As part of my due diligence on another potential investment, I recently came across 21 Holdings (ticker: 1003.HK), a Hong Kong-listed holding company with a market cap of only HK$205m. This has proved to be a truly terrible investment over the last few years: a story of repeated, dilutive equity issues, share consolidations and dubious acquisitions: 100,000 shares at the end of 2007 have now been consolidated to a single share. During the last six years, the company has raised over HK$800m through numerous equity issues and spent around HK$600m, on what have proved largely worthless acquisitions.
21 Holdings Limited (the Company) was previously called GFT Holdings Limited and until the middle of 2007, its main business had been manufacturing and trading toys. In June 2007, it sold the toy manufacturing business; retaining a 60% shareholding in a trading business, Yanyan Force Limited. At 30 June 2007, it had net assets of just HK$43m. The Company was raised new money in the second half of 2007 through a rights issue, share placing and convertible bond issue (which was almost immediately converted into shares). By the end of 2007, the Company was essentially a shell company with cash of HK$235m. At this time, the Company had two executive directors: Mr Ha Kee Choy, Eugene; and Ms Ma Wai Man, Catherine (appointed October 2007); and three independent non-executives: Mr Chui Chi Yun, Robert; Mr Cheng Yuk Wo (also appointed October 2007); and Ms Leung Sau Fan, Sylvia (appointed February 2008).
With cash available, the Company was looking for acquisitions with a “primary ambition to seek prosperous and lucrative investments”. One potential investment had been a coal-mining joint venture in Inner Mongolia including “magnetic-levitated wind power generation”. With this optimistic outlook, an investor might at this point have decided to invest HK$10,000 in the Company’s shares.
By April 2008, the Company had found a suitable candidate, announcing the acquisition of the Century 21 group of companies for a total consideration of HK$430m. The target included three main operating companies: Century 21 Hong Kong, Century 21 Property Agency and Century 21 Surveyors. As a bit of background, Century 21 Real Estate is a US company that operates a global estate agency franchise business. In 1993, it granted the franchise rights for Hong Kong to Century 21 Hong Kong. All the Century 21 estate agents in Hong Kong operate as franchisees. Century 21 Property Agency is an estate agency business, which at the time of the acquisition operated four out of the 120 Century 21 franchises in Hong Kong and Macau. Century 21 Surveyors operated a valuation and surveying business. The three businesses had combined revenue of HK$89m and operating profit of HK$25m in the year before they were acquired, both big increases on the prior year. Not surprisingly for a people business, net assets were low at HK$25m, although at the time of the acquisition it only had 106 employees, including agents.
The valuation does look a bit rich, although the Hong Kong property market up to the beginning of 2008 had been performing strongly: volumes had been rising strongly for several years. The Company relied on a valuation report from independent valuers, BMI Appraisals, to justify the price paid. The approach taken by the valuers was somewhat convoluted. They applied a sales multiple of 2.2x, which was the median, historic multiple out of three “comparable” acquisitions (two from the UK, one from China) to the target’s projected sales in three years time; to take into account expected growth in the business. This was then discounted back to give a current value, using a discount rate of 14% (14.03% to be precise), of HK$465m. No projected financial information was actually provided, nor is it clear who produced them, although the projections were clearly adopted by the Company. But it is possible to back out the projected revenue, which was around HK$300m, more than three times historic levels. It is not explained how such rapid growth would be achieved. Somewhat surprisingly, the valuers did not mention what was probably the best the direct comparable, Midland Holdings, a Hong Kong-listed property agency, and one of the two dominant major agencies in Hong Kong, which at the time was trading at an historic EV/sales multiple of 1.3x and historic EV/EBIT multiple of 6x. No attempt was made to value the business using earnings multiples as the “volatile and transitory nature of earnings” makes earnings multiples “difficult to interpret”. Obviously, without access to the projections and business plans available at the time, second-guessing the valuation is difficult. However, I find it difficult to justify a value close to the amount paid. Valuing the company on same multiples as Midland would imply a value of around HK$115-150m.
The vendor was Mr Ng Kai Man, who apparently was the original founder of Century 21 Hong Kong. The consideration was to be paid in three parts: cash of HK$200m on completion, HK$100m in the form of a promissory note payable within 18 months and the remaining HK$130m as a convertible note with a maturity of three years. Mr Ng would also join the board of the Company after the acquisition was completed. It is somewhat surprising that Mr Ng was effectively able to cash out immediately from the transaction, particularly in view of the reliance on future growth to justify the price paid and the fact that he was joining the Company. While some of the consideration was deferred, it was not dependent on the businesses meeting any financial or other targets. And although Mr Ng retained an indirect equity interest via the convertible note, he was not taking any downside risk, except if the Company was unable to repay the promissory note and the convertible note. The acquisition was completed in July 2009, when Mr Ng joined the board.
