Tianmei Beverage Group Corporation Limited

Overview

Tianmei Beverage Group Corporation Limited is a Chinese company based in Guangzhou with two arms to the business. The first is as a distributor and promoter of packaged food products, placing different suppliers’ goods at convenience stores and supermarkets. The second is a bottled water company that sells water produced by a Chinese water processing plant they have a contract with. They are using the Prospectus to raise 10 million dollars, selling 25% of the company in the process. The money will be used to buy the water bottling plant they currently source their water from and to start importing Australian food products to China and promoting it at their contracted stores.

Valuation

From a pure valuation perspective, Tianmei China is a fantastic deal. According to the Prospectus they made a profit of over 4.3 million dollars in the first half of 2016, and the IPO values the company at 34 million, meaning the Price to Earnings (P/E) ratio is well under five if you annualised those earnings. On top of this, both arms of the business are in massive growth areas: The bottled water market in China has seen double digit annual growth due to pollution concerns and the growth in demand for Australian food and health products in China has been astronomical. You can see this in the impressive premiums that the market places on any Australian company that is exposed to Chinese consumers: Bellamy’s was trading at a P/E of 40 a little while ago, and even after sacking their CEO and concerns about their accounting, the share price has only shrunk to a P/E of 10. The A2 Milk company is trading at a massive P/E ratio of 68 and Blackmores is trading at a P/E of 20 largely thanks to growth potential in China.

It’s basically impossible to come up with a valuation that isn’t higher than Tianmei’s listing price using a discounted cash flow analysis. Even if you put a ridiculously high discount rate of 20% and assume a conservative growth rate of 6% for the next 8 years before levelling off to 1%, you still end up with a company value of over $40 million. The way I see it then, if you are evaluating this stock, investigating the exact growth rate of the bottled water market or Chinese supermarket conditions is a waste of time, as whatever you come up with is going to show the stock is a good buy. Instead, the simple question for any potential investor is can we trust this company? As a relatively unknown company operating in a country that doesn’t exactly have a spotless reputation for good corporate governance, it is hard not to be suspicious. The story they are selling through their accounts is one that anyone would want to invest in. The question is, is this story true?

Personnel

According to John Hempton, a role model of mine and someone who inspired me to start this blog, the best way to find out if a company is dodgy is to look at the history of the key management personnel. Hempton’s hedge fund Bronte Capital does just that, following people who they believe have been involved with companies that were fraudulent for potential targets to short sell.

http://www.theaustralian.com.au/business/the-deal-magazine/bronte-capitals-john-hempton-sniffs-out-corporate-frauds-and-shorts-them/news-story/9a836e4a83124b0e079accbbc285e3d4

Unfortunately, it’s hard to find nearly any English information on most of the key people in the company and I don’t speak Mandarin, so the only person I can really look into is the chairman, an Australian guy called Tony Sherlock. Tony Sherlock has been around for a long time in the M & A and finance world. He was the chairman of Australian Wool Corporation, worked at PWC in the risk division for ten years and co-founded Bennelong capital, a boutique corporate advisory firm. Judging by his Linkedin profile he looks like he is in his late sixties at the youngest, as he finished a Bachelor of Economics in 1969. Would a guy nearing the end of a successful career working risk his reputation promoting a company that wasn’t above board? It seems unlikely. He’s built up a solid reputation for himself over the years and it would be strange for him to risk it that late in his career. Of course nothing is certain, and it’s possible he’s got some secret gambling condition that makes him desperate for cash or simply doesn’t know that the company is fraudulent, but overall it seems like a positive sign that he is the Chairman.

History

One of the initial things that made me suspicious of Tianmei is its age, as according to the prospectus the company only started in 2013. Trying to unpick the exact history of Tianmei China is a painstaking undertaking, as there are a ridiculous amount of holding companies that have been created along with business name changes. As far as I can understand it though, it looks like the Tianmei business was created in 2013 by Guangdong Gewang, a Guangzhou based business started in 2010 that sells supplements of selenium, a chemical element that Guangdong Gewang claim is vital to human health. While I was initially suspicious of a company selling a supplement that I’d never heard of, after doing some research it actually looks legitimate. Although selenium deficiency is very rare in the West, apparently it is a problem in some parts of China due to crops being grown in selenium deficient soil. During a restructure in 2015 Guangdong Gewang separated the selenium supplement business from the water and FMCG businesses, and as a result created Tianmei. Interestingly enough, Guangdong Gewang is applying for admission to the Nasdaq for their own IPO currently. Guangdong Gewang still hold 22.5% of Tianmei through Biotechnlogy Holding Ltd, a company incorporated in the British Virgin Islands. (Both these companies seem to have a real love of the British Virgin Islands, Tianmei’s ownership also is funnelled through a British Virgin Islands company.) While the history isn’t exactly stable, there are no obvious red flags I could find to turn me off investing in Tianmei.

