Monday, September 22, 2008

My view on Bright World takeover (Part 2)

In order for the BW takeover to become a reality, there are altogether 8 conditions to be fulfilled. They can be found in the pre-offer announcement in the SGX website. Currently BW is trading at about $0.34, a whopping 50% discount to the takeover offer by CAHC. I believe the main reason why BW is trading at such a low price is because investors are skeptical that all the 8 conditions can be fulfilled under such gloomy economic outlook.

Out of the 8 conditions, investors are mainly concerned on the following 3 requirements:
1) shareholders of the Offeror holding 33.33% or more of the IPO shares do not vote against the Offer Transactions and exercise their redemption rights in relation to their IPO shares;

Comments:
At this moment, i would rate the possibility of the rejection of the offer transaction and cash redemption by the current shareholders as low. Why do i say that?
Many other blank check companies have a redemption threshold of 20%, which makes it more difficult for such companies to consummate their initial business combination. Thus, because CAHC permit a larger number of stockholders to exercise their Redemption Rights, it will be easier for them to consummate an initial business combination with a target business which stockholders may believe is not suitable. CAHC has increased the redemption percentage to 33.33% from the more typical 20% in order to reduce the likelihood that a small group of investors holding a block of our stock will be able to stop them from completing a business combination that is otherwise approved by a majority of our public stockholders and to be similar to other offerings by blank check companies currently in the market.

2) the Group Companies’ profit after tax (PAT) for the six-month period ended on 30 June 2008, nine-month period ending 30 September 2008 and full year period ending 31 December 2008 should not decrease by 10 per cent or more as compared to the same period in fiscal year 2007.

Comments:
Unless you are an insider working in BW, it is impossible to forecast accurately the revenue for the next 2 quarters. However, i am aware that rising raw material cost and a slowdown in their customers' manufacturing activity can severely impact the bottomline. Baring a sharp drop in revenue, i dont see any problem with BW fulfilling the 10% condition. Using HY08 results, we are able to have a clear idea on how much more profit is need for the rest of the year.

PAT in RMB 000 (thousands)
6 mth:

Y2007 52586
Y2008 79003
9 mth:

Y2007 95350
Y2008 At least 85815 (HY08 achieved 82.8%)
12 mth:

Y2007 144865
Y2008 At least 130378 (HY08 achieved 60.59%)

3) The Chinese authorities may not approve this takeover.

Comments:
Investors who are aware of the recent failed bid by the Carlyle Group to acquire a 45% stake in Xugong Construction Machinery Co Ltd may be skeptical that this acquisition by CAHC, which is a foreign entity, will materialize. The failure of the deal has once again drawn attention to the political challenges facing foreign investors in China, especially in so-called "strategic" sectors. China is concentrating on its key strategic sectors and machinery is now a part of that. Probably a few years ago if a foreign company wanted to buy into such assets it wouldn't have created much trouble, but lately China has been trying to control them more. The key point is that they want these key industrial sectors to remain in Chinese hands, whether through funds or other channels. In my opinion, I believe the Chinese authorities will give the green light for this BW takeover because, ultimately, when the whole acquisition is completed, Mr. Wang, who is a Chinese national, will gain control of CAHC which BW is a wholly owned subsidiary.

Some investors may think, if it is such a good opportunity to double your money over the course of a few months, why are the insiders not buying?
I have extracted the answer from the pre-offer announcement by CAHC:
CHAC and the Sellers have agreed to refrain from taking any action that would be prejudicial to the successful outcome of the Offer. In addition, until the termination of the Offer or the consummation of the Transactions, CHAC and the Sellers have agreed not to solicit or enter in negotiations regarding an alternative transaction. Furthermore, World Sharehold has agreed to procure that Bright World and each of its subsidiaries (collectively, the “Group”) (A) refrainfrom taking certain actions without the obtaining the prior written consent of CHAC and (B) operate their business in the ordinary and usual course.

Does CHAC have the financial muscle to carry out this takeover?
As at 30 June 2008, there are USD125 million in CHAC trust account. After this whole acquisition is completed, they would have used up USD50 million as World Share's 77.42% equity ownership position in Bright World is paid for using CAHC’s shares. This leaves them with the cash holding of USD75 million to acquire any of the four companies controlled by Mr. Wang Wei Yao.

