It has been a little more than a year since we set up stockresearchasia.com in early 2015 to provide Asia based investors with proprietary stock research. While we did not envision it at the beginning, 2015 has turned out on hindsight to be a tricky year for investors to navigate in Asian equity markets. And 2016, for now at least, has proven to be far worse. Many Asian markets have plunged in tandem with the global markets to levels last seen in 2012 or earlier, led by China and exacerbated by an oil price collapse. It is hard to predict when the malaise would end except it inevitably will. As Herb Stein famously remarked and we agree, “If something cannot go on forever, it will stop.” In the meantime, we should see the market throw up good buying opportunities, ones that we hopefully can continue to exploit to our advantage.

It is against this backdrop that we are proud to say that our calls in the last year or so have mostly been spot on.  To recap, we have made outright recommendations on six stocks, five listed on SGX (Memstar, Chuan Hup, PCRD, MILF, IPC) and one on Bursa (Abric). We have also, when deemed fit, made a few situational analyses (Falcon Energy, Kejuruteraan Samudra Timur, Tiger Airways), giving investors some insights into ongoing corporate actions or potential strategic options from a corporate finance perspective.

Performance of our picks

Overall, our recommendations have outperformed the benchmark indices on an absolute basis by an average of 23% as at 31 December 2015. The outperformance would have been more pronounced if annualised but we see the computation of such data misleading and academic in nature at best. The 5 buy recommendations generated an average total return (including dividends) of 13.9%. This includes the short term arbitrage of MIIF where profits were locked in after just 2 weeks. Excluding MIIF, the buy recommendations generated average returns of 16.5%. Memstar, our lone sell recommendation, was down 55.0% as at end 2015 before getting suspended for being unable to complete its reverse takeover of Longmen Group, the transaction risk of which we have flagged out multiple times over the course of the year. 

A summary of our performance is presented below accompanied by key updates on selected companies that we have covered:

Figure 1. Our recommendations have outperformed benchmark indices by a significant margin

Abric Berhad- cash realised from impending delisting

Following a year during which Abric has failed to find a suitable acquisition opportunity for it to extend its Bursa listing, the company has announced on 18 January 2016 that it will be going ahead with a delisting exercise. In conjunction with the delisting exercise, the company has announced a cash distribution of RM0.43 per share (vs last traded price of RM 0.48), which we estimate is roughly equal to its cash holdings less all liabilities as at September 2015 on a fully diluted basis. This does not include the approximately RM0.07 cash it was due to receive 12 months after the completion of disposal in December 2014 (i.e. December 2015).

As Abric has already announced its decision to dispose of its remaining assets and voluntarily wind-up, shareholders are expected to be entitled to a further cash distribution post delisting. We think that shareholders should also be able to realise an eventual amount close to the Company’s NAV of RM0.64 per share. With a finely balanced shareholding structure (controlling Ong family owns 35%, super minority Pui Cheng Wui 23% and others 42%, fully diluted assuming full conversion of warrants), minority shareholders can also take heart that their interests should be fairly taken care of post delisting. 

Memstar Technology- RTO woes not over

Memstar’s troubles in trying to complete the acquisition of Longmen Group continues unabated. In our previous report, we questioned Memstar’s over optimistic valuation of the target, then valued at US$420 million. Following the umpteenth supplemental agreement, the acquisition price has been revised downwards first to US$323 million in July, then to US$200 million in December, translating into an eye-popping 52.4% in reduction in value in less than a year! This is accompanied by a loosening in the conditions precedent of the acquisition particularly those pertaining to the Target group’s fund raising obligations. However, given the difficult current market conditions, we are still not optimistic that the conditions can be met even with the significantly lowered bar. And to add to shareholders’ woes, Memstar has suspended trading of its shares yet again on 6 January 2016. 

The only silver lining in all these is in SGX’s decision to grant the Memstar additional time (until end May 2016) to complete the acquisition. We can only hope that Memstar shareholders have taken heed of our multiple warnings and disposed of their holdings in time.