Ownership

One of the things I like about this IPO is that the initial listing at least isn’t just a way for the owners to cash in. As a jaded, though still cautious believer in the theoretical benefits of capitalism, it’s nice to see an IPO doing what a stock market is meant to do; allocating capital to a business that wants to grow.

A strange thing about the ownership structure is that the equal largest shareholder with 22.5% ownership is a woman called Han Xu, an Executive Director who from her photo looks to be in her mid-twenties. How does someone who finished their bachelor’s degree in 2011 and a Masters of International Finance in 2013, afford 7.2 million dollars’ worth of shares in the company? Perhaps a more basic question is how can someone who left university three years ago and never studied law end up as the ‘legal expert’ and executive director of a soon to be publicly listed entity, when fully qualified lawyers of her age are still working 70 hour weeks as Junior Associates? The most obvious explanation would be she is the daughter of someone important. After doing some digging around I found that one of the co-founders of the original Selenium supplement company was a guy called Wei Xu. While I don’t know how common the Xu last name is in China, it seems reasonable to assume that they could be related.

Is this potential Nepotism enough to be a concern? I don’t really think so. While she might not be the most qualified person for the job, If anything it’s reassuring that the co-founders of the company are maintaining their holdings. The third largest shareholder of Tianmei is a guy called Mengdi Zhang, whose father Shili Zhang was another initial co-founder of the Selenium business according to Guangdong Gewang’s filings for their Nasdaq IPO.

Verdict

Overall I think this looks to be a pretty good IPO. While of course there are always risks with investing in a company this young and especially one operating in a foreign country, the price is low enough to make it worthwhile. It seems the listing is about both raising capital as well as creating a link with Australia so they can start importing Australian foods, which perhaps explains why they have listed at such a low price; the benefits for them isn’t just the capital they intend to raise. If the market gains confidence that Tianmei is legitimate, the company could well double its market capitalization in the next 12 months and I will definitely be along for the ride. 

Eildon Capital

Overview

Eildon Capital is currently a subsidiary of the publicly listed investment company CVC Limited.  The company focuses on high yield debt and investments in the property sector. They plan to raise between 2 and 10 million dollars via the IPO, with a market capitalisation on completion between 24 and 32 million. In the prospectus, they state that their goal for debt yields on property are between 12 and 18 percent before management fees and taxes. As a Mezzanine finance company, security on these loans will usually be equity in the ventures themselves.

There’s a lot of things to like about this prospectus; an experienced and stable management team, a good track record and at least on the surface a reasonable price, with every one dollars’ worth of shares bought giving you $1.01 of net assets in the newly created company. I’ve got a few misgivings though, and there are three main reasons I won’t be taking part.

The property sector 

As a long term believer in the idea that the housing market is overdue a downward correction, it’s hard to think of who would be more exposed to this than a company specialising in high yield property development loans. A substantial portion of their current assets are mezzanine loans to apartment developments in Melbourne, the Gold Coast and Brisbane. When I think “housing bubble,’ an apartment development in the Gold Coast is probably one of the first things that comes to mind. While Eildon stress in the prospectus that they have ways to mitigate their risk, if they are getting double digit yields on loans it’s hard to believe they are able to protect themselves that well.

Vanda Gould

Another thing that makes me a little suspicious of this listing is a controversy that has been hanging around Eildon capital’s current parent company, CVC Limited. Founded in 1985, one of CVC Limited’s founding directors and chairman for many years was a guy called Vanda Gould. Vanda Gould resigned in 2014 after becoming embroiled in a lengthy dispute over tax avoidance with the ATO. He recently lost an appeal to the high court over a tax bill of more than $300 million for companies he owns and advises, and is also facing criminal charges relating to tax avoidance that could potentially land him in jail. The guy seems like one of the real characters of Australian investing, his chairman’s letters for CVC would regularly get pretty philosophical, quoting Shakespeare and referencing interest rates from ancient Rome and Babylonia. While these days he holds no position at CVC and you won’t even find his name on the website, it’s hard to believe he is completely disentangled from all of CVC’s various affairs. To give an example of a potential continuing connection, over 10% of the shares of Eildon capital will be held by a company called Chemical Trustees Limited on listing, a company that had its assets frozen in 2010 due to alleged tax avoidance in relation to Vanda Gould. I have no idea if there is still any connection between Chemical Trustees and Vanda Gould, but if they end up having to sell their holding in a hurry or the shares are seized it could have a significant effect on the share price.

