Stockwatch: A speculative, takeover arbitrage play
23rd December 2014 09:20
by Edmond Jackson from interactive investor
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China was promoted as a growth story but making money has been fraught with woe. Fidelity fund manager Anthony Bolton tarnished his reputation launching an investment trust that ran into losses, and China-related shares aimed at Western investors have often disappointed - ending up acquired at low points. Even Warren Buffett is getting his fingers burnt as a Chinese electrical car maker he holds - BYD Co. - has plunged 40% amid a worsening outlook for the Chinese car market.
 is one such example in the London market I have followed for maybe 15 years; now in its end-game. The company is UK-incorporated but operates from Hong Kong, nowadays an investment holding company with interests in oil products and urban gas supply to China. It has always appeared a good growth prospect yet the stock has traded volatile-sideways.
Board members are predominantly Chinese and the two founding brothers own a controlling 51% stake. Despite there being "independent directors" such a structure has likely deterred institutional investors and broker coverage, another reason the shares have languished. The nagging worry is that while this kind of company ticks certain rules of cricket, you never know when it might throw a googly.
A well-timed, if oddly-structured, buyout offer
| Year ended 31 Mar (no forecasts available) | 2009 | 2010 | 2011 | 2012 | 2014 (15 months) |
| Turnover (£m) | 192 | 276 | 139 | 123 | 262 |
| IFRS3 pre-tax proft (£m) | 18.1 | 26.1 | 12.2 | 7.7 | 49.4 |
| Normalised pre-tax profit (£m) | 17.4 | 23 | 6.7 | 6.2 | -16.8 |
| Normalised earnings/share (p) | 0.4 | 0.5 | 0.1 | 0.2 | -0/6 |
| Cash flow per share (p) | 1.5 | 1.3 | 1.4 | 1.3 | -0.2 |
| Capital expenditure per share | 1 | 0.7 | 1.6 | 1.1 | 0.4 |
| Dividend per share (p) | 0 | 0 | 0.1 | 0.2 | 2.4 |
| Net tangible assets per share (p) | 3.9 | 4.9 | 4.6 | 7.5 | 13.2 |
| Source: Company REFS. | |||||
After the non-index shares more than halved this year from 14p to a five-year low of 6.3p, a cash offer of 10p a share is proposed by Fortune Dynasty Holdings, a British Virgin Islands company owned by two Fortune directors. With 56.91% of the shares in support, only 42% of the remaining minority holders are needed to achieve the required 75% acceptance level. The news release is quite sketchy; a formal offer document is expected from 14 January, it should be possible for a potential investor to find via .
What raises "takeover arbitrage" interest is a potential further 50% upside to the 10p basic offer, assuming Fortune disposes of its stake in Hong Kong-listed China Gas Holdings (Fortune previously divested gas interests to). This compares with Fortune's current share price of about 9.5p.
To Western eyes, the near £200 million stake is the rightful property of owners; whereas the board proposes a "contingent valuation right" to a further 5p a share assuming the volume-weighted average price achieved in CGH over a 12-month period is above HK$11. Properly, minority shareholders are entitled to whatever value is realised, hence this seems a googly.
The recent chart and statistics show CGH peaking around July at $16 then falling to about $12 where they trade on a price/earnings multiple near 21 times and yield 0.9%. Such a profile may be exposed to a shift in market sentiment, say if China has problems with its soaring debt.
But CGH is one of the largest city gas companies in China, well-positioned to capitalise on the trend to urbanisation and natural gas usage. Long-term it should have excellent prospects (partly why it is opportunistic to buy out Fortune Oil after the share price drop?) and at last July's prelims Fortune said: "our shareholders will continue to have good exposure to this rapidly expanding market through a company where commensurate dividend growth is anticipated."
On 13 August Fortune acquired a further 13.25 million shares at HK$14.8, taking its CGH stake near 935 million or 18.6%. Note 11 to September's balance sheet cited the fair value of the stake as £201.7 million equivalent, based on the then share price of HK$12.88. Overall net assets were £360.2 million or 13.9p a share with intangibles of just £370,000.
Directors changed their tune when poised to bid
Then on 1 September the Chinese government hiked gas prices by 20% (effectively ending a subsidy) which has contributed to the fall in CGH's share price. The tone of Fortune's 28 November Interim Management Statement turned worrisome, saying for example that the slowdown in Chinese growth and fall in oil prices "has increased our inventory risk"... "the slowdown in the growth of China's property market will reduce the rate of gas connections and associated fees in city gas concessions"... and "as a result of the possible uneven timing of distribution of dividends received (from investee operations) Fortune Oil will require careful treasury management in order to avoid future cash shortfalls."
Fair to an extent, when oil prices are plunging, but in the words of the late Mandy Rice-Davies: "They would say that, wouldn't they?" when poised to make a cash offer.
What irks is seeming potential for a transfer of value in the CGH stake, to the buyout directors (if CGH shares recover). And what might happen if a conditional average share price of HK$11 is not achieved? In pricing Fortune Oil shares at about 9.5p currently, the London market ascribes no value to this proposal whereas you'd expect to see Fortune trading say at 11-12p, all-considered. The return of value from CGH is therefore a key issue which may become clearer as the shareholders' meeting approaches - on or before 28 February.
Shareholders are in a hard place - but could yet exact additional value to the basic 10p/share offer
Their dilemma is no rival bid being likely given the elements of corporate control; and then a de-listing in March. Yet the buyout directors must still achieve a 75% majority and minority shareholders can express their views, especially if January's offer document still begs questions. If they are left aggrieved then the buyout directors run some risk, this gets picked up online as discontent simmers, to affect their reputations longer-term. So minority shareholders are not powerless.
At 9.5p, Fortune Oil is therefore a "takeover arbitrage" situation to watch, also as a test of the conduct of Chinese business (listing in London). With a low chance of the deal falling through, a 10p basic offer to conclude next March and potential further return, the risk/reward profile is interesting.
For more information see fortune-oil.com/.
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