There are a number of historical connections, which are worth noting:
- In 2001, Mr Ng sold a 66% controlling interest in Century 21 Hong Kong (which is just the franchise operations) to Capital Strategic Investment (now CSI Properties).
- The interest was sold to Capital Estate, a listed associate of CSI in 2003 for HK$6m.
- Capital Estate subsequently sold the shareholding back to Mr Ng for HK$4m in 2007.
- Ms Ma was an executive director at CSI between March 2001 and September 2007. Both Ms Ma and Ms Ng were executive directors of Capital Estate from 2003 until 2005, when CSI sold its interest in Capital Estate.
- The Company, which at that time was called Capital Prosper, was an associate of CSI until November 2003. Ms Ma was a director between March 2003 and April 2004.
- Mr Cheng has also been a director of CSI since 2002.
I have not been able to find out much historical information about Century 21 Property Agency or Century 21 Surveyors, which were formed in 1999 and 1995 respectively.
At the time of the original April announcement, the Company planned to raise an additional HK$150m from external investors: HK$100m through a convertible note placing and HK$50m through a share placing. The Company also announced a 1-for-5 share consolidation. After the acquisition, assuming full conversion of the convertible notes, current shareholders would own 38% of the Company, whilst Mr Ng would have a 28% shareholding. Nonetheless, the market reaction was very positive to the announcement of the acquisition, despite the dilution. The share price, which had drifted downwards since the end of 2007, more than doubled on very high turnover; well above the conversion price of the convertible notes. The businesses being acquired were effectively valued at more than HK$700m.
However, the worsening financial crisis appears to have prevented the external fund raisings, as neither went ahead. By the beginning of December 2008, the share price had fallen significantly. It still owed HK$230m to Mr Ng for the promissory note and the convertible note, whilst the current share price was well below the conversion price. The Company was clearly in a very difficult position financially: heavily leveraged and a substantial payment, of HK$100m, due to Mr Ng in around 12 months time. It was also running out of cash: most of the Company’s cash had been used for the acquisition and its operations were loss-making on a cash basis. At the end of 2008, it had cash of only HK$12m.
In December 2008, the Company announced a capital raising, which if successful would raise HK$150m, including a placing of shares at an effective discount of 75% to the current market price and a convertible bond issue to raise HK$120m. The cash crisis faced by the Company was not mentioned. The main rationale given for the fund raising was to repay the promissory note, as the interest cost on the new convertible bonds at 2.25% would be lower than the 3% paid on promissory note. The second reason given was to broaden the shareholder base and improve liquidity. Almost in passing, it was mentioned that it would “also provide additional working capital for business development of the Group”. The capital reorganisation involved a further, 1-for-20 share consolidation. If implemented in full, the equity issued would largely wipe out the existing shareholders, who would be left with less than 6% of the Company after conversion of the convertible bonds. Not surprisingly, the share price took a further nosedive. During 2008, the shares lost more than 90% of their value; our investor’s shareholding would now be worth a mere HK$973. The Company’s market cap was just HK$23m.
At this point, It is not clear that it was actually worth injecting new equity into the business, given the outstanding debt of HK$230m owed to Mr Ng. The performance of the Century 21 business, not surprisingly, had been very weak in the second half of 2008 as property transactions dried up: the Company wrote-off HK$174m of its value less than six months after completing the acquisition. Perhaps existing shareholders were lucky to keep anything. Despite the significant discount, the Company appears to have struggled to find new investors. By mid-May, it had raised around HK$41m: HK$23m from two share placings and HK$18m in convertible bonds. Despite the limited success in raising new funds, the Company demonstrated that its priority was to repay Mr Ng: it use HK$30m of the proceeds to repay part of the promissory note. At 30 June 2009, cash was still only HK$12m. In June 2009, it was announced that Ms Leung had resigned her position as a non-executive director and would be replaced by Mr Lui Siu Tsuen, Richard, and that Mr Ng would become Chairman.
The share consolidation took effect in February 2009. The (adjusted) share price reached a low point in early March 2009. However, the shares then started a remarkable run, obviously helped by the strong recovery in the overall market and the Company’s high leverage. Nonetheless by late July, when the shares were suspended, the share price had increased to HK$1.91 per share, an eight-fold increase from the March low point. On 30 July, the Company announced an agreement to set up a joint venture, in which it would hold 80%, to develop a wind farm in Inner Mongolia, comprising four phases, with the initial phase requiring investment of RMB500m. The announcement raises a whole host of questions, but perhaps they are irrelevant, since just over a month later it was announced that the agreement had been terminated due to a “change in the market condition of the alterative energy source business”. In the intervening period, the share price had increased further, reaching a peak of HK$2.29, valuing the Company at HK$728m. Share turnover during this period was also very high.
