Shell planter's guide to making a killing on the stock market

PUBLISHED : Saturday, 22 January, 2011, 12:00am
UPDATED : Saturday, 22 January, 2011, 12:00am

Ever heard of a job called the shell planter? No, these aren't people who grow mussels, oysters or pearls. Instead, they plant 'listed shell companies' in the stock market.

It is not a tiny business; the returns are in the hundreds of millions of dollars.

Thanks to the strong desire by mainland corporates to list in Hong Kong, a 'clean' shell company with zero liabilities can now easily fetch HK$300 million, up from HK$50 million in the mid-90s.

'Below that number, no one will pick up the phone,' said an insider. Even a shell on the much-less-liquid GEM board is priced at around HK$100 million.

Private entrepreneurs up north want a shell for various reasons. It can help obscure the ownership of a firm that may involve government officials; it can hide fishy invoices or a huge unpaid tax bill, either of which could not face the microscopic examination involved in a formal listing; or it can be for those who hate all the regulatory hassle in listing.

One simply buys a shell and then injects the business. Various prominent entrepreneurs have chosen this alternative. Among them is Wong Kwong-yu and his Gome Electrical empire.

Another beauty of owning a shell is that while the owner is looking for a good buyer and good price, he or she can enjoy the 'rent', as insiders call it. It's simple. A mainland punter pays the owner the rent, accumulates some shares, announces an asset injection into the shell, sells the shares when they rise and then calls off the injection for 'technical reasons'.

'We are talking about two to three times return in two years,' said another banker.

But there aren't many shells around. It's too troublesome to make a shell from a debt-ridden company. Planting a shell from scratch is a better alternative.

One needs a decent amount of seed money, an excellent understanding of the rules and good connections. It is, therefore, not surprising that most of the shell planters are former investment bankers with many accountant and lawyer friends.

So how is it done? After reading about two real cases - one on the main board and one on the GEM board - I will try to show you the craft in the form of a 'semi-documentary'. For obvious reasons, names, numbers and dates are made up.

Paul X started his watch-trading firm with three partners two decades ago. In really good years, it churned out about HK$10 million in profits. But the four all knew they'd seen the best times. They wanted to get out but demand was sluggish.

In late 2008, a family friend brought X to a shell planter. He was promised a fortune within 18 months by turning the watch firm into a listed shell. X could not believe his ears. To him, the business was old and rusty.

To the shell planter, it was a pot of gold: first, the watch business was simple. It involved little know-how and capital. And it could be easily maintained at a very low cost.

Potential buyers loved that because the regulators had tightened the rules and barred shell companies from getting any asset injections within 24 months of any ownership change. During that period, the watch-trading business would save the listed shell from turning into a 'cash company' - which really has no business and would have to be de-listed under the rules.

Second, it had no factories. Fixed-asset valuation and disposal can be troublesome and unwelcome chores to a potential purchaser. Third, it had no bank loans or hidden liabilities.

Fourth, the four partners controlled 100 per cent of the business and wanted out simultaneously. Mainland buyers are terrified by the Grand Field fiasco, in which a fight between the shell buyer and remaining shareholders resulted in a two-year trading suspension. Potential buyers now look for a shell where they have absolute control.

X jumped at the deal. So did his partners. Within days, a team of professionals marched into his office to prepare for a public offering. He was told to hire one of them as the financial controller.

In June 2009, the public offer was launched with a fund-raising of HK$100 million. By selling some old shares, X and his partners pocketed half of that. The other half went to the company.

Let's call that the first instalment to the founding shareholders. That's pretty standard. Other forms include share sales to an 'independent' party to pay off shareholders' loans or a pre-IPO dividend.

Though lots of touch-up was done to the books, X did wonder who would buy into a business with few prospects or barriers to entry. But he was told not to ask. Somehow, the money did arrive and he even read about oversubscriptions in the newspaper.

'That is not at all a surprise,' said a hedge fund manager. 'There have been offers of 10 per cent guaranteed returns if you agree to bet no less than HK$200,000 on a particular IPO via some specific private banks.'

As if magic was at work, the share price of X's firm went up 12 per cent in the first week and a significant share of its public float changed hands. But from then on the stock headed south.

In January 2010, the company issued a profit warning and its share price plummeted to less than two-thirds of its IPO price. Nobody wanted it except the informed ones.

Seven months later, the company announced that X and his partners had agreed to sell their 75 per cent control to an investment house for HK$120 million.

To the outsiders, that was surprisingly low, given the company was sitting on HK$90 million in cash and the offer price per share was only two-thirds of the market price. To X, that was part of the original deal.

The investment firm then made a general offer to the remaining shareholders and, not surprisingly, only a few accepted it.

Within two months, the shell planter had taken majority control of the company. X and his partners got the second instalment, which was, of course, much less than the HK$120 million official price tag.

So, next time when you have the leisure to read through a prospectus and wonder who will buy into this piece of rubbish, you know a shell planter is at work.