StyNet, Part 1: Digital Mess
21 July 2002
We kick off a series of related articles with coverage of Digital World Holdings Ltd (Digital World, 0109), formerly known as Q-Tech Holdings Ltd.
As this story develops over the next few days, you will see how a network of small companies, many of them floated on GEM, have helped generate revenue for each other's IPO track records - including the IPO of a GEM financial adviser itself. You will also see how a series of massive rights issues by main-board listed disaster zones have funded similarly massive outflows to "independent third parties" for highly-priced acquisitions leading to huge write-offs.
Because this story is so complex, we are breaking it down into sections, so pay attention and stay tuned. The first and heaviest is here, and if you get through this, the others will all make sense. You almost certainly do not own shares in these companies (and nor do we), but the studies will show you how some of the worst corporate governance can affect your investments.
History
Digital World started life in 1993 as a distributor of Korean and Japanese TVs, air conditioners and video compact disc players to Hong Kong and mainland China, usually on a non-exclusive basis, eking out a small net profit of around 5% of turnover. The company was listed under the name of Q-Tech Holdings Ltd on 12-Jan-98 in an IPO sponsored by Lippo Securities Ltd involving the issue of 67m shares (25% of the enlarged capital) at HK$0.80 per share.
Post-IPO, the company was owned 47.25% and 20.75% respectively by its co-founders Mr Yu Kwok Leung (Mr Yu), the Chairman, and Mr Thomas Lui Jung Ning (Mr Lui), an executive director responsible for sales and marketing.
A further 7.5% was held by "two existing shareholders". Although they were not named, it is possible to figure out from the pre-IPO reorganisation at the back of the prospectus that they were Ms Siana Tang Hok Lam and Mr Kaiman Wong Chun Ching (Mr Wong) in equal proportions. We know nothing about them except that Mr Wong was an Executive Director of HK-listed B-Tech (Holdings) Ltd from 30-Jan-01 to 12-Apr-01.
The IPO flopped, being only 0.42x subscribed in the public tranche, and despite this there were a miraculous 265 applications for the minimum 2,000 shares each, ensuring that the company met the minimum required number of shareholders. Of the 25% offered, 9 employees took up the full 2.5% in the employee tranche, the public took 9.56% and 12.94% of the company was taken up by the underwriters.
Apart from Mr Yu and Mr Lui, the other two executive directors were Mr Yu Zhi Wen (Mr Z W Yu) who is Mr Yu's nephew, and Mr Lam To Ming (Mr Lam), the finance director.
Early trouble
The prospectus dated 30-Dec-97 was just a day before the 6-month deadline based on latest audited accounts of 30-Jun-97, at which date the group had lent a total of $67.7m to related companies of which the Executive Directors were also shareholders and/or directors. The Company had only $1.9m in cash, while bank borrowings totalling $113.0m, or 212% of net tangible assets before the IPO.
Despite this, the group managed to pay a pre-IPO dividend of $13m on 1-Dec-97, and all the amounts due from related companies were repaid a week later.
It didn't take long for the company to get into trouble. Nine months in fact. On Sat-26-Sep-98 it announced that out of the IPO proceeds of $42m, it had only spent $5m of the intended $17m on new product promotion, had not spent any of the intended $17m on setting up showrooms in the PRC, and had instead diverted the remaining $37m to unnamed "financial institutions" as security for trade loans.
Investment tip: when ever a company talks about debts to "financial institutions" you can be fairly sure that they don't just mean banks, they mean brokers and licensed money lenders too, which can be run by just about anyone. It's a sign that a company may have trouble getting enough credit from banks.
At the same time, the company revealed that 65% of its shares had been pledged by Mr Yu and Mr Lui to a number of stockbrokers for margin financing, and several of the unnamed stockbrokers had demanded payment for margin calls.
On top of that, a supplier called Thakral Corporation (HK) Ltd (Thakral) had filed a claim against South Boss Resources Ltd (South Boss), the group's principal trading subsidiary, for unpaid debts of $17.1m.
On Mon-28-Sep-98, the stock plunged 36% to HK$0.033 per share, already down 96% from the IPO in just 9 months. The brokers had had begun selling off the pledged shares in the market, selling 10.9% of the company that day. The following day, a further 54.4% was sold, reducing the two co-founders to just 2.2% of the company. Of this, 27.99% was acquired by Mr Lam at between $0.045-0.050 per share, 93% below the IPO price.
Details now emerged that the co-founders had pledged their shares "on various occasions" between Feb-98 and Sep-98. By ceasing to be controlling shareholders within 12 months of listing, Mr Yu and Mr Lui had broken Listing Rule 10.07.
Regulatory note: as a result of this case and others like it, note (3) was added to Listing Rule 10.07 to require a controlling shareholder who pledges shares within 12 months of listing to announce it. However, there is still no such requirement if the shares are pledged any time after the first anniversary of listing. In our view, this should be a continuing obligation.
