Treasure Hunting Reverse Mergers and Acquisitions
The recent anticipation of reverse mergers and acquisitions (M&A) caused the prices soar of Celestial Asia Securities Holdings (CASH) series stocks, namely CASH Financial Services Group Limited (CFSG) 時富金融服務集團 (00510.HK) [up 42.67% on 2012-09-19] and Net2Gather (China) Holdings Limited 網融(中國) (01049.HK)* [up 38.89% on 2012-09-19]. Tracing back a few months ago, another similar case happened. Vanke Property (Hong Kong) Company Limited, a wholly owned subsidiary of China Vanke Company Limited 萬科企業股份有限公司 and Wing Tai Properties Limited 永泰地產 (00369.HK) entered into an agreement on 13 May 2012 such that Vanke would use HK$1,079 million to acquire 73.91% of the total issued shares of Winsor Properties Holdings Limited 南聯地產控股 (01036.HK) from Wing Tai.
Seeing such a trend of China private companies to get publicly listed on Hong Kong Stock Exchange (HKSE) through this shortcut (reverse M&A), some individual investors began to rush for shell stocks (underlying companies are no longer actively involved in business) or stocks that were deemed to be qualified for reverse M&A, looking forward to getting more than 100% return after the takeover, despite the little (or negative) company profit and low liquidity of most of these stocks. It seems to be no difference from playing with fire since quite often those investors/speculators have to deal with thinly traded as well as highly volatile penny stocks.
For almost all cases, patience is required because only God and insiders know when the M&A will take place. In other words, opportunity costs can be pretty high! Even worse, some of the shell companies would probably perform reverse stock splits and then issue rights at a huge discount. UL CREATIVITY 無限創意控股 (08079.HK) is a real world example of such corporate actions. This is actually a tactic adopted by shell companies to dilute the shares of existing investors and deter new individual investors from purchasing the shares.
Anyways if we are clear about the risks behind speculating shell stocks, here are some common characteristics (not rules!) of shell stocks:
- Simple business nature of the companies (easy to be understood by acquirers)
- Business at the mature phase of the business life cycle
- Big discount on the stock prices compared with the corresponding companies’ net asset values (NAV)
- Low debt ratios (No acquirer would like to repay debts for the acquiring companies)
- Huge portions of shares owned by major shareholders so as to make things more controllable and to reduce any uncertainty caused by other shareholders (This is one reason why most shell stocks are very illiquid)
Lastly, it is preferable to pick stocks that pay a substantial amount of dividends regularly (see our earlier post “On Dividends”) in order to compensate:
- liquidity risk because of low turnover and large bid-ask spread, and
- opportunity costs since this “Treasure Hunt Game” can take years (or forever).
* In early September 2012, the company proposed to change the name to “Celestial Asia Securities Holdings Limited 時富投資集團有限公司”.
Image Source: http://www.devon.gov.uk