanguard buys Grand Promise

You will be delighted to learn that China Vanguard did not perceive any problem with due diligence, because less than 8 months after CMT gave up, on 17-Jan-08, China Vanguard agreed to buy Grand Promise from Ms Cheung and others for a whopping US$200m (HK$1.56bn), or 6.5 times the price at which Ms Cheung had offered to sell it to CMT. Of course, China Vanguard didn't mention the previous deal in its announcement. The consideration was satisfied by issuing about 2.26bn shares at $0.69.

Notice that by now, Ms Cheung was no longer the sole owner of Grand Promise. She owned 80% of it via Best Frontier Investments Ltd, which was 99.89% owned by her and 0.11% by her husband. For the remaining 20%, 7.2% was owned by Mr Soraharjo Wong, 3.4% by Mr Lo Po Tong, 3.0% by Anna Lo Wai Kwan, 2.0% by Rocky Tang Ping Fai, 2% by Mr Yam Tak Cheung (the joint controlling shareholder of CMT), 1.4% by Chan Ka Yin, the company secretary of Aptus, and 1.0% by Mr Wong Sze Chuen. We don't know what they paid for their shareholdings, if anything.

In between the China Motion and China Vanguard deals, Grand Promise had done some fund-raising, issuing 5-year convertible notes on 30-Nov-07 in the amounts of US$25m to Liberty Harbour Master Fund I, L.P. (Liberty Harbour), which is managed by a unit of Goldman Sachs, and US$10m to Evolution Master Fund Ltd, Segregated Portfolio M (Evolution), managed by Evo Capital Management Asia Ltd, the local unit of Evolution Capital Management LLC. Apparently they too were happy with their own due diligence. The notes were convertible at a Grand Promise valuation of US$240m, 20% over the price of the China Vanguard purchase. As part of the deal with China Vanguard, the two noteholders were given an option to exchange the Grand Promise convertible notes into shares of China Vanguard at HK$0.80 each. The notes have an accruing yield of 7% p.a., and security over the shares of Birdview. Not only that, but China Vanguard executed a "deed of adherence" which makes it jointly and severally liable for the debt with Grand Promise.

In the year to 30-Jun-09, China Vanguard booked revenue of HK$22.9m on the provision of Karaoke content management system services and licence fee collections, and an operating loss of $8.2m. In the latest quarterly report for the 3 months to 30-Sep-09, China Vanguard said it had coverage of 2,200 venues with its Karaoke content management system. It didn't specify the revenue, but by deducting other segments from the total we can see that it was not more than $11.05m.

As a consequence of the poor performance of Grand Promise, after a partial redemption, China Vanguard has entered into a series of agreements and undertakings to delay the rights of Liberty Harbour and Evolution to redeem the remainder of their bonds, the latest of which was announced on 30-Oct-09, in return for restrictions on withdrawals from China Vanguard's group bank accounts. For a company in this much trouble, it is somewhat amazing that China Vanguard still has a market cap of HK$1.38bn at tonight's closing price of $0.43. Although it had net assets of $2.17bn at 30-Jun-09, that included $2.22bn of goodwill, including $1.88bn on the acquisition of Grand Promise and $0.14bn was on the acquisition of Best Delight. So there is very little in the way of tangible value. Which brings us neatly onto:

China Vanguard buys Best Delight - from whom?

Now, do you remember that when CMT was going to buy Grand Promise, the vendor was Best Delight, and that a disclosure of interest shows that Best Delight was owned by Ms Cheung, Chairman and controlling shareholder of China Vanguard?

Well, on 8-May-08, China Vanguard agreed to buy Best Delight from Capital Day Investments Ltd (Capital Day) for HK$139m in cash, which was completed on 30-Jun-08, the last day of China Vanguard's financial year. The deal was not disclosed at the time. The annual report for the year ended 30-Jun-08 mentions on page 24 that China Vanguard acquired Best Delight without saying what it is. Note 32 on page 113 of the accounts tell us more. It shows that Best Delight had "Available-for-sale financial asset" of $63.78m, non-bank borrowings of $63.9m, and negative net assets of $0.07m.

On 30-Jun-08, China Vanguard only had one available-for-sale financial asset, so this must be the one it acquired that day by buying Best Delight. Note 21 on page 98 shows that the $63.78m asset is "equity securities issued by a private entity incorporated in the PRC" and that the group "holds a 9.99% shareholding right". The same asset was still in the accounts on 30-Jun-09. We have no idea what it is. The goodwill of $139.07m paid for this single-asset company implies that this asset is worth $202.9m, or more than 3 times Best Delight's carrying cost for it.

The accounts still didn't say when the acquisition was made or from whom. Fortunately, China Vanguard needed to produce a "Major Transaction" circular for something completely unrelated, on 24-Jun-09, and such circulars are required to disclose all "material contracts" within the last 2 years, so there, on page 162 of the PDF, you will find the dates and the name of the vendor. The contract was briefly on display in the company's office, but we didn't spot this in time to go and find out who signed it for Capital Day.

Policy issue: the Listing Rules should be amended to require "documents on display" to be filed electronically with HKEx and left in the archive forever.

Investors should be told: why did China Vanguard pay so much ($139m) for so little ($0.07m of net liabilities)? Who owned Capital Day - was it Ms Cheung (in which case this should have been treated as a connected transaction) or someone else? If she had sold Best Delight to Capital Day, which then flipped it to China Vanguard, then how much did she get for it? Who provided the non-bank loan to Best Delight? And what is Best Delight's principal asset anyway?

Personal properties of ancestors

The latest wheeze of China Vanguard's subsidiary Aptus is to get into the death industry. They have conditionally agreed to buy a BVI company which "currently holds various parcels of land and a number of old houses in Yuen Long, New Territories, Hong Kong and construction works have commenced to refurbish them as ancestral halls for providing the storage space of personal properties of ancestors". We assume that "personal properties of ancestors" is a euphemism for ashes. The price on this deal is a modest HK$1,755m, somewhat more than its net negative assets of $12,512 at 30-Nov-09. The vendor is owned by "Kong Lung Cheung". A person of that name was an ED of Skyfame Realty (Holdings) Ltd (0059) from 26-Jul-04 to 29-Dec-04, when it was known as renren Holdings Ltd.

The price shall be satisfied as to HK$85m in cash deposit, HK$1.5bn in Aptus convertible bonds, $20m in secured promissory note, $150m in unsecured promissory note; and $20m in cash on completion. Rather worryingly, the $85m deposit can be paid "at any time and in any amount after signing the S&P agreement". At 30-Sep-09, Aptus had net assets of just HK$28.3m.

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China Vanguard's Grand Promise 10 December 2009