CHINA MINZHONG trades at around 84 cents, offering about 40+% upside to a possible general offer at $1.20.  Why the big discount that the stock is trading at?

CMZLinGuoRongChina Minzhong chairman Lin Guo Rong has paid S$40 m in earnest money to PT Indofood.One might say the broad market is in a slump but there are other more specific angles to look at. First, a recap of events:

31 Dec 2014: China Minzhong's chairman announces his intent to acquire 347 m China Minzhong shares, representing a 52.94% stake, from PT Indofood Sukses Makmur at S$1.20 per share. The chairman, Lin Guo Rong, is seeking to raise funding for the acquisition and for a mandatory general offer.

14 Oct 2015: CMZ BVI (the vehicle of China Minzhong's chairman) and PT Indofood enter into a binding MOU. CMZ BVI agrees to pay PT Indofood an earnest sum of S$40 m no later than 30 December 2015.

30 Dec 2015: CMZ BVI pays earnest sum of S$40 m to PT Indofood.

There is a broad range of views among investors as to why there is a big discount to the possible GO price despite Mr Lin's payment of the earnest sum:

NEGATIVES:

1. Uncertainty: The discount reflects uncertainty that CMZ BVI can secure the necessary funds for buying the shares from PT Indofood and for the mandatory general offer. "Mr Market had already assigned a very low probability that it will go through," as a post in Valuebuddies.com said.


Funding is indeed the most significant hurdle because the sum required is substantial at about S$535 million, according to NextInsight's estimate. 

That's made up of S$416 m for PT Indofood's 347 m shares and S$119 m for 98.8m shares from minorities, and excludes 13.39 m shares held by the chairman and the CFO. (According to the MOU, PT Indofood is not to tender its remaining 30% stake, or 196.25 m shares, for the general offer.)

2.  Difficult to raise $: A related point is that funding for M&A has been getting harder to secure in China, and credit markets are in turmoil.

3. Tough terms: Potential financiers have the upper hand in negotiations. After all, it's CMZ BVI which is keen to buy back a controlling stake in China Minzhong. That being the case, financiers will negotiate for tough terms.

4. Due diligence: There is still "detailed due diligence on China Minzhong" to be completed by potential financiers, and who knows what finding might de-rail the proposed acquisition.

5. Plan B: The MOU is not a public document as NextInsight learnt, so the terms and conditions are not known. Could there be a Plan B for both parties which have a different outcome?

It's a lesson from a recent case whereby a Chinese strategic investor signed a MOU with the controlling shareholders of AsiaTravel.com to mount a GO for the company. Later, there was a change of plan and the investor decided to instead inject S$100 m cash into the company in exchange for new shares of AsiaTravel.com (see: ASIATRAVEL.COM: No takeover but China investor to pour in S$100 m).

6. Skeptical: Investors are skeptical about S-chips and are looking past any big discount on China Minzhong. As a post in Valuebuddies.com said: "It is weird, these deals are supposed to be highly certain and lucrative, and using rational reasoning, the market should not be lagging so much from the offer price, but i think too many scam with 'S' chips have made people wary for too good to be true deal."

 

POSITIVES:

1. Progress: Yes, the funding required is substantial and looks daunting -- but CMZ BVI said it "has made progress in its discussion with potential financiers on the funding arrangement." 

2. Earnest sum: The most important indicator on the likelihood of Mr Lin being able to buy out PT Indofood and minorities is the payment of the earnest sum of S$40 m by his vehicle CMZ BVI. 

Likely, the cash came from a financier (or financiers), who would not have handed it to CMZ BVI without being near certain that everything is in order.

If the S$40 m came instead directly out of Mr Lin's pocket, then it's an equally positive sign because he certainly would not risk losing S$$0 m unless his talks with financiers have convinced him that the necessary financing is his for the asking. 


3. Non-refundable: The earnest sum, which works like a deposit for many types of transactions such as real estate purchases, is non-refundable. 

To quote China Minzhong's announcement, "If the Parties fail to sign the SPA (sale and purchase agreement) by the Expiry Date, the MOU shall be terminated and PT Indofood shall be entitled to forfeit the earnest sums paid by CMZ BVI, and CMZ BVI shall have no right or claim against PT Indofood for costs, expenses, damages, losses, compensation or otherwise."

The MOU's expiry date is 14 Oct 2016, ie a year after the signing.

Now, if the SPA materialises, the share price of China Minzhong can be expected to rise to a whisker of the GO price, which will be a solid gain from the current share price level.

China Minzhong had RMB2.6 billion in net cash (equivalent to S$570 million).  This huge cash pile is possibly a strong source of assurance for the financiers to lend S$534 m to CMZ BVI for the latter to buy a 70% stake in the company.
4. Safe acquisition: From potential financiers' point of view, it is likely that China Minzhong is a safe target for the buyout by CMZ BVI.

China Minzhong had cash of RMB4.4 billion as of end-Sept 2015 against bank borrrowings of RMB1.8 billion -- which works out to RMB2.6 billion in net cash (equivalent to S$570 million).

This huge cash pile is possibly a strong source of assurance for financiers being approached to lend S$534 m to CMZ BVI for it to buy a 70% stake in Minzhong.

In addition, at S$1.20 per share, CMZ BVI will be buying the shares at a discount to their Net Asset Value of RMB7.87, or S$1.71, per share. 

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