Chuan Hup Holdings- hit mainly by FX losses

When we first recommended Chuan Hup, it was on the back of its extremely robust balance sheet, under-appreciated assets and the possibility of a bumper dividend arising from its disposal of CHO shares to Falcon Energy. While Chuan Hup’s financial strength and asset backing have remained largely unchanged, we were disappointed in the board’s decision not to reward its shareholders with a bigger payout. It did announce and pay a total dividend of 3 cts though for its financial year ending 30 June 2015, representing a yield of almost 10% of the prevailing price when our report was first posted.

Results wise, Chuan Hup continues to be hit by the effects of a strengthening US dollar against both SGD and AUD even if its units’ underlying businesses have not deteriorated as much. PCI, its SGX listed electronics manufacturing arm, for example, recorded a 62% plunge in its latest 1Q16 profit after tax from US$1.6 million to US$0.6 million, largely due to a US$1.5 million foreign exchange loss (vs +US$0.1mil the year before). Strip that out and adjusting for mark-to-market profits/losses and the core profit would have remained almost the same as the 1Q15’s. Similarly, a US$6.1 million hit from foreign exchange losses was the main culprit for Chuan Hup reporting a loss of US$3.9 million for 1Q16 vs a profit of US$3.0 million in 1Q15.

For its joint venture property development projects in Australia, the results have been mixed. Toccata, which has been completed is almost fully sold. We estimate that only 10-15% of the sales have yet to be recognised. Meanwhile, Concerto, the largest of the 3 projects by development value, has sold an additional 50 units over the past 11 months to achieve 68% in total sales. With completion due only in 2017, we believe there is still enough time for the JV to ramp up sales to 80-85% or more, similar to what Toccata achieved at its completion. Sales in Unison on Tenth, however, has made little progress in the last few months in particular and 48% of its units remain unsold despite the fast approaching completion deadline. That said, as we have stressed in our previous report, we do not expect any negative cashflow impact from these projects as Chuan Hup’s main obligations in these is in injecting the land while Finbar contributed the working capital. 

Figure 2. Sales performance of Chuan Hup’s JV development projects have been mixed

As at the latest balance sheet date of 30 September 2015, we estimate that Chuan Hup still holds, after accounting for dividends paid after, adjusted net cash and short term securities worth S$0.194 per share or almost 73% of its last traded price of S$0.265, which should provide a strong buffer against the current market volatilities. 

Pacific Century Regional Development- delisting imminent if share buybacks continue

Since our report highlighting PCRD’s aggressive share buybacks and suggesting that this may be a prelude to majority shareholder Richard Li potentially privatising the company, PCRD has not shown any intent to restrain its share buyback activities. In the past 9 months, the company has acquired a further 89.1 million shares, shrinking the public float to a precariously low 10.2%. We estimate that the company can only acquire and cancel a further 5.1 million shares before its trading has to be halted pending a delisting decision to be made.

Figure 3. Aggressive share buyback from PCRD has shrunk public float precariously close to 10% threshold

To recap a point made in our update report on 5 May 2015:

“Under the current regulatory regime, there are a few ways that PCRD's privatisation could take place: through a general offer, a scheme of arrangement, a voluntary delisting or a forced delisting by SGX due to low free float (<10%) coupled with an exit offer. Based on current circumstances, we see the last two as the most likely options. Both would require a reasonable exit offer to be tabled and the appointment of an independent financial adviser ("IFA") to opine on the fairness of the offer as stipulated in the SGX listing rules. We note that IFAs tend to benchmark fair value of a company's shares to the market prices of its underlying assets where such values are available as in the case of PCRD. As such, we do not expect any exit offer, if it materialises, to deviate greatly from the fair value computed using this methodology in order to obtain a positive recommendation from the IFA.”

Figure 4. PCRD’s key underlying assets, HKT and PCCW, are up 6.9% and 3.5% respectively in the last 3 months and has held up well vs HSI, which declined 17% over the same period.

