M&C on the Cheap
14 July 2000

Revised 15-Jul-00

On 26-Jun-00 Hong Kong listed CDL Hotels International Ltd (CDLH) announced (Word format) its second restructuring in 14 months.

CDLH is proposing to sell its 52.4% stake in UK-listed Millennium & Copthorne Hotels plc (M&C) to its Singapore-listed parent, City Developments Limited (CDL) for HK$6,100m (GBP522m). This represents about GBP3.534 per share in cash. The transaction is a "connected transaction" and therefore is subject to independent shareholders' approval.

Conditional on the sale, CDLH will distribute between $7,210m and $7,610m to its shareholders (including CDL) by way of a capital reduction. This is equivalent to between HK$3.38-$3.49 per current share in CDLH.

Now normally when a company is taken over, it commands a substantial premium to market price. M&C has a hotel portfolio of 115 hotels with 30,500 rooms in 13 countries. Several of these hotels are partly or wholly-owned by third parties and managed by M&C, so the net book value does not include the future profits from the management contracts. Therefore, assuming valuations have not changed since the year-end, if CDLH were to market its majority stake in M&C then it could expect bids from other hotel companies at net book value or higher.

If you are a shareholder of CDLH, watch carefully. The M&C net book value at 31-Dec-99 was GBP4.683 per share. That is 32.5% more than what CDL is offering you for control of M&C. We also note that the assets of M&C include companies acquired from CDLH in the 1999 restructuring at a discount of some $1,736m (then GBP139m) to valuation, or another GBP0.493 per share. That would take net assets up to GBP5.176 per share, which is 46% more than what CDL is offering. In addition, some of the original M&C properties are held at cost or at older valuations.

Even the market price of M&C, without a takeover premium, was yesterday (13-Jul-00) GBP4.105 (it was GBP3.985 just before the announcement). That's16% more than what CDLH is offering. CDLH is 54.2% owned by CDL. The public and others (including Hong Leong Singapore, the controlling shareholder of CDL) own 45.8% of CDLH. Let's look at how much value the public is losing here.

The public effectively own 45.8% of the 147.78m shares in M&C which are held by CDLH. That's about 67.69m shares. They are being offered GBP3.534 per share, but in a sale it would likely fetch at least GBP4.683 per share, being the net book value. The difference of GBP1.149 per share amounts to a total disadvantage of GBP77.8m (HK$908m). If you include the valuations of the assets acquired from CDLH in 1999, then the difference is GBP1.642 per share, for a total discount of GBP111m (HK$1,298m).

To put it in terms of CDLH, that's a value-loss to public shareholders of around HK$1.37 per share of CDLH. That's the value that CDLH shareholders will give up if they approve this deal.

Share options

It gets worse. The announcement of the deal includes reference to the 187.12m outstanding executive share options in CDLH. A check of the accounts reveals only 91.02m outstanding at the end of 1999. Further checking reveals that of the 96.1m  options granted since the year end (net of any which have been exercised or lapsed) 87m of these options were granted to the directors of CDLH in late February (they were disclosed on 1-Mar-00 and 2-Mar-00), just 4 months before this restructuring was announced.

That's equivalent to 4.2% of the issued shares of CDLH. Of course, we assume they had no intention back in March of proposing this transaction (including the capital distribution) since otherwise the granting of options would have been illegal insider dealing.

The new options give the right to subscribe $2.06 per new share between 13-Mar-00 and 14-Jan-05, and the directors who got the options are:

Just by exercising the options, the directors will receive HK$3.38-3.49 per share in the distribution, compared with the exercise price of $2.06, and they will still own the shares afterwards. That hands them an instant gain of between HK$114.8m and HK$124.4m, at the expense of all the other shareholders (incuding CDL itself). The possible exercise of the share options is the reason for the variation in the amount of the distribution, but all rational option holders will exercise, and that puts the likely distribution per share at the lower end of the range.

On top of that, the directors already held 67m options at $2.24 per share granted on 13-Oct-97 and exercisable until 14-Sep-02 (equivalent to 3.2% of CDLH). These will yield a further gain of at least $76.4m from the distribution. So the board will walk away with at least $191.2m clear cash profit on their options as well as the resulting shares in CDLH.

Kwek Leng Beng is the Chairman and MD, Kwek Leng Joo is his brother, Kwek Leng Joo is their cousin, and Gan Khai Choon is their brother-in-law. The Kwek family controls CDL through the privately-held Hong Leong Investment Holdings Pte Ltd.

Outside of the family, Miguel Ko is the Deputy Chairman and CEO of CDLH. Wong Hong Ren is a non-executive director of CDLH and is the Group Investment Manager of Hong Leong Management Services Pte Ltd. Lawrence Yip is the finance man, and Tan I Tong is a non-executive director who also sits on other boards in the Hong Leong group.

Was the option limit broken?

