I feel almost too lazy to write about this.
A couple of months, a reader brought up several investing ideas to my attention. The kingboard copper foil situation in particular, was interesting to me because it’s an arbitrage situation, and the investing thesis would thus be different from your typical undervaluation thesis.
All details blocked out for privacy reasons, the said reader would like to remain anonymous.
Check out the date: Sept 2016.
Well that’s an important point, as you’d see later.
So I have had… 5 months? or so to work on this. I did take a quick look at it, it seemed intriguing, but I was really busy with work and other things to look at. End of the year is usually a very busy period in the healthcare office where I work, but yea, no excuses.
Anyway, I chugged this into a “TO LOOK AT MORE CLOSELY” folder that I keep.
If someone bothers to email me with an idea and include specific data like that, the least I’d do is pay attention.
I’ll do a quick summary for readers who are not privy to what’s happening at Kingboard Copper Foil (KCF).
KCF is majority owned by Kingboard Chemical Holdings (KCH), which is listed in Hong Kong. The holdings are spread out via a complex web of holding companies, with cross holdings too to boot. I had a hard time figuring out each of their holdings, but it’s not really necessary to go into that.
We just need to know that KCH owns about 64.6% of KCF.
KCH is also ultimately, the only major customer of KCF, and in turn, gets their copper foil from KCF at what the minority shareholders are alleging, at rates that are way below market rates.
Subsequently, the minority shareholders blocked the IPT mandate, which means that KCF’s management could no longer just continue their normal operations of selling copper foil to their buddies at KCH at disgustingly low rates.
Well, KCF’s management are an enterprising bunch though, and to get around the blocking of the IPT, they licensed out the use of the facilities of KCF to “a third party” (Harvest Resource Management).
Guess who Harvest ended up selling the copper foil to? Yup. No prizes for guessing. Harvest then resold the copper foil to KCH, effectively bypassing the blocking of the IPT by the minority shareholders.
I mean, these guys are not even being subtle about it. The third party is literally called “Harvest Resource Management”???? LOL. That’s really sticking a middle finger up to the minority shareholders.
“Yup. No doubt about it, we’re here to harvest the copper for KCH!”
To deviate a bit, in the court ruling, even the judge found the Respondents’ defence that they do NOT know Harvest’s commercial interests to be incredulous:
“The Respondents effectively conceded that the effect of the Agreement was to circumvent the IPT Mandate from the Kingboard Group perspective in that Laminates was able to access a supply of copper foil from Harvest comparable to that which the Company formerly supplied.
However the Respondents insisted, principally through Mr. Lo but through Mr Ong as well, that the Company had no knowledge of Harvest’s commercial intentions.”
Anyway, a hedge fund, POPE asset management, came in, took a large stake (9.98%) and subsequently sued for minority oppression.
OK, that was a really quick summary. Along the way, of course there’s the history of how KCF came to IPO, why there’s an IPT mandate in place to begin with, to avoid all this controversy blah blah. I shan’t go into details here. It does make for very interesting reading though.
This is one instance, when I really wished my DD is less thorough. Cos then it’d be faster. And I wouldn’t miss the boat. Afterall, it’s not really that necessary to know the full history. But let me move on with the story telling.
So as it stands, POPE sued under Section 111 of the Companies Act 1981:
- Section 111of the Companies Act 1981 (“Alternative remedy to winding up in cases of oppressive or prejudicial conduct”) provides as follows:
“111(1) Any member of a company who complains that the affairs of the company are being conducted or have been conducted in a manner oppressive or prejudicial to the interests of some part of the members, including himself, or where a report has been made to the Minister under section 110, the Registrar on behalf of the Minister, may make an application to the Court by petition for an order under this section. 5
(2) If on any such petition the Court is of opinion—
(a) that the company’s affairs are being conducted or have been conducted as aforesaid; and
(b) that to wind up the company would unfairly prejudice that part of the members, but otherwise the facts would justify the making of a winding up order on the ground that it was just and equitable that the company should be wound up,
the Court may, with a view to bringing to an end the matters complained of, make such order as it thinks fit, whether for regulating the conduct of the company’s affairs in future, or for the purchase of the shares of any members of the company by other members of the company or by the company and, in the case of a purchase by the company, for the reduction accordingly of the company’s capital, or otherwise.”
