Don your sleuth's hat to enter Huishan's prospectus maze
After combing the fine print to work out who is selling down – and what they will make – in dairy producer's float, unsettling questions remain
A listing prospectus is usually not the most readable of documents, whether intentionally or not. The one prepared by three big securities houses for mainland dairy producer China Huishan Dairy Holdings is a classic.
The document, which was published a month after the Hong Kong exchange issued a guidance letter requiring prospectuses to be more user-friendly, provides no straight answer to a very fundamental question: who is selling what?
Just think of a listing in which the controlling shareholders are cashing out. How much confidence do they have in the company's future?
That's particularly important in assessing a company that has a short history like Huishan. It began operation in 2009 and profit numbers were largely distorted by "biological asset fair value change" - meaning the value of the cows and grass.
Let's walk through the maze. On the cover of the prospectus, the company says it selling 2,534 million new shares and 874 million old shares. So some existing shareholders will pocket a quarter of the money raised.
The summary provides no clue as to who they are, but says the company will get HK$6.9 billion. Some "selling shareholders" would receive HK$2.1 billion and the "selling shareholders and option grantors" would gain HK$3.5 billion "pursuant to the over-allotment option".
Calculations indicate that the existing shareholders will be selling 568 million shares more than Huishan said on the prospectus cover, and pocket 45 per cent of the offering. The underwriting agreement, 250 pages in, sheds some light. The existing shareholders enjoy an "over-allotment option" if institutional investors oversubscribed for its shares. Instead of the firm issuing more shares to satisfy demand, as in most other IPOs, the "selling shareholders and option grantors" will unload their stakes. Still, it doesn't say who they are.
Under the "substantial shareholders" section, it says the company's founder and controlling shareholder Yang Kai will sell down from 67.4 per cent to 49.73 per cent. Hong Kong tycoon Cheng Yu-tung is also cutting his stake in Huishan, from 15.72 per cent to 11.58 per cent. Yet, the numbers don't add up; the list is incomplete.
You turn to the last resort - the definitions section - and find the names of four companies that give no hint as to their owners. Unless your memory is so good that you remember seeing the names in the summary section, that's very much the end of your fact hunting if you have no internet access - even though the prospectus runs to almost 490 pages. But if you download the prospectus and search for the companies, one by one, you come back to the summary section, which points to the "History and Corporate Structure" section. (Doesn't sound likely, right? Unfortunately, it is.)
It said Cheng lent Huishan US$170 million in 2011 in return for 4 per cent annual interest and a 15.72 per cent stake upon listing.
Four investors - Jiangsu tycoon Zan Shengda; Huishan's financial adviser Investec; mainland investor Zhao Xiaohong and Hong Kong businessman Cheung Wing-hong - struck a similar deal with a total loan of US$120 million. They are getting the stake at a juicy 68 to 70 per cent discount to the IPO price. There is also a Swiss infant milk producer, Hero, which sold Huishan a factory in return for its 6.5 per cent stake.
Joining the dots, two things become apparent. First, Cheng, Zhao, Cheung and Hero will sell some of their shares in the public offering. Second, if the share sale is oversubscribed, the four will unload further. Investec and Zan will sell, too.
To know exactly how much they are selling and to calculate their profit, you will have to read the fine print in the Appendix, under "statutory and general information". (Yes, no one will go there. Your columnist was directed there by the search key.)
Lost? The professionals advising Huishan have done a great job. (Or your columnist has done a poor one.)
But the details matter. Cheng Yu-tung's case is most telling. From the details, one can work out that the tycoon, whose backing is one of the key attractions in this IPO, will have largely recouped his loan upon the listing.
Given the strong demand for the deal, there is a good chance that the over-allotment option will be exercised. Cheng will unload 380 million shares, cutting his stake in Huishan from 15.72 per cent to 9.91 per cent. At the top of the price range, at HK$2.67, he would cash out with HK$1.01 billion.
Together with the 4 per cent annual interest he is charging, Cheng will get back HK$1.13 billion, or 85 per cent of his loan. Similarly, other investors will have covered more than 80 per cent of their cost.
As long as the company doesn't go bust, any future share sale by Cheng and the other four backers will be mainly profit. What incentive do they have to push the company on performance? By the way, their right to appoint two directors and the chief financial officer of Huishan will expire upon the listing.