Small investors pay price for oblivious management

The world was turned upside down in September. Investment banks collapsed, and stocks, property and commodities dived from historic peaks. And there is not even a chink of light at the end of the tunnel yet. But some people apparently have no idea that all this occurred, especially when they negotiate purchases from their controlling shareholders. The case I am referring to is China BlueChemical's acquisition of a phosphate mine and phosphate fertiliser plant. I am writing this not because I own a few shares in it but in the belief that there will be more such incidents to come. On December 13, BlueChem announced that it would buy Dayukou Chemical and ZHJ Mining from its parent CNOOC Group for 1.26 billion yuan (HK$1.43 billion), in order to broaden its urea-based business. It said the price was based on the valuation of Beijing Pan-China Assets Appraisal. Dayukou's sales and net profit grew 57.9 and 224 per cent, respectively, in 2007. Its latest unaudited sales and profit also recorded handsome growth. Sounds fair? Wait. Both the asset appraisal and unaudited results were dated June 30 last year. And a quick Google search will tell you the international and domestic fertiliser market turned from heaven to hell from September onwards. The price of di-ammonium phosphate (DAP) and mono-ammonium phosphate (MAP), major products of the target companies, experienced a non-stop rally in the past two years that reached its peak in September. The financial tsunami changed everything. According to mainland industry websites, domestic DAP and MAP prices fell 33 and 53 per cent, respectively, between August and last month. Demand remains weak, and half of the domestic production capacity has closed down. Did the management take any of these facts into account in doing the purchase and in accepting the valuation of Pan-China? If so, on what basis did they accept it? Is it because they believe the mainland appraisal house was insightful enough to have foreseen the dramatic reverse in market conditions three months later in estimating the future cash flow of the target companies? Or is it simply because the listing rules accept asset appraisal reports and audited results that are no more than six months old? In short, legally and technically, BlueChem's management is safe. The company has made no mention of the deterioration in the fertiliser market in the past months. Neither is there any answer to the above questions. How has the market deterioration affected the valuation of the assets? I don't have the figures. But I will refer you to a rare and interesting paragraph in a property valuation report prepared by Jones Lang LaSalle Sallmanns for the company. In the report dated October 31 last year, Jones Lang LaSalle valued the factories and related land at about 483 million yuan. But at the end it said: 'The continued turmoil and instability in the financial markets is continuing to cause volatility and uncertainty in the world's capital markets and real estate markets ... As a result there is less certainty with regard to valuations, with the result that market values can change rapidly in the current market conditions ... We would recommend that users of this report seek our latest opinion on the market for their real estate decisions.' If Jones Lang LaSalle includes this disclaimer-like paragraph in its two-month-old report, I wonder how much justification a responsible management can claim from a six-month-old one given the turmoil we are going through. Some people will argue that good businessmen take risks. Some will add that getting updated reports can take several months. Then there are the months that will be needed in renegotiation and in getting approval from the state asset manager. I would never underestimate the pain in getting all the official chops on the mainland. Neither am I anti-business. It's all about fairness. We are now in a buyers' market. Would it be too much or too difficult for the seller, CNOOC Group, to provide an adjustment clause that commits a partial return of the consideration should the profit of the two companies fail to reach a target level? This is a fair alternative to the provision of updated valuation and renegotiation of price when the future remains uncertain. But the BlueChem management did not get one. Of course, the management would argue that the independent financial adviser finds the price they paid in line with the trading average of comparable stocks in Shanghai and Hong Kong. Well, that would not be too difficult a case to make, given the low free flow and distorted valuation of the A-share market. This is a case of how standard rules and regulation have fallen short of shareholders' protection in a time of unprecedented turmoil. It will not be the last such case, given that many majority shareholders got burnt in the latest market crash and are starved of cash. My advice? Do your own research, rely no more on the company circular and keep your fingers crossed.