It also seems that some investors got wind of the termination before the announcement. On 7 September 2009, the shares fell to HK$0.50 per share from the prior day’s close of HK$1.89 on high trading volumes before they were suspended. The announcement resulted in more selling pressure with a large number of shares changing hands. Interestingly, whilst the investors in the May convertible bond issue had converted the entire issue in July at HK$0.18 per share, they do not appear to have sold their shareholding until after the September announcement. Furthermore, Mr Ng did not convert his convertible note.
Before the end of 2009, the Company took advantage of improved market conditions to raise additional funds: HK$18m from a share placing and HK$145m from a 4-for-1 rights issue. By the 2009 year-end, the Company had HK$97m in cash and had completely paid the HK$100m promissory note due to Mr Ng. He still held the HK$130m convertible note, although the share price was again well below the adjusted conversion price. Prospects for the estate agency business had also improved during the year: turnover for the business in 2009 was HK$92m and it earned an operating profit of HK$7m.
Despite all the turmoil, the Company finished the year with a market cap of HK$314m, implying a value of around HK$350m for the estate agency business. Our imaginary investor would have faired less well, if he’d kept his shareholding: this would now be worth only HK$470, less than half the value a year earlier, mainly due to dilution from the rights issue.
The Company wasted no time in re-starting its fundraising efforts in 2010, raising HK$11m in early January and a further HK$50m in April from share placings. The proceeds were used to redeem HK$60m of the convertible note, which Mr Ng had transferred to a third party; he retained HK$70m. Ms Ma resigned as a director in April and Mr Cheng was re-designated as an executive director from an independent non-executive director. In September, Mr Lam Kwok Cheong became a non-executive director; Mr Lam had previously been a director of the Company between 2004 and 2007. The share price continued to slide and by the end of August had more than halved since the start of the year.
In September 2010, the Company announced the acquisition of a property agency business in mainland China for HK$180m in cash. The business, which had only been established in 2009, earned revenue of only HK$2m in 2009 and less than HK$1m in the first eight months of 2010. Gross assets were less than HK$1m. The vendor was a BVI company, Prolific Wise Limited, controlled by two people Mr Yeung Oi Leung and Ms Hui Ping Lam. Mr Yeung was supposed to have joined the Company after the acquisition, but I have not been able to find any other details about either of these two people. The main justification for the acquisition price was contracts that the target had with various property developers in mainland China. The target would earn commissions, typically of around 1%, on the sale of new property; some of the contracts were on an exclusive basis, whilst others were non-exclusive. Revenue from these contracts was not expected to be fully realised until 2011 and subsequent years. Again, BMI Appraisals provided a valuation report, which the Company used to support the acquisition price. They put a value of HK$210m on the target business. This was based on the assumption that the business would earn revenue of RMB42m from eight projects in 2011. Their valuation was based on an EV/sales multiple of 4.38x, derived by averaging an “exhaustive list” of two comparables. To this they applied a marketability discount of 25% and a control premium of 30% (after which they largely arrived back where they started), giving at a final valuation of RMB180m, or HK$210m. No attempt was used to value the target using profit multiples.
The Company financed the acquisition with another rights issue: this time 10-for-1, raising HK$214m before expenses. The Company also proposed another capital reorganisation involving a 1-for-20 share consolidation. In addition to financing the acquisition, the proceeds were used to redeem the remaining HK$70m of the convertible note held by Mr Ng, at a small discount to the face value. Following this, Mr Ng had been paid the entire consideration from the sale of his business to the Company.
The market reaction to the acquisition was clearly negative. The shares fell 27%, when they resumed trading, and continued to fall. The Company’s market cap by the year end was only HK$60m. The shareholding of our hapless investor fell a further 85% during the year, and would now be worth a mere HK$72.
During 2010, the Hong Kong estate agency business had produced a steady performance: revenue increased slightly to HK$93m, whilst operating profit had declined slightly to HK$7m. At the same time, the Company wrote down the value of its investment in the business by HK$164m, following the HK$174m written off in 2008; goodwill was now carried on the balance sheet at HK$92m.
Despite the obvious lack of market enthusiasm for the transaction, the rights issue was approved by shareholders (although the 99% of the shareholders who voted were in favour, this only represented 30% of the shares) and completed at the beginning of January. The Company also wasted no time in seeking additional funds; announcing a special placing within a matter of days with a view to raising a further HK$55m, which represented 30% of the existing share capital. The Company had entered into a memorandum of understanding with a view to investing HK$35m in “a PRC entity which will be engaged in provision of community payment services and property agency services in the PRC. However, for some reason, the placing did not proceed and was subsequently cancelled, although the Company announced that it was continuing to negotiate the MOU.