As at 22 January 2016, PCRD’s stakes in PCCW and HKT, both of which shares have held up well despite the recent market turmoil, is worth a total of S$0.61 per share. While it remains to be seen if the “reasonable” offer by Richard Li comes close to matching the market value of PCRD’s underlying assets in the event the mandatory delisting and exit offer is triggered, we believe that that any IFA appointed will use this as a benchmark to base its recommendation on. Richard Li would thus find it hard to justify offering an amount that is significantly less. With the shares trading at $0.37 as at 22 January 2016, we believe PCRD still has significant upside. 

Closing note

While our first year scorecard has certainly been encouraging, our focus is solely on longer term returns. In that regard, we do not expect our picks to be able to outperform the markets by such wide margins year in year out. However, we are confident that with a relentless focus on value and our core competencies, we would be able to generate a positive return on our picks relative to the market over the long run. 

Recap

As our readers would recall, we have made multiple warnings beginning from January 2015 (reports 1, 2 and 3) regarding what we see as unsubstantiated optimism over Memstar's proposed US$420 million RTO of Longmen Group Ltd ("Longmen"), a private developer of coal bed methane ("CBM") resources in Shaanxi Province, China. Over the course of the past 5 months, the proposed deal has seen the deadline for Longmen to satisfy its conditions precedent lapsed no less than three times, the last of which fell on 31 March 2015. 

In Memstar's last significant update released on 6 March 2015, it announced that it had gotten a conditional approval from SGX for a 6-month extension of time to meet the requirements for a new listing, i.e. from 11 April 2015 to 11 October 2015. 

However, on 6 April 2015, the Company suddenly suspended the trading of its stock and has since then remained largely silent over both developments on the proposed RTO and its own listing status. 

Our Views and Recommendations

The Company's lack of response so far has been disappointing. Given that the stock has been suspended for more than 2.5 months, we can only surmise that the Company had fallen short of the conditions imposed by SGX for its continued listing.

One can imagine the dismay and anguish that minority shareholders are currently going through over the uncertainty of their investments. We feel strongly that the Company owes it to these shareholders to provide an immediate update of the situation at the very least. Likewise, shareholders should consider taking a proactive approach to seek answers from the Company and its management.

This unfortunate episode should also serve as a warning to investors in other companies with similar profiles: cash companies, which may or may not have announced an RTO deal, with rapidly approaching deadlines for them to meet conditions to continue their listings and trading at levels far above the value of their net tangible assets including cash. Jaya Holdings Ltd and E2-Capital Holdings Ltd are two such companies that come to mind. While the situation with Memstar might not manifest itself with these two counters, investors would do well not to be overly optimistic when pricing in potential upside from RTO deals, especially when completion is far from certain. 

Events since last update on 10 February 2015 (link)

Memstar Technology Ltd announced on 6 March 2015 that it had entered into a 2nd supplemental agreement to extend fulfillment of key conditions precedent, that were supposed to have first been fulfilled by 31 January 2015 and then by 28 February 2015, to 31 March 2015. These conditions include Longmen Group Ltd (or "Target") successfully completing Tranche 2 Fundraising of US$15 million and the Target entering into an off-take agreement with Petro China and/or CNPC for the purchase of the Target’s coal bed methane.

Memstar also announced that it had successfully obtained a 6-months extension of time to meet the requirements for a new listing, i.e. from 11 April 2015 to 11 October 2015. The extension is, however, subject to the following conditions:

1. The submission to SGX of the Proposed RTO application of Longmen by 30 April 2015; and
2. Memstar providing quarterly updates of key milestones, via SGXNET, on its progress in completing the Proposed RTO by September 2015.

Our Views

The conditional extension granted by SGX effectively means that the latest extension of time by Memstar for Longmen to fulfill the conditions precedent may well be the final one. Should Longmen fail to meet these conditions precedent by 31 March 2015, Memstar is unlikely to be able to meet the conditions set by SGX to extend its own listing status to 11 October 2015.

Such a scenario would pose a major setback to existing shareholders as we have previously warned. Recall our estimates that the Company only has an NTA backing of S$0.003. In the event that it is forced to delist, shareholders would probably not be able to monetise their shares for much more than this amount.

