A recent court case highlights the dealings of Chen Lip Keong, controlling shareholder of Cambodian casino firm Nagacorp (3918). Given his numerous outside interests, and the ongoing pledges of shares, investors should be concerned about how much debt he might be carrying and the risk that he may need to, or be forced to, sell part or all of his stake in Nagacorp.

Nagacorp controller's dealings
28 January 2011

It seems like we get more information from court judgments than we do from corporate disclosures these days.

One case that caught our eye before Christmas, and we are now finding time to write up, is Chen Lip Keong v Evolution Master Fund Ltd SPC, Segregated Portfolio M in the Court of First Instance. This ongoing case concerns Chen Lip Keong (Dr Chen), the founder, controlling shareholder and CEO of NagaCorp Ltd (Nagacorp, 3918), which operates the only licensed casino in Phnom Penh, Cambodia on a 70-year franchise from 1995, and claims the exclusive right to casinos on Cambodian territory within a 200-km radius of Phnom Penh (minus a few bits) until the end of 2035.

The defendant in the court case, which we will call EMF, is managed by Evolution Capital Management LLC (ECM). ECM was founded in 2002 by Michael Lerch, its Chief Investment Officer, and is based in Santa Monica, California. Over the years, ECM has invested in a ragbag of companies listed in HK, none of which we would touch with a barge pole, but that's what makes a market. Its local licensed entity is Evo Capital Management Asia Ltd.

Nagacorp listed on 19-Oct-2006. According to the judgment, prior to that, Dr Chen became acquainted with Frank Dominick, then Managing Director of the Evolution group of companies, and on 13-Jun-2007, EMF agreed to lend Dr Chen US$15m, repayable within 12 months of the drawdown, secured by Dr Chen's pledge of 114,333,658 shares (5.51%) of Nagacorp. The loan was drawn down on 18-Jun-2007. We note that EMF disclosed a security interest in 114,333,659 shares (Pledged Shares) on 13-Jun-2007, and that it also acquired a derivative interest in 49,263,993 shares.

According to the judgment, some time prior to 19-Nov-2007, Dr Chen delivered to Mr Dominick a further 10m shares, for reasons which are in dispute.

On 6-Jun-2008, Dr Chen and EMF agreed to extend the loan by 1 year to 18-Jun-2009. On 23-Sep-2008, due to a falling share price, EMF required Dr Chen to deliver a further 27,088,159 shares to keep the value at not less than US$30m, that is, twice the loan amount. Rounding this up, the next day Dr Chen delivered another 30m shares.

On 10-Jun-2009, the loan was extended again, with US$7.5m (less dividends) to be repaid by 30-Jun-2009 and the other half by 31-Oct-2009. The 40m additional shares that Dr Chen had already delivered were then formally pledged to EMF, taking the total to 154,333,658 shares.

By Nov-2009, with US$7.5m outstanding, there was a further extension, with US$2m due by 31-Dec-2009 (which was duly repaid) and the remaining US$5.5m by 31-Mar-2010. In preparation for repayment, Dr Chen told EMF that there would be payments from two sources, and obtained an e-mail from Richard Chisholm (Mr Chisholm), General Counsel and Chief Compliance Officer of ECM, confirming the amounts due. US$3.5m of the payment came from a new lender, DMG & Partners Securities Pte Ltd (DMG) of Singapore, in exchange for the release of 100m shares to DMG, and the remaining shares were to be released to LGT Bank after payment of the balance. Dr Chen's private company, and DMG, paid the agreed amounts on 30-Mar-2010, and DMG received 100m shares, but the remaining shares were not released.

Dr Chen then instructed lawyers Richards Butler to chase EMF for the remaining shares. On 9-Apr-2010, Mr Chisholm for EMF replied that:

"It's clear that your client has not provided you with the entire story. The obligations under the loan agreement have not been met. In addition, the counterparty has been in default. Lastly, there are other obligations that your client has breached."

After further warnings from Dr Chen's lawyers, two weeks later on 23-Apr-2010 EMF finally gave specifics on what it said was wrong, responding through lawyers Simmons & Simmons. It said that an event of default had occurred because Nagacorp had traded below $1.43 per share for more than 3 consecutive days, and that there had been delays in repayment of principal and interest, both constituting events of default for which interest was due - claims it had not previously made. It also said, and here's the shocker, that:

"a sum of HK$134,750,000 would become payable by [Dr Chen] to [EMF] by close of business on 7 May 2010 under an oral agreement made in 2008 which obliged [Dr Chen] to buy from [EMF] at its request, up to 55 million shares in Nagacorp at the predetermined price of HK$2.45 per share" (emphasis added)

In other words, EMF says that Dr Chen had orally granted a put option. That anyone would do this by word of mouth, over such a large value, might seem implausible, unless at least one of the parties had a good reason not to put it in writing, because of the evasion of some law or regulation.