In March 2011, a litigation crisis loomed for the Company. Under a legal dispute dating back to 2004, a former director had sued the Company, claiming HK$45m plus interest relating to loans from two subsidiaries. In early March, the Hong Kong High Court found in favour of the plaintiff. The Company appealed the decision, but made a provision of HK$84m in its 2010 accounts: if it were to lose, the final bill, including interest and costs, was likely to be around HK$90m. As an interim measure, the Company was required to pay into court HK$50m. The Company raised HK$27m via a placing in March 2011 to make an interim payment; and, in May 2011, launched another rights issue (this time 8-for-1) and another share reorganisation, including a 1-for-10 share consolidation. The rights issue would raise HK$119m, which was more than its potential liability, but the Company needed to continually raise additional working capital to cover losses from its operating businesses.
With all that was going on, it would be easy to forget the operating performance. However, 2011 was not a good year. Revenue from the Hong Kong business declined 38% to HK$58m, whilst the newly acquired mainland China business, which had been expected to deliver around HK$50m of revenue in 2011, in reality, only generated around HK$10m. The Company immediately started the process of writing down the goodwill associated with the acquisition, reducing it by HK$95m, as well as writing down the Hong Kong business by a further HK$54m.
There was some good news on the litigation front in December 2011: the Company’s appeal was successful. However, the plaintiff subsequently appealed this decision, so the uncertainty would continue through 2012 and into 2013.
Nonetheless, the Company ended the year in reasonably robust financial shape. It had no debt, cash of HK$85m and financial investments of HK$52m. It was also due to be repaid HK$50m it had paid into court for the litigation, although the risk of an eventual judgment against it remained. However, the share price languished with the Company’s market cap only HK$90m. For our unfortunate investor, his investment would now be worth less than HK$1, diluted away by the two rights issues during the year.
By the Company’s standards, 2012 was a relatively uneventful year: remarkably, there were no equity issues, although the company did implement another capital reorganisation and a 1-for-5 share consolidation: 100,000 shares at the end of 2008 had been consolidated to a single share. The Hong Kong business recovered strongly, recording revenue of HK$101m, for the year, although operating profit was only HK$4m. Revenue for the mainland China business increased to HK$12m, although it recorded an operating loss of HK$8m, similar to the prior year. Goodwill for the mainland China business was written down to zero and the carrying value of intangibles (mainly customer relationships) was written down by an additional HK$20m to HK$34m.
The share price continued to drift lower during the year. By the year-end, at first glance, the Company might have looked like quite an attractive investment opportunity, trading at a significant discount to book value: it had a market cap of only HK$66m and book value of HK$160m, which included a provision of HK$87m for the litigation. The Company was debt-free, and had cash of HK$108m and trading investments of HK$77m, plus a Hong Kong property business that was worth a modest amount. Even if the Company was required to pay HK$90m in litigation, on paper, it still looked good value. Perhaps.
In January 2013, despite the large cash balance, the Company decided to raise a further HK$12m through a share placing for “general working capital”, which represented nearly 20% of existing share capital. During the first half of the year, the Company’s operational performance was weak. Revenue in the Hong Kong business declined by more than 50%, whilst revenue in the mainland China business declined 70%. In August, the Company sold its 60% shareholding in the perpetually loss-making, toy-trading business for HK$100,000 to the minority holder of the remaining 40%, who happened to be Mr Ng’s brother. The business had revenue of only HK$23m in 2012 and made an operating loss of HK$1m. The Company also effectively wrote off a HK$16m shareholder loan made to it. It is unclear why a trading business would be, seemingly, a permanent loss maker.
Further good news on the litigation front occurred in September, when the Court of Final Appeal eventually dismissed the claim against the Company, which will enable the HK$87m provision to be released. At 30 June 2013, the Company had cash of HK$143m and financial assets of HK$56m. The Company’s share price has also recovered up this year, increasing by more than 150%. Its market cap is now around HK$215m. Our poor investor will have made back some of his losses: his shareholding would now be worth nearly HK$2.
I have provided a narrative description of the Company’s history over the last few years. It is also instructive is to look at the aggregate cashflow over the 5-year period between 2008 and 2012 (see below).
During this period, the aggregate sources and uses of cash have been relatively simple. The Company had an aggregate, negative operating cashflow of HK$81m; and, in every year, it had negative operating cashflow. The Company spent around HK$600m on acquisitions and raised just over HK$600m from equity issues, including three rights issues, six share placings and one convertible bond issue. This does not include additional funds raised in 2007 or 2013. The Company did not pay a dividend during this period.
It is difficult to know what to make of the above. At best, this is an egregious example of poor management and the abuse of shareholders. Yet, the management remain in place with cash available to continue the process. The Company is clearly not an isolated case. It is certainly not a good advert for governance standards in Hong Kong: rules exist, which are supposed to protect shareholders, but appear to be of limited benefit in practice. It is profoundly disheartening that this should be allowed to happen in what is supposed to be a developed market. Caveat emptor is the clear lesson.