ARGH, Why can’t lawyers just talk in plain SIMPLE english. WTH is all that about?
“that to wind up the company would unfairly prejudice that part of the members, but otherwise the facts would justify the making of a winding up order on the ground that it was just and equitable that the company should be wound u”
How many times do you have to read this before you understand what it’s talking about?
For me, about 4 times.
Anyway, for the sake of the sanity of my readers, I’ll translate all the disgusting lawyer talk, into plain english so that we commoners can understand what these high gods are talking about. (Ever wonder why there are so many lawyer jokes around?)
So under section 111, the courts may:
- WIND UP THE COMPANY
- REGULATE THE CONDUCT OF THE COMPANY IN FUTURE
- FORCE MAJORITY SHAREHOLDERS TO BUY OUT THE MINORITY SHAREHOLDERS
- FORCE THE COMPANY TO REPURCHASE SHARES OF THE MINORITY SHAREHOLDERS)
To be successful in a suit under section 111, the petitioner (POPE, in this case) must:
SHOW INTENT TO OPPRESS MINORITIES, JUDGE WILL NOT QUESTION THE SOUNDNESS OF MANAGEMENT’S DECISION IF IT RELATES TO BUSINESS STRATEGY, AND THE ACT SHOULD NOT BE USED AS AN EXIT STRATEGY IF THERE ARE MERELY DISAGREEMENTS AMONGST THE VARIOUS PARTIES.
Sorry for the Caps. Those are my personal notes when doing my DD, and I wrote them in Caps to differentiate from some other source materials. Lazy to type all that out again, so just cutting and pasting now.
In summary, the courts struck out 1 complaint by POPE, but ruled in their favor with regard to the oppressive behavior of the majority shareholder.
In my DD, I read a blog post from someone who talked about “the company” losing the suit and blah blah. That’s inaccurate. We gotta be clear here, cos it matters.
The suit is between a minority shareholder (the Petitioner) and the majority shareholder (the Respondents). The company itself, KCF, is not party to the suit. But of course, the company is at the centre of attention.
Alright, so the courts ruled in favor of POPE and the losing majority shareholder in turn, appealed the decision. The appeal is slated to be on the 6th and 7th March (next week). I’m not sure when the verdict would be out, probably within a month or so?, if the earlier suit is any guidance.
Here, I’ll deviate a bit to give kudos to POPE. They really garnered my respect while I was doing DD on this. We have heard of many activists funds coming to our shore of late. Dektos, Quartz Capital etc. Yet, those activists have thus far, to my best knowledge, only done stuff like propose higher dividend payouts, capital distribution, selling of assets blah blah.
I could talk about all that myself too. No rocket science there.
POPE, on the other hand, really stuck their heads out on this. They are like the rallying board for the minority shareholders, leading the way in a suit. The whole saga has played out over many years, and honestly, I think from an investing standpoint, even if they are successful, the annualized ROI on this would be at best, meagre. Afterall, time (and inflation) is a bitch when it comes to capital management. Not to mention the legal costs.
But they have a big fan in TTI from this. If it’s any comfort.
Even the above mentioned said reader who brought this to my attention, has been vested in this since 2013. It’s been a long drawn out saga, and the company stopped paying dividends long ago. So it’s been tough on the minority shareholders for many years.
By all accounts, the appeal is likely to fail. The judge in the earlier suit, is the Chief Justice btw. That already should give one some idea of how likely an appeal, overturning his decision, is going to turn out.
So what does all that leave us, when the appeal fails?
The courts would mandate that the majority shareholder buyout the shares of the Petitioner.
Unfortunately, the verdict applies only to POPE’s shares, and only to the shares that POPE bought BEFORE they brought up the suit, not after.
So an enforced buyout is not by all means certain… yet.
Still, let’s think of the situation logically.
