Current Price: HK$3.47
Offer Price: HK$3.92
Expected Closing: TBD
This idea was shared by Andy.
This is Chinese privatization by the parent company with risky shareholder approval conditions. The average daily liquidity for the last week stands at <US$50k.
Chinese equity investment firm Powerleader Investment is taking 8236.HK private by merging it with subsidiary Shenzen Speed Top Network Technology (private) in exchange for HK$3.92/share in cash. The company is listed on both the domestic stock exchange and in Hong Kong. Essentially this is an asset transfer from one subsidiary to another with a certain strategic rationale behind it (more details below). The parent owns 56% of the domestic 8236.HK shares and none of the H shares (total economic ownership of 42%).
The offer is subject to multiple shareholder approvals:
- Buyer's shareholder approval. Powerleader Investment holds 70% of Shenzen Speed Top, while the remaining part is owned by various partnerships.
- 2/3rds of total 8236.HK shareholders present and voting in the meeting.
- Approval from 75% of independent domestic 8236.HK shareholder votes cast and not more than 10% of independent domestic shareholders rejecting the transaction. This condition is guaranteed as all domestic shareholders have agreed to vote in favor.
- Approval from 75% of independent H shareholder votes cast and not more than 10% of independent H shareholders rejecting the transaction. This is the main issue as information on H shareholders (25% of total share capital) is unavailable, while the blocking stake is only about US$3m.
The main risk is H shareholder approval, however, it seems that so far the majority of H shareholders were supporting management and the direction it is leading the company. Two recent votes (more information below) got 100% approvals from H shareholders (around 55% of total H shares participated), which is encouraging that the upcoming privatization vote will pass as well.
Certain information is still limited and should hopefully be included in the composite document expected to be released by the 20th of November:
- Information on H shareholders.
- Information on the whole remaining Powerleader group and its owners (Li and Zhang).
- Unclear situation and current state of Shenzen Speed Top (why is it not operating since July).
Favorable aspects of this trade
1. The price comes at 4 year high (ignoring the recent 1-day spike in July) and values the company at 8.5x 2019 earnings, while the company itself was trading at only 4x earnings in Dec'19. So the offer reflects the recent cloud computing hype in China (cloud computing ETF is almost 2x since Dec'19) and looks quite fair.
2. There is a sound strategic rationale and the offer itself looks credible. It doesn't look like the buyer will withdraw the proposal. The main business of 8236.HK is various server and IT related solutions. China is currently pushing the development of 5G/AI, which provides an opportunity for the company to seize the market:
To hedge against the epidemic impact on the economy, the Political Bureau of the Central Committee formally proposed to speed up the construction progress of new infrastructure such as 5G network and data center in March, so as to vigorously promote the industry informatization such as smart government administration, smart transportation, smart medical care and smart grid. ITAI industry is under large-scale development in China.
The company wants to jump on this train, is now applying for various research/development project funding and qualification accreditations. It specifically intends to expand its services in the strictly regulated industries such as military, IT application innovation, etc. However, under PRC law, companies that are more than 20% owned by foreigners are restricted from participating in the aforementioned industries:
according to the relevant PRC regulations (i.e. ‘‘武器裝備科研生產單位保密資格認定辦法’’), the foreign shareholding (for this purpose, foreign shareholding includes that of a shareholder from Hong Kong, Macau and Taiwan) of the regulated suppliers must not include (i) any direct foreign shareholding; or (ii) an indirect foreign shareholding exceeding 20% of its issued share capital. As the Group is not able to comply with the above regulation, the Group is LETTER FROM THE INDEPENDENT FINANCIAL ADVISER – 15 – prohibited from obtaining the relevant licence and hence cannot directly sell products to these specific clients. In order for the Group to transact with the PRC’s military force and military industrial technology research institutes
Up till now 8236.HK was providing its services (service hardware and software products) via another company of the Powerleader group - Powerleader Network Security (private). 8236.HK sells its products to Powerleader Network, which re-sells it to the military clients:
The clients of the Group for server hardware and operating systems include the military force and military industrial technology research institutes. The Group does not possess the necessary qualifications to directly sell products to the clients concerned, while Powerleader Network Security possesses the necessary qualifications. The server hardware and operating systems can only be sold through Powerleader Network Security to the clients with military background.
The delisting of H shares would allow the company to sell into the military and IT innovation industries directly without transactions through intermediaries and also save the costs of being listed in HK. Also, the management argues that there is no reason to stay public (never has and doesn't intend to raise equity), while delisting would allow it to focus on longer-term goals rather than the share price.
3. Although the information on H class shareholders is limited, it seems that so far the majority of H shares have been actively supporting the management decisions and participation in the military industry. In the recent vote (3rd Nov) to approve historical co-operation transactions (server hardware, software sales) with Powerleader Network Security (needed according to HK exchange rules), 55% of the total H shares have voted in favor and 0% voted against. Similarly in September's meeting to vote for certain Powerleader Group intercompany cooperation agreements - 57% of H shares were voting and 0% of the votes were cast against.
4. The downside appears to be limited as shares are currently trading slightly below the pre-announcement price (HK$3.62/share. Q3 results showed a bit larger impact from COVID-19 on the company's main business segment than the H1 results.
Powerleader Science & Technology Group
The company is a cloud computing solutions provider in the PRC. It's main segment is server and storage solutions (91% of revenues in 2019) - provides server (hardware, software) and artificial intelligence (intelligent computing products) for various sectors including military, universities, internet companies, finance, medical and etc. With the surge of big data, AI, blockchain, and 5G infrastructure the company expects that the demand for servers and cloud computing will continue to grow.
The company saw a rather minor impact from COVID-19. H1 operating revenues were actually 6% higher YoY, however, the main impact of the pandemic was taken by the company's server, storage and solution segment (down by 6% YoY). Q3 showed a bit larger impact - total operating income decreased 10% YoY, while server, storage segment fell by 17%. The company explained that in Q3 most server market activities went back to normal and Q4 results are expected to show an improvement.
75% of the total share capital is domestic shares and 25% is H shares. Powerleader Investment holds 56% of domestic shares and 42% of total share capital. Powerleader Investment is owned by Powerleader Asset Management (engaged in equity investments), which is controlled by (husband and wife) - Li Ruijie (vice-chair of 8236.HK) and Zhang Yunxia (chair of 8236.HK).
Shenzen Speed Top
Speed top was engaged in the resale of server room, server racks, and bandwidth, provision of cloud services and content delivery networks, etc. It is stated that the company did not conduct any business since July 2020.
66.5% of Speed Top is owned by Powerleader Investments and 3.5% by Ms. Zhang.