Since the announcement of this takeover news, there have been some positive developments in China’s machinery industry:
China's machinery industry reports a 17.4 percent increase in the added value in July, and a 20.9 percent rise in export delivery value, according to China's National Development and Reform Commission. Experts held that the reform of the value added tax (VAT) has helped boost the development of the industry.
It will drive enterprises to invest on fixed assets, such as machinery equipment, said Zhu Qing, director of the financial department with the Renmin University of China. He predicted that this policy would be carried out nationwide in 2009 on the ground of industrial restructuring and the declined economy increase rate.

The country's eight million companies will be allowed from next year to use fixed-asset
investments to offset valued-added tax payable to the government, according to sources. Analysts said reforming the tax system was a prelude to a new round of economic sweeteners from Beijing as policymakers struggled to cushion the impact of weakening global and domestic economies. The adjustment in value-added tax will mainly ease the burden on manufacturers that have large investments in fixed assets such as factories and machinery. Analysts estimate that the change will reduce funds flowing into government coffers by between 100 billion yuan and 150 billion yuan a year. Analysts said the top beneficiaries of the policy change would be machinery and equipment makers, which have large fixed-asset costs that can now be offset.

Readers can draw their own conclusions if this represents an excellent opportunity, as the potential gains outweigh the associated risks.

7 comments:

Anonymous said...

Hi Level 13,

Interesting analysis. I did a quick analysis and the earnings ain't that bad. Base on its 1H2008 results, BW should be on track to record another year of increase earnings.

However, one thing puzzles me. The stock chart of BW is like a roller coaster. From the initial high IPO price of 0.74 it plummeted to 0.39. The same thing occurred again in July 2007 to Feb 2008. Is there any logical explanation behind this or is it due to speculation?

Putting the takeover aside, what do you think is the fair value of BW?

I'm not familiar with take overs but don't you think CAHC almost 100% premium over its current price too good to be true? If CAHC values BW at about $0.70, why isn't BW trading at least near to that level?

Cheers!
Derek

level13 said...

Hi derek,

Share prices always fluctuate regardless of speculation or logical explanation. I have not done any fair value calculation of BW. Maybe you can refer to the price of similar competitors or do a discounted cash flow analysis to get a rough idea of what the fair value is. Nevertheless, in this gloomy market, nobody cares about the fair value or fundamentals any more. As mentioned in my posting, I see opportunity in this counter because it is trading at a 50% discount to the takeover price. The main reasons why this is happening is because of the high number of conditions that have to be satisfied and the long waiting time for the confirmation of this takeover. Nowadays, investors are happy to exit the market and that’s why you see BW share price going lower with low volume turnover.

In short, there are some risks involved in this takeover offer and that’s why the share price will never trade at $0.70. It has to be lower to reflect the inherent risks. In my opinion, a 50% discount is just too much.

Cheers!

Anonymous said...

Hi Level13,

Thank you for your explanation makes me wanna dig out more. Any idea who BW competitors are (in Spore or China)?

Cheers!

level13 said...

If my memory did not fail me, the list of competitors in China can be found in BW IPO prospectus.

Cheers!

Anonymous said...

Hi level-13,

BW sh prc sudden dropped fr 0.30 to 0.24. Is this a good discount to accumulate or a sign that the deal fallthru ?? There r worries that glocal credit squezz will hamper fund raised for buyer. BTW, the NAV for BW is 0.33. What make CAHC pay such high premium ?? may be something i don see but u see ?

level13 said...

Price drop under low volume only shows that the weak holders are leaving the market in a panic. If the deal really fall through, you can expect very high volume turnover. However, one will need to monitor closely the events (CAHC shareholder voting & meeting, BW 3Q results) which will be taking place in the next few weeks.

Cheers!

Anonymous said...

There is some chg pertaining to deed of undertaking. What is your view on these chg (why & who benefit) ??? Does these chg positive to small invetors?

The Board of Directors of Bright World Precision Machinery Limited (the "Company") wishes to inform the shareholders of the Company (the "Shareholders") that CIMB-GK Securities Pte. Ltd., acting for and on behalf of China Holdings Acquisition Corp. ("Offeror"), had on 24 October 2008 announced, inter alia, that the Offeror had on the same day entered into a deed with World Sharehold Limited and its shareholders, namely, Mr Wang Wei Yao and Mr Shao Jian Jun to amend the Deed of Undertaking dated 20 July 2008 (the “Supplemental Offer Announcement”).