Following on the heels of the cash offer for GP Hotels, I would like to discuss yet another similar offer for a deep value (CNAV) stock that we had invested in previously.
Kingboard Copper is a Hong Kong based company that is listed on the SGX.
What made us invest in this stock
It was in 2014 when we first picked up Kingboard Copper. The stock had a CNAV discount of 52% and POF score of 2. It had zero debt and was sitting on a mountain of cash totaling HK$1.1 billion.
After deducting liabilities, Kingboard Copper still had a net cash position of S$0.26 per share. At that time, the counter was only trading at S$0.19. This meant that for every S$1 we spend buying the share, we will actually get to own S$1.38 in cash.
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We invested in the stock at an average share price of S$0.189.
We rely on such quantitative rules to decide on our investments. We understand that many investors would find the process uncomfortable. It is not easy to invest in a largely unheard of ‘penny’ stock in a staid industry.
However, more often than not, investors’ biases worsen the stock selection process. For example, investors tend to show prejudice to smaller and unfamiliar stocks even when they have been proven to offer a higher rate of returns.
Other investors would even be wondering – why would a stock be selling below its cash value? There must be some catch.
Why is the stock undervalued
The management has not declared any dividends for more than 5 years despite having a large pile of cash. This is despite the company being profitable and the cash amount continuing to increase over the years. Investors tend to avoid such stocks because they are uncertain of achieving any returns at all when none of the profits are being distributed as dividends.
Another possible reason could be due to Kingboard Copper’s major customers being the related companies in the Kingboard Chemical Group. This could potentially lead to preferential pricing of Kingboard Copper’s products and deny shareholders of higher profits. There was an independent report by Ernst & Young which I will elaborate further below.
I attended the Annual General Meeting in 2016. There were a few vocal shareholders who voiced their unhappiness over the situation. They were concerned mainly about the lack of dividends and the hoarding of cash.
The Chairman, Lam Ka Po, explained that he had plans to pursue the opportunity in electric cars as copper foils are needed in batteries. However, he did not want to utilise the cash at a time when the Company is faced with a litigation issue and the Interested Person Transaction (IPT) mandate has not been passed (explained in the next two sections).
Shareholder sued the majority shareholders
This litigation was brought about by Annuity and Life Reassurance Ltd, who owns 2.4% in Kingboard Copper, for minority shareholder oppression. The lawsuit was lodged in Bermuda where Kingboard Copper had registered the Company.
The Court had ruled in favour of Annuity and Life Reassurance and ordered the Company to offer other minority shareholders the option to have their shares redeemed upon the same terms and conditions.
That was enough to send the share price much higher.
The method and principles to value the Company shares were supposed to be determined in the Court hearing on 21st April 2016. However, the hearing did not finalise the method and valuation and was subsequently adjourned for further discussions. There was no further updates about this case since then. The majority shareholders have also submitted their appeal.
Ernst & Young’s report and we decided to sell
An independent review was commissioned to look into the Interested Person Transactions (IPT) between Kingboard Copper and the related companies. It was also to determine the independence of Harvest Resource Management Limited. Ernst & Young (EY) was appointed and have published their report.
It is a long report so I will share some main points and my opinions after reading it.
1) EY assessed the estimated Gross Profit forgone due to the lower selling price of Kingboard Copper’s products to the Kingboard Group during the Relevant Period to be HKD 1,176,757,000. This was approximately 8.5% of total sales for the Relevant Period.
2) EY discovered that Mr. Lin Yi Yuan (shareholder and director of Harvest Resource) was a director and a former shareholder of Shenzhen Jiyada Trading, a wholly-owned subsidiary of Kingboard Chemical, and also the legal representative and executive director of Dong Wei (Fogang) Trading, a partially owned subsidiary of Kingboard Chemical. The management’s announcements of the total independence of Harvest Resource were therefore, inaccurate.
3) EY observed that the Harvest Resource office was sparsely furnished. There were a few staff employed but there was little activity going on. They also observed that the products at the warehouse had Kingboard Copper’s labels instead of Harvest Resource’s. However, there was not enough evidence to determine the relationship between Harvest Resource’s directors / shareholders and that of Kingboard Chemical.
Even though the report was not conclusive of any wrongdoings, we preferred to err on the safe side. We were wary of that fact that further evidence might result in a violation of the Exchange rules or even the Companies Act. Hence in October 2016, we decided to sell out our entire position at a share price of S$0.235 for a small gain of 24%.
Voluntary cash offer
On 3rd Mar 2017, Excel First (related to the founder of Kingboard Chemical, Paul Cheung Kwok Wing) proposed a cash offer of $0.40 for each Kingboard Copper share. That was a 17.6% premium above the last trading price before the offer was announced.
The offer letter also stated the intention to delist the Company. The offer was unconditional so every shareholder who has accepted the offer will be paid accordingly for the shares sold.
We would have made a 112% gain if we had not sold off our stake earlier. However, this is investing and we have no regrets.
Despite paying a slight premium over the last traded price, an examination of the history indicated periods where Kingboard Copper was trading above $0.40. Shareholders who have paid more than the offer price might be reluctant to give up their shares at a loss.
Shareholders should also be mindful that the offer of S$0.40 is still way below the book value per share of S$0.68.
Kingboard Copper was trading as high as S$0.415 on the first trading day after the cash offer announcement was made. Investors were still keen to buy above the offer price in anticipation that the offer would be revised upwards.
It is definitely interesting to watch as the events unfold.