If the majority shareholder buys out part of POPE’s shareholdings, they’d still need to get an IPT and if the minority shareholders still refuse to give a mandate, the impasse continues. I’m guessing even though the courts rule that it’s only applicable to shares bought before the suit, the KCH would just buy out POPE completely. Just to get them out of the way, if anything.
So in my mind, there are several situations, and I’ve tried to put some effort into figuring out what happens in each situation:
- KCH buys out POPE’s shares in its entirety, goes back to minority shareholders and succeeds in getting an IPT mandate, and the company goes back to selling copperfoil cheaply to KCH
- KCH buys out POPE, but the impasse continues and the minority shareholders refuse to grant the IPT mandate
- KCH privatizes the company aka buy out everyone
I can’t think of any other scenarios besides these 3. We now have a court enforced ruling to get all parties to the table, so something has to move. The court is the catalyst here.
Now, in scenario 1, I think what’s important is to look at the financials of the company.
The company is horribly undervalued because of this saga. Like outright disgustingly undervalued.
Just look at the cash on hand.
The company has total liabilities of HKD 124million, but holds errrr HKD 1.56billion in cash!
It’s a net cash company… MANY TIMES OVER!
It’s safe to say that even in the case of scenario 1, the share price, which was around $0.28 when I first started my DD, would have to re rate sharply upwards to reflect the dispersion of the cloud of uncertainty.
That’s a good start.
Scenario 2 is the one that I’m most worried about. If POPE is out of the way… who’s going to stand up to the big bully? I don’t have much confidence in retail investors. Most retail investors would bail at an instance, and KCH has shown that they don’t give a damn about the share price of the company. KCF is just their slave, sending cheap goods to the parent company.
How would a bunch of retail investors be able to compete with KCH?
I communicated my doubts with the above mentioned reader. His reply (which is an enlightening one):
If the minorities are united, the company would at least have to provide some concessions to get the IPT passed.
Scenario 3, seems the most likely at this point. The company has just announced a general offer, offering $0.40 to all minority shareholders for a buyout deal.
$0.40 is extremely miserable though IMO, the book value of the company is $0.66 for gods’ sake!
How many times have you seen a privatization succeed when the offer price is a fraction of the book value? Plus it’s only a slight premium to the last traded price of $0.32 before the trading halt.
I doubt the $0.40 offer would succeed.
I assessed these scenarios before the trading halt and the privatization offer and decided that hey, 2 good scenarios out of 3 is pretty good odds to have. Plus the 3rd scenario may turn out to be good too, if the reader whom I’ve been communicating with, is right.
So with that, I decided to allocate $150k to take up a position.
That was on the 27th Feb 2017…….. RIGHT BEFORE THE FREAKING TRADING HALT.
I waited patiently, hoping that the trading halt was in relation to the appeal process. But now we know, the trading halt was for the general offer for privatization.
It’d really be a home run for me if I had managed to take up the full position that I intended. I’d be riding on the coat tails of others. Others would’ve sat through multi years of torture from this whole saga, while I’d have come in right at the last part, and enjoyed the fruits.
But it’s not to be.
Well, it’s safe to say that the share price would likely shoot up when markets open next week. It may even go past the $0.4 offer, if shareholders decide that there’ll be a renewed, better offer somewhere down the road.
After some consideration though, I’ve decided not to take up a position. Yes, I’m 1 day late to the game. Even at $0.4, at a purchase price of $0.32, that’d be a 25% gain… or more… in 1 day.
AHHHHHHH. Sometimes, life throws you so much lemons, it’s suffocating.
After several weeks of work on this, the only return I’ve derived… is that… well, I’m rather well versed with section 111 of the companies act.
For the other existing minority shareholders, I’ll concur with the opinions of the mentioned reader. So I’ll just share his latest opinion here, and you guys can make your own judgement.
On a different note, since my previous post, it seems I’ve gathered a bunch of fellow Drs as readers. While I’m genuinely flattered by all the compliments, I’d really wish to stay anonymous for now.
SG TTI should still be about sharing deep value, intensively researched ideas with strong substantiation, grounded in fundamental analysis.
And occasional travel destinations.