Hankore Environment Tech Group Ltd - How would it survive working capital crunch without reverse takeover by China Everbright International Ltd?

25/2/2014 – Hankore Environment Tech Group Ltd has signed an agreement with HKSE-listed China Everbright International Limited for a reverse takeover.

Hankore will acquire China Everbright International Ltd's wholly-owned subsidiary China Everbright Water Investments Ltd and allot new shares to it at 7.03 Singapore cents per share.

This means China Everbright International Ltd will own more than 50% of Hankore's entire share capital.

However, the announcement, made on December 30, which was a Sunday, didn't mention the exact number of new shares to be issued as it would depend on the valuation of China Everbright Water Investments Ltd, to be determined by two independent valuers.

China Everbright International Ltd is a subsidiary of China Everbright Group which, in the words of Wikipedia, is a "state-owned enterprise operated under the supervision of the State Council of the People's Republic of China".

It adds that the "State Council" is synonymous with the Central People's Government and is the chief administrative authority of the People's Republic of China.

In short, China Everbright International Ltd is a Chinese-government-owned enterprise.

Mr Tang Shuangning is the Chairman of China Everbright International Ltd.

He is a member of the 11th National Committee of the Chinese People’s Political Consultative Conference.

Of late, Mr Tang has been in the news.

Late last year, The New York Timesreported that US federal authorities were investigating New York-based Investment Bank JPMorgan Chase for hiring Mr Tang's son, Tang Xiaoning, with an aim to corner "existing and potential business opportunities".

According to the news report, Mr Tang Shuangning approached a JPMorgan executive in Hong Kong in March 2010, seeking a position for his son, who was once a Goldman Sachs and Citigroup employee.

Until that point, JPMorgan didn't have much business with China Everbright Group, which was headed by Mr Tang Shuangning.

But soon after appointment of his son, Mr Tang approached JPMorgan to advise a China Everbright Group's subsidiary on a S$300 mln private placement.

And a year later, while Mr Tang's son was still employed with JPMorgan, China Everbright Group's banking subsidiary hired JPMorgan as one of the several financial advisors for listing on the Hong Kong Stock Exchange.

But due to unfavourable condition of the world markets, the IPO was deferred.

In 2011, JPMorgan offered another one-year contract to Mr Tang's son.

In 2012, China Everbright International Ltd hired JPMorgan to advise on a S$162 mln sale of shares.

The contract of Mr Tang's son was renewed by JPMorgan in May last year when an executive urged (as quoted in the NYT), "Given where we are on China Everbright, I think we may need another contract for Xiaoning".

Probably, the executive was hinting at business opportunities from the revival of China Everbright's banking subsidiary's listing plans.

But in November last year, the South China Morning Postreported that JPMorgan pulled out of the IPO of China Everbright Group's banking subsidiary in Hong Kong.

The bank was cooperating with an investigation, but had not been accused of any wrong-doing.

Investor Central. Asian insights for global investors. We ask the tough questions of Asian companies which global investors need answers to.

Question

1. Why didn’t China Everbright go through normal listing channels?

This is a question to be asked of all companies coming to market without a prospectus – if they are so keen to list on the Singapore market, why not go through the normal process?

How will investors in the new Hankore know what they’re buying into?

Question

2. Is it an interested party transaction?

Nie Jian Sheng, the CEO and an executive director of Hankore, worked at the Tianjin Commission of Commerce, before joining the company in December 2011 (refer page 15 of FY13 annual report).

His employment history includes the position of department chief and the deputy head of the Foreign Affairs Office of the Tianjin Municipal People’s Government liaison office in Hong Kong.

Mr Lin Zhe Ying, an executive director of Hankore, is also a specialist to the State Development Bank (now known as China Development Bank).

He is a member of the SME committee of the Shenzhen Stock Exchange.

We already know that China Everbright International Ltd is a Chinese state-owned enterprise.

Therefore that makes us wonder if the present and past relationships of the CEO and an executive director of Hankore with the Chinese government makes the proposed reverse takeover an interested party transaction.

Question

3. Is the proposed reverse takeover in the best interest of Hankore's minority shareholders?

Hankore's board consists of eight directors namely, David Chen Dawei, Nie Jian Sheng, Yau Wing-Yiu, Lin Zhe Ying, Chen Da Zhi, Paul Lim Yu Neng, Lee Kheng Joo and Fonda Cheng Fong Yee.

Mr David Chen Dawei is the Executive Chairman of the Board.