As we have also highlighted previously, the valuation of Longmen appears rich compared to that of its larger LSE-listed competitor, Green Dragon Gas Ltd. The most ideal scenario for Memstar shareholders would therefore be for a cut-price deal to be negotiated and consummated with Longmen. However, given the dire  circumstances, a deal based on the current price is still better than none for shareholders. Indeed, Memstar may well choose to waive the existing conditions precedent just to push the deal through.

Share price of Memstar is $0.015 as per close of market on 17 March 2015, down 25% from $0.020 from our first report issued on 21 January 2015 warning investors that the price then was unjustified. (See chart below)

Recommendations

Even though the share price has declined to $0.015, where it was at before the RTO announcement, we would still caution investors to stay away given the uncertainties surrounding the deal and Memstar's own listing status. We do not discount any positive news or developments from the RTO giving a temporary boost to Memstar's share price. However, any potential gain has to be weighed against a likely loss of 80% in value (share price of S$0.015 vs S$0.003 NTA backing) should the deal fall through.

Events since our first report (link)

Trading in Memstar Technology Ltd was temporarily halted from 2 to 5 February 2015 in what must have been a nerve-wracking few days for its shareholders. 

Recall that in our previous report, we had highlighted risks relating to completion of the RTO, which is subject to a host of conditions. Two of the key conditions were supposed to have been met by 31 January 2015:  

1. the Target successfully completing Tranche 2 Fundraising of US$15 million; and  
2. the Target entering into an off-Take agreement with Petro China and/or CNPC for the purchase of the Target’s coal bed methane. 

The company subsequently announced on 5 February 2015 that it had entered into a supplemental agreement to extend the deadline for fulfilling the 2 conditions above to 28 February 2015. The shares have been trading within a range of $0.018-0.020 since our first report and last closed at $0.019 on 9 February 2015. See below:

Our Views

The extension of deadline highlights the non-completion risks shareholders face even as the clock is ticking on Memstar's own 11 April 2015 deadline to fulfill SGX continuing listing requirements. While SGX could possibly grant an extension for the RTO to complete, we reiterate that should it be aborted, the prospects of shareholders being able to extract any meaningful value out of their shares would be quite dim.  Even if the RTO is successfully completed, the implied market valuation of Longmen (representing the combined group) post completion at US$526 million looks rich compared to its much bigger competitor, Green Dragon. 

Updated comparison table:

Recommendations

At $0.019, the share price seems to have fully priced in certainty of deal completion. We still do not think this is justified given the multiple risks factors that might affect completion. Downside risks far outweigh any upside potential, if any at all. Investors should steer clear at this price. 

Memstar Technology Ltd has surged 33.3% in the last one month since announcing a reverse takeover ("RTO") on 20 December 2014 of Longmen Group Ltd ("Target"), a private developer of coal bed methane ("CBM") resources in Shaanxi Province, China. While the announcement may be a welcome boost to shareholders of Memstar given that it has only until 11 April 2015 to meet requirements to stay listed or be possibly forced into a delisting by SGX, we think that the surge is more speculative in nature and not backed by fundamentals. We see no reason for the shares to trade at the current price of S$0.020 pending further details on the acquisition.

Background

Memstar announced that it had entered into an agreement to acquire Longmen for US$420 million (S$546 million[1]) by issuing 33.81 billion consideration shares at S$0.01615 per share, a 7.7% premium to its closing price of S$0.015 on 28 November 2014, the last trading day before trading was temporarily halted pending the RTO announcement.

Longmen owns participating interests in 2 CBM concessions (collectively "Longmen Concessions"):

1. A 60% participating interest through a production sharing contract (PSC) entered into with China National Petroleum Corporation (CNPC) to explore, develop, produce and sell CBM gas covering 2 blocks of area in Hancheng, Shaanxi effective for 30 years from March 2007.
2. An 80% participating interest in a gas extraction agreement (GEA) with Hancheng Coal Mine Bureau for CBM extraction in 3 mines in Hancheng effective for 20 years from July 2008. Coal mining is currently ongoing in these mines with concurrent CBM production.

The Longmen concessions contain net 2P (Proved and Probable) CBM reserves of 190 billion cubic feet, with a present value of approximately US$917 million calculated using the standard 10% discount rate (otherwise known as a PV10 value, a common nomenclature for Oil and Gas reserves).