Pricing concerns

The last thing going against this prospectus is CVC Limited’s current share price. With net assets of $214 million as of the end of the last financial year, CVC’s market capitalisation has hovered around the 196 million dollar mark for the last couple of months. This means every 1 dollar you invest in CVC Limited buys you $1.09 of net equity on CVC’s balance sheet. That’s 8 cents more than you will get of Eildon Capital’s equity if you take part in the IPO. As CVC currently owns Eildon capital, this could mean that the IPO is priced above the current market price. Of course, it’s impossible to know for sure what assets exactly on CVC’s balance sheet the market is undervaluing, but it could just as well be the Eildon capital assets as anything else. If this is the case, there is a real danger the share price will drop by around 6% or 7% upon listing. If you are a long term believer in the company this may not bother you, but it does mean you may need to commit to holding these shares for quite a while if you want to make money.

Verdict

Despite all these issues, the target returns will no doubt be enticing for some investors, and if you have an appetite for a bit of risk and are not currently that exposed to the housing industry taking part in this IPO could make sense. For me though, my scepticism of the housing market along with concerns about the Vanda Gould connection makes me happy to give this one a miss.

The offer closes on the 24^th of January.

Ardrea Resources

Overview

It’s hard not to be charmed by the prospectus of Ardea resources. Something about the long term consultant getting his first shot at a Managing Director role, the all or nothing plan of investing all money raised into exploratory digging in the next few years and the hopeful and earnest pictures of gold nuggets, abandoned mine sites and old letters makes it feel like something out of a Poldark episode.

The whole project seems to be a creative way Heron Resources management have dreamt up to finance exploration of some of their existing tenements they think look promising without annoying their shareholders who would rather they focused on their existing mine. Ardrea resources will be given the tenements and in exchange Heron Resource shareholders will be given over half of the shares in Ardrea Resources. Ardrea will then raise 6 million dollars through the IPO selling off the other shares

While it's an elegant solution, it is a rather expensive way of doing things. The IPO will apparently cost $900,000, or 15% of the money raised and that’s before the additional salaries of board members and directors that will need to be paid each year are factored in. The cynic in me thinks that if those gold nugget pictures that are talked about so excitedly in the prospectus where compelling enough Heron Resources management would have convinced shareholders to let the company do the drilling themselves, though perhaps that's unfair.

Analysis

The payoff tree for Ardrea is pretty simple: The two year exploration will either turn up something that warrants a mine, or the company will have burnt through nearly all its money on the exploration drilling and the shares will be close to worthless. This means that in order to evaluate this deal we need to decide on two things: how much the share price will be if the drilling turns up something, and the likelihood of that happening.

To try and quantify what the Ardrea share price would be if the drilling work uncovers a feasible mine site we can use the share price of Heron Resources itself. As it stands currently, Heron Resources has had the Woodlawn mine approved as economically feasible with works due to start early next year. With this information supposedly factored into the share price, the company has a market cap of just under 52 million dollars. If you subtract the net cash the mine has of around 24 million dollars, it means the market value of the Heron Resources mining site plus any other remaining tenements is around 28 million dollars. The market cap on listing of Ardrea Resources will be 14.3 million if fully subscribed, meaning that if Ardrea was to find a mine site that a feasibility report showed was worth developing, the market cap and share price doubling to 28.6 million and 40 cents respectively may be a reasonable assumption. I know this may be overly simplistic, but there seem to be so many unknowns in regards to what could be found that trying to be more specific seems futile.

Trying to assign a percentage to the drilling finding anything is harder still. I’m not going to even pretend that phrases like “’wallaby style magnetite epidote alteration’’ mean anything to me, so the Prospectus isn’t really much help in this regard. There are a couple of things though that make me feel this percentage isn’t that great. Firstly, these tenements are not exactly new, with the Prospectus mentioning they have been looked at by previous miner’s numerous times, which can hardly be a good sign. Secondly, I keep coming back to the idea that if this really was a great opportunity, there must be easier ways to raise 6 million than through an IPO. Surely there would be private investors who would jump at the chance to put up money if they thought this opportunity was worthwhile. With all this in mind, I find it hard to be confident that the drilling prospects are above 50%.

With that low of a chance of a payoff, the deal doesn't seem that enticing.

There’s one more reason I’m reluctant to invest in this Prospectus. One of the conditions of the prospectus is that Heron Resources shareholders get priority if the IPO is oversubscribed. This means that for the average non-Heron Resources holding investor you are in a catch 22 situation: If the Heron Resources shareholders know this is a good deal, all or most of the shares will be snapped up before reaching the general public, and you will be left out. If, on the other hand, Heron Resources Shareholders think that this drilling project isn’t worth it, your bid will probably be filled.

Verdict

This one is a pass for me. If I had shares in Heron Resources it might make more sense, but as it stands there are too many potential downsides to make the potential payoff worthwhile.