In defence of the demand for return of the shares, Mr Chisholm told the court that the Put Option was concluded orally between Dr Chen and EMF "some time towards the end of October 2007" (not in 2008 as it had said on 23-Apr-2010) and the 10m shares that were delivered in Nov-2007 were as security for his obligations under the put option. That seems hard to believe when you consider that 10m shares were only worth about $23.4m at the time, only about 17% of the amount of the alleged put option.

 EMF says that the oral agreement was as follows:

EMF says it bought about 44m shares at $2.45 per share (presumably, an average of actual purchase prices) between 30-Oct-2007 and 20-Mar-2008, which it would not have done but for the put option. Looking at the market data during that period, we find total volume of 170.474m shares at an average of $2.238 per share. So EMF's purchases were about 26% of total market volume.

EMF says that on or about 23-Apr-2010, the date that it replied to Dr Chen, it exercised the Put Option to sell the shares to Dr Chen, and that he failed to pay for them.

To verify the market purchases, we looked at EMF's disclosures. The disclosure as at 26-Oct-2007 when it crossed the 8% disclosure boundary shows that its long position (excluding derivatives and pledged shares) was 2,456,000 shares. That was 4 days before it says it started buying in purported reliance on the put option.

On 1-Nov-2007, EMF apparently stopped treating the Pledged Shares as a security interest and started treating them as assets under management (code 202), as shown in this filing. On 14-Dec-2007, it went through the 9% boundary, by which stage its holding (excluding derivatives) had increased to 126,947,659, or 12,614,000 if you exclude the Pledged Shares. On 5-Mar-2008, it went through the 10% boundary, by which stage it held 148,083,659 shares, or 33,750,000 if you exclude the Pledged Shares. On 10-Jun-2009 (the day of the supplemental loan agreement) the disclosure shows the increase of 40m (being the additional shares pledged) and EMF then starts treating the original Pledged Shares as security interests again. Apart from those, and excluding derivatives, it has 34,050,115 shares. There are no further disclosures during the relevant period to 20-Mar-2008, but we can see that EMF's claims to have bought about 44m shares are consistent with these disclosures.

If the alleged oral put option is true, then it appears that EMF was acting in concert with Dr Chen to support the share price, without him disclosing it. EMF had upside potential, but its downside would be nil as long as Dr Chen honoured the put option. He would have had a disclosure obligation of his contingent interest in 55m shares under the put option.

The court dismissed Dr Chen's application for summary judgment, concluding that the matter must go to trial. So unless there is a settlement, the details of this case should emerge in full trial. Meanwhile, the SFC should be looking closely at Dr Chen's various dealings.

At the time of the Nagacorp IPO, Dr Chen also had controlling interests in Karambunai Corp Bhd, a resort firm in Sabah, FACB Industries Inc Bhd, a stainless steel pipes and fittings maker, and Petaling Tin Bhd, a property developer, all of which are listed in Malaysia and are relatively small compared to Nagacorp. According to their web sites, he remains involved as President of Karambunai, Executive Director of FACBI, and President of Petaling Tin. None of these positions was mentioned in the AGM circular of 29-Apr-2010 when he came up for re-election. That's a breach of Listing Rule 13.51(2)(c). He also has a private company which is or was involved in oil and gas exploration in the Gulf of Siam, called Resourceful Petroleum Ltd.

Dr Chen has also pledged 148m Nagacorp shares (7.10%) to Yardley Finance Ltd, wholly owned by Mr Chan Kin Sun (Mr Chan), on 9-Nov-2009. Mr Chan has a regulatory history. Another block of 236,956,383 shares (11.38%) was pledged, probably by Dr Chen or his trust, to OSK Investment Bank (Labuan) Ltd on 22-Sep-2010, according to the filing. DMG is jointly owned by OSK Investment Bank Bhd of Malaysia and Deutsche Bank.

Given Dr Chen's numerous outside business interests and the share pledges, investors should be concerned about how much debt Dr Chen might be carrying against his shareholding and the risk that he may need to, or be forced to, sell part or all of his stake in Nagacorp.

© Webb-site.com, 2011

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