On first glance, it seems that the Stock Exchange limit on the granting of options, traditionally 10% of the issued shares (excluding those issued when options are exercised) under all schemes in a 10-year period, may have been broken. At least 32m options were granted in 1994, 19.05m in 1995, 1m in 1996 and 90.225m in 1997. Together with at least 96.1m since the end of 1999, that makes a total of 238.375m options.

Now of these options,12.13m were exercised between 1-Jan-95 and the end of 1999, so we must exclude those. The latest issued share capital is about 2,064m shares, less the exercised options leaves 2,052m. By comparison, the options granted are 11.5% of this figure. Has the limit been broken?

Directors' dealings

Miguel Ko became CEO of CDLH on 18-Jan-00 having been an Independent Non-executive Director since Aug-93. He had no shareholdings at the end of 1999 but, before and after the option grant, he bought 1m shares between 8-Feb-00 and 10-Feb-00 (which were not publicly disclosed until 1-Mar-00) and another 2m between 27-Mar-00 and 5-Apr-00, at an overall average price of only $2.18 per share. The distribution will net him up to $3.93m of cash profit on those shares.

Scrip Dividend

Meanwhile, CDLH declared a scrip dividend with a cash alternative in relation to its final dividend of 6 cents per share for 1999. Those who elected for cash lost out, because just 4 days after the scrip was allotted, the proposed sale and capital distribution were announced. Needless to say, CDL took the scrip, and they could argue that since this was the default option, they did not take any action on the basis of the planned proposal. Still, other shareholders may wish they had known about it before electing for cash.

Alternatives

The independent non-executive directors (INEDs) of CDLH are Mr Lo Ka Shui (head of the GEM Listing Committee and deputy chairman of Great Eagle), and Mr Jackson Lee (also known as Li Chik Sin), who is a director of Singapore-listed Metro Holdings Ltd and Hong Fok Corp Ltd. It is the INEDs' job to advise independent shareholders how to vote. These guys are going to have a tough job. Incidentally, Mr Lo won't have far to go; CDLH's head office is 5 floors below its landlord Great Eagle's in Great Eagle Centre, Wanchai.

The INEDs are being advised by Platinum Securities Co Ltd. In the course of reaching their opinion on the transaction, the INEDs and their advisers would in our opinion be negligent if they did not consider the following two alternatives:

Option 1

If CDLH wishes to sell M&C, then why not put it up for sale in the general market and invite bids? It would almost certainly fetch more than CDL is offering. If CDL wanted to buy it, they could bid for it too. The proceeds could then be distributed to shareholders of CDLH. It seems impossible to argue that the terms of the proposed sale to CDL are "fair and reasonable" if a better offer can be obtained in the open market, so let's settle it that way.

Option 2

Alternatively, if CDL wishes to retain a stake in CDLH, then why not give all shareholders that choice, by distributing the shares in M&C to all shareholders of CDLH. As a result, CDL would receive about 28.4% of M&C, but it could top this up by making a general offer to the other shareholders of CDLH to purchase the M&C shares from them. They may find some takers, because not everyone wants UK-listed shares. The offer would have to be better than CDLH shareholders could get by selling their M&C shares in the UK market, instead of the discount they are currently being offered.

If CDL chose not to increase their holding, then M&C would be 67.3% publicly held (and 4.3% by Hong Leong) and would be a potential takeover target. That should result in a market re-rating of M&C nearer to net asset value.

Not the first time

Of course, we know why CDL will not like either of our options - they would remove some or all of the discount that CDL wants to receive under the current proposal. It would invite takeover bids for M&C, and it would increase shareholder value. That's not CDLH's style.

Back in Apr-99, the companies comprising the Asia Pacific hotel interests of CDLH were injected into M&C for GBP436m (HK$5,446m) including shareholders' loans of $508m. The net price for the equity was therefore $4,938m. However, the net book value of the companies (adjusting for Mar-99 and Apr-99 appraisals of hotels) was HK$6,674m. So the discount of $1,736m represented 26% of net assets acquired.

CDLH held 52.5% of M&C and maintained this by using part of the proceeds to take up a rights issue in full. As a result, CDLH suffered the discount on the 47.5% of the Asia Pacific Companies that they effectively sold.

That discount amounted to HK$825m. At that time, CDL had no conflict of interest on that deal and was able to vote it through. However, M&C took the acquired assets into their books at acquisition cost, not at market value. So CDL now benefits from that discount (unless values have declined).

And guess what - the Independent Adviser on the deal was Platinum Securities Co Ltd, the same expert that will be advising the independent directors this time.

Just say no

If you are a CDLH shareholder, it may seem that, with the shares having fallen so far, trading at a big discount to net asset value, that the cash distribution is a bribe worth taking in return for approving the deal. We don't think so. They are effectively offering you your own money at a discount. Independent shareholders would do better to press the company to distribute the shares in M&C, or put the M&C majority stake up for sale in the open market, rather than sell control of it to CDL at a discount. Vote against the transaction.

© Webb-site.com, 2000

Organisations in this story

• China Tian Yuan Healthcare Group Limited

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