The Target is 50.43% owned by LESS Longmen Co Ltd, a fund of funds, with the remaining shareholders a collection of private equity funds and current and prior management.

The Target has been loss making for FY2011-13 and is in a net liability position of US$43.7 million largely due to existing liability and derivative tied to redeemable preference shares in issue of US$99.1 million in total.

The RTO is subject to, amongst other conditions, completion of 3 tranches of fund raising exercises at various stages:

• Tranche 1: Initial US$5 million refundable deposit, to be raised by Memstar and paid to Target, which carries a option to convert into Target shares at valuation of US$210 million. (Tranche 1 has been completed on 6 January 2015)
• Tranche 2: US$15 million to be raised by Target on or before 31 January 2015
• Tranche 3: US$60 million to be raised by Memstar on or before completion of RTO
  

Our Views

At the current price of S$0.020 per share, Memstar has a market capitalisation of  S$61.1 million taking into account new shares that were issued pursuant to the Tranche 1 placement. This is backed by an NTA of just S$9.2 million comprising the S$6.6 million refundable deposit paid to Target with the remaining in cash.

Completion of the transaction is far from certain and subject to a host of conditions including further fund raising exercises to be completed and Target being able to successfully procure all exploration rights to be renewed for maximum possible term.

As we have noted before, RTOs historically do not enjoy high completion rates (see here). This is also the second attempt by Longmen to list on SGX after having previously failed to reach agreement on terms following a non-binding MOU signed with PSL Holdings Ltd back in 14 May 2014. The exclusivity for the MOU lapsed on 13 October 2014 and a similar refundable deposit of US$5 million has since been returned to PSL.

Memstar has been classified as a cash company under SGX listing rules since 11 April 2014 and has just until 11 April 2015 to meet SGX requirements to continue to be listed. Should the transaction be aborted for whatever reasons, there is likely to be insufficient time for Memstar to seek another target to maintain its listing status and shareholders will be left with a company that has little assets other than cash of just S$0.003 per share vs the current price of S$0.020!

Further, we note that the main reason for the current optimism could lie in the Target's reported 2P reserves of 190 billion cubic feet with a PV10 value of US$917 million. Investors should, however, put this into perspective against the following:

• The PV10 value was computed based on a report dated 31 December 2013. Although CBM prices usually trade at a slight premium to conventional natural gas prices, there is nonetheless a strong correlation between the two. As natural gas prices has softened considerably in the last one year[2],[3], there is a risk that the reported PV10 value using CBM price assumptions then may be on the high side. That said, possible mitigation to this risk could come from increased Chinese government subsidy. 
• The Longmen Concessions are largely still at the pre-production stage. Although the GEA covers an area which is currently in production, it is not a significant revenue contributor as yet as witnessed by Longmen Group's paltry revenues of US$0.5 million for FY13 and just US$2.6 million on average for the last 3 FYs.
• Under the PSC, there are two main blocks: a north block covering 234.3 sq km, which is still in exploration stage and largely inactive, and a south block covering 171.8 sq km, for which exploration has been completed and full-scale commercial production is planned for early 2016. There is likely to be significant capital expenditures required in order to bring both blocks under the PSC to full commercial production and contribute to the bottom line.
• Longmen's much larger competitor, LSE-listed Green Dragon Gas (Bloomberg code GDG:LN) has, as at November 2014, 2P reserves of 380 billion cubic feet with a PV10 of US$3.1 billion and 6 PSCs covering 7,566 sq km. Green Dragon currently has a market capitalisation of US$852 million (GBP 562 million) and Enterprise Value of US$872 million. 
• Comparing the two, Longmen’s valuation appears excessively rich:

Recommendation

While the RTO is a potential lifeline for Memstar shareholders who might otherwise be faced with the unwelcome prospect of a forced delisting by SGX come 11 April 2015, investors should be cognisant of the significant downside risks posed in the event the deal is aborted. Even if the RTO is completed successfully, the current price of S$0.020 per share is unjustified based on currently available information and on valuation grounds. We see no reason for it to be trading at such lofty levels.