Mr Nie Jian Sheng is the CEO and an executive director of the company.

Mr Yau Wing-Yiu is the CFO and an executive director.

Mr Lin Zhe Ying is another executive director.

Mr Chen Da Zhi is a non-executive director and brother of Mr David Chen Dawei.

While Mr Paul Lim Yu Neng is the Lead Independent Director, Mr Lee Kheng Joo and Ms Fonda Cheng Fong Yee are the other independent directors on the Board.

Apparently, the independent directors are in a minority on the Board of Hankore.

According to page 4 of the Code of Corporate Governance 2012, released by Monetary Authority of Singapore, independent directors should make up at least half of the Board of a company where the Chairman is not independent.

The aim is to ensure a strong and independent element on the Board, which is able to exercise objective judgement on corporate affairs independently, in particular, from the Management and the shareholder(s) with more than 10% stake(s) in the company.

"No individual or small group of individuals should be allowed to dominate the Board's decision making", adds the Code of Corporate Governance.
In the case of Hankore, Mr David Chen Dawei - the Executive Chariman - owns a 16.47% stake in the company.

Mr Chen will have to resign as Chairman in a few years.

That's because the Monetary Authority of Singapore says the above guidelines regarding the independence of the Board shall be mandatory at the AGMs following the end of financial years commencing on or after May 1, 2016.

Hankore's financial year ends on June 30.

Therefore, it will have to adopt the guidelines regarding independence of the Board, latest, by the AGM for the financial year ending June 30, 2017.

In essence, the Code of Corporate Governance 2012 has highlighted that the Board of Hankore is not independent enough to protect the interests of minority shareholders.

Would Hankore appoint an independent financial adviser to guide minority shareholders before they vote on the deal at a special general meeting?

Hankore's December 30 announcement didn't mention an appointment of an independent financial adviser.

Question

4. Would it not survive without the proposed reverse takeover by China Everbright International Ltd?

Recently, in an interview with NextInsight, Mr David Chen - the Executive Chairman of Hankore - acknowledged that his company cannot compete with the likes of China Everbright International Ltd.

He said, the water treatment industry in China is dominated by large players which have access to low cost funds.

Mr Chen revealed that Hankore's existing cost of funds of 7%-8% is about twice than that of a state-owned enterprise like China Everbright International Ltd.

The news report also refers to a JPMorgan research report which said the wastewater treatment capacity of China Everbright International Ltd would double to about 4 mtpd after the transaction.

JPMorgan sees the acquisition of Hankore to be "potential positive" for China Everbright International Ltd.

We assume the investment bank's research report is independent of any investment banking relationship.

In its FY13 Annual Report (page 46), Hankore's management raised doubts over its ability to operate as a "going concern".

On June 30, 2013, Hankore's current liabilities exceeded the current assets by RMB 179.3 mln.

That's despite it making a RMB 99.5 mln net profit during FY13.

On June 30, 2012, Hankore's current liabilities exceeded its current assets by RMB 138.2 mln, despite a RMB 102.6 mln net profit during FY12 (refer page 43 of FY12 Annual Report).

On June 30, 2011, Hankore's current liabilities exceeded its current assets by RMB 134.3 mln, even as it made a net loss of RMB 407.2 mln during FY11.

Apparently, the negative working capital of the company has been widening despite it being profitable in FY12 and FY13.

In other words, Hankore's operations aren't generating enough cash flows to bridge the working capital gap.

In the absence of that, the management aims to avert a crisis by raising funds via a S$300 mln medium term note (MTN) programme and refinancing its existing loans.

But as Hankore's Executive Chairman has already pointed out the cost of loans is as high as 7%-8%.

Moreover, in August last year, Hankore raised S$50 mln in its MTN programme at an interest cost of 7.5% per annum.

Therefore that makes us wonder if the projects of Hankore are profitable despite borrowing funds at such expensive rates.

In that case, can it really operate on a "going concern" basis if the reverse takeover by China Everbright International Ltd fails?

(Total number of questions in the full story: 15)

We have sent these questions to the company's IR agency (charlotte@financialpr.com.sg, jasmine@financialpr.com.sg, yitsung@financialpr.com.sg) and its internal audit firm (marketing@rsmhk.com) to invite them for an on-camera interview, and/or seek their written response.

Ngo Yit Sung at Financial PR replied: "We have conveyed your questions to the management, they may need some time to revert".

So far, we have not had any further reply (which is why you are seeing this message).

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