STuffed!
25th September 2002

Sometimes Webb-site.com can read like a "how-to" guide on the abuse your minority shareholders. It is unavoidable - by documenting regulatory loopholes, if they are not subsequently closed, then they may be exploited.

First a small one...

In Jan-02, we criticised South China Holdings Ltd for spewing out unlisted shares in its subsidiaries as dividends in specie, in effect a form of creeping delisting. This avoided the rules on spin-offs, but with no guarantee that the distributed shares would ever be delisted. So far, in the case we highlighted, Jinchang Pharmaceuticals Holdings Ltd has yet to be listed anywhere and shareholders are left holding unlisted stock in a company which is not subject to the Listing Rules.

...then a big one

Now roll the clock forward to 11-Jul-02, and we find an announcement by Sing Tao Holdings Ltd (STH, subsequently renamed Shanghai Ming Yuan Holdings Ltd) that it would distribute all the issued shares of Sing Tao Media Ltd (STM) to its shareholders as a "special interim dividend in specie", 1 unlisted share in STM for every STH share held.

STM owns the newspapers and magazine business of STH, including the English-language Standard  and the eponymous Chinese Sing Tao daily. The distribution reduced STH to a small property-owning group.

Although an interim dividend itself would normally require only a board resolution, this one was so large that it needed a reduction of the share premium account to create enough distributable reserves before the dividend could be paid, which required a special resolution of shareholders, in turn requiring a 75% majority of votes cast.

Global China Group Holdings Ltd (GC) owned 74.5% of STH, so it was certain of approving the capital reduction proposal. At the same time as the dividend announcement, GC announced that it would sell its 74.5% stake in the shrunken shell of STH to a BVI company owned by Mr Yao Yuan and his brother at $0.524 per share, triggering a general offer for STH.

GC also announced a voluntary general offer under the takeover code for the 25.5% of STM it didn't already own, offering 1.75 new CG shares for each unlisted STM share. 

The accountants got to work, and by an announcement on 26-Jul-02 had figured out that the dividend would reduce the net assets of STH as of 31-Dec-01 from HK$755.0m to $104.9m, or from $1.80 to $0.25 per share. In other words, the dividend of STM shares represented 86.1% of the net assets of STH.

The 27-Jul-02 circular convening the shareholders meeting regarding the dividend offered very little information on STM, but in any case, the outcome of the meeting on 19-Aug-02 was in no doubt with GC's 74.5% vote. Minority shareholders of STH were about to receive unlisted shares in respect of 86.1% of the net assets of their company, and they had no choice in the matter.

The Offer for STM

Although STM, after being distributed, was no longer subject to the HKEx Listing Rules, the offer by GC for STM was still subject to the SFC's Takeover Code, because STM was a "public company" under paragraph 4.2 of the Introduction to the Code.

The board of the unlisted STM was the same as the board of STH, so the independent non-executive directors were Mr Stephen Fan Sheung Tak, an accountant, Mr Tung Chee Chen, Chairman of shipping group Orient Overseas International Ltd and brother of Hong Kong's Chief Executive, and Mr Yao Kang, a retired director of various Swire companies.

On 27-Aug-02, the latest practicable date prior to the posting of the offer document, GC shares closed at $0.33. This valued the 1.75 GC shares offered for each ST share at $0.5775. However, in the offer document, GC chose to focus on the fact that on 11-Jul-02 it had arranged a placing of new shares to 3 companies, owned by anonymous "independent third parties" at $0.6388 per share (nice lucky number). The offer document stated that the offer valued the STM shares at $1.12 on that basis. We find the comparison misleading, because the placing price has no bearing on the market price achievable for accepting STM shareholders.

In addition, the pro forma net asset value of STM at 31-Dec-01 was HK$1.535, so the offer value of $0.5775 was a 62.4% discount to the net asset value.

Fait accompli

Whatever you think of those offer terms, the key point is that investors should not be forced to choose between a privatisation offer and holding unlisted stock. That is not a real choice, and allows the offeror to name its price. By using its control of STH to distribute STM as an unlisted dividend, GC left investors with a fait accompli. The independent directors correctly wrote:

"STM Independent Shareholders who continue to be interested in the future prospects of [STM] and consider retaining their shareholdings in [STM] may hold an illiquid investment for which no recognized market will exist. In addition, under this circumstance, shareholders of [STM] will become investors in a private company with less transparency, more limited financial reporting requirements and with fewer opportunities to vote on significant acquisitions or realizations of significant assets, than would be the case for a publicly traded company listed on the Stock Exchange.

It is a pity that the independent directors didn't voice any public objection when the STH board declared the dividend in the first place. The combined effect of the dividend and the offer was that GC acquired 100% of STM from STH by issuing new shares with a market value equal to a 62.4% discount to STM's net asset value. They could have proposed that as a connected transaction, which would have required approval by independent shareholders of STH, but instead avoided that by using the dividend route.

So cynical was this approach that STH didn't even bother to send out share certificates in respect of the dividend, instead saying that anyone who didn't accept the offer by GC would get STM share certificates after the offer completed. Needless to say, STM shareholders caved, and when the offer closed, GC had received enough acceptances to compulsorily acquire the remaining shares, making STM a 100% subsidiary.

Regulatory Note

Mr Andrew Sheng, Chairman of the SFC, said in a recent speech,

"At the controversial end of the spectrum of transactions are those that appear unfair but comply with the non-statutory rules. These should lead to rule changes"

This is a classic case in point. We said it in January and we'll say it again: the Listing Rules should be amended to prohibit listed companies from making dividends in specie unless the distributed assets are themselves listed.

In addition, where the distributed assets are listed on a different recognised stock exchange, then the distribution should require independent shareholders' approval, because an overseas listing may make it difficult for independent shareholders who don't have overseas brokerage accounts to sell their distribution.

If the rules are not changed, then this will not be the last time that a company spontaneously delists itself by distributing the bulk of its assets as an unlisted company. Delisting, as we have recently seen, destroys value by removing liquidity and regulatory oversight. Meanwhile, the share prices of all listed companies will continue to be discounted for the risk of this kind of action.

Think about it. How would you feel if a company whose shares you own announced that its controlling shareholder had decided that the company will distribute 90% of its assets as an unlisted stock, and you had no choice in the matter but to accept whatever offer is on the table?

Special dividend in specie? These things should be renamed "specious dividends".

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