A new shareholder
On 13-Oct-98 the Company belatedly announced that it had been informed on 9-Oct-98 by Mr So Chee Keung (Mr So) that on 29-Sep-98, in the big sell-off, he had acquired 16.79% of the Company. Mr So was the finance director of Styland Holdings Ltd (Styland, 0211) until he resigned on 30-Oct-93, having joined Styland in 1986. On 17-Nov-98 Mr So was appointed as an executive director of Digital World.
On 1-Dec-98, Digital World reached a "heads of agreement" on a proposed settlement with Thakral, which was formalised by an agreement dated 15-Dec-98, in which the company would procure the transfer of 3 bungalows in Zhongshan City, PRC and allot 28.5m new shares to Thakral, representing 9.6% of the enlarged issued share capital of Digital World. Bungalows, did we say? Yes, the company had no bungalows. The announcement stated:
"The Company will purchase the [bungalows] from the respective property owner at market prices and then procure the transfer of the [bungalows] to [Thakral]"
Wouldn't it have been simpler just to give Thakral the cash and let them buy the bungalows if they wanted? The deal was formalised with an agreement on 15-Dec-98. It is probably a pure coincidence that Styland had a development project in Zhongshan, PRC which included bungalows, which according to its accounts had already all been sold by 31-Mar-98.
The price which Digital World paid for the bungalows and identity of the vendor were not disclosed.
Founders step down
On 14-Dec-98, the day before the deal with Thakral was formalised, the co-founders Mr Yu and Mr Lui stepped down but remained as non-executive directors. Mr Z W Yu also resigned from the board. That left just two executive directors: Mr Lam became Chairman and Mr So became Vice Chairman.
On 28-Dec-98, it was announced that claims had been made by finance companies Winly Advance Co Ltd and Tin Ching Finance Co Ltd, against South Boss and Mr Yu for $2.3m and $7m respectively. To cap off a disastrous year, on 31-Dec-98 Digital World announced that Daewoo had decided not to renew its distribution agreements with the group, and the agreements expired that day.
Profit warning
On 14-Jan-99, the two co-founders resigned their non-executive directorships. Two days later, the Company warned that it may not have met the profit forecast in the prospectus for the year ended 30-Jun-98. It also spoke of "a slowdown in the settlement of debts owed by the debtors, which are located in the [PRC]". Laying the responsibility squarely on previous management, the new management said that if provisions for bad debts were necessary during the audit in progress, then the group may not be able to meet the profit forecast.
Spot the vanishing auditor
It subsequently emerged that Ernst & Young, the auditors at the time of the IPO when the profit forecast was made, had already resigned on 7-Jan-99 and been replaced on 8-Jan-99 by local firm Johnny Chan & Co, something the board did not get around to announcing until 27-Jan-99.
Regulatory note: there is no requirement in the Listing Rules to announce a change of auditors - only to tell the Exchange privately. This should be fixed, and the appointment of new auditors should be subject to shareholders' approval.
1st rights issue
Meanwhile, on 21-Jan-99 Digital World announced a 10:1 consolidation of the shares, together with a huge 9:2 rights issue at $0.28 per new share, enlarging the capital by 450%. The financial adviser was Emperor Capital Ltd, while Ever-Long Securities Co Ltd (Ever-Long), a wholly owned subsidiary of Styland, was one of the underwriters.
Mr Lam and Mr So, who held 25.29% and 15.51% respectively, undertook to take up all their rights, and a Mr Chan Yuen Tung (Mr Y T Chan), described as "a business associate of Mr Lam" undertook to apply for 12.825m shares. This person was presumably Mr Jimmy Chan Yuen Tung, who was a director of HK-listed Star East Holdings Ltd (then known as DC Finance Holdings Ltd) until 1-Feb-99. He was briefly mentioned in our article on Singapore Hong Kong Properties Ltd on 7-Jul-99. Thakral was entitled to 12.825m shares in the rights issue, and Mr Y T Chan undertook up those rights instead.
INEDs quit
The announcement stated that an independent board committee would be formed comprising Peter Tsao Kwan Yung (Mr Tsao) and Alfred Donald Yap (Mr Yap), the two original independent non-executive directors from the IPO. However, they weren't sticking around - Mr Tsao resigned on 26-Jan-99 (the day before the change of auditors was disclosed) and Mr Yap resigned on 10-Feb-99. When the going gets tough, the tough get going. Each cited "an increasing workload from other business commitments". Nice to know where their priorities lay. At the last count, Mr Tsao, a former Secretary for Home Affairs in the HK Government, was an independent non-executive director of at least 10 other HK-listed companies.
Replacing them were Mr Chui Wai Kit, appointed on 11-Feb-99, and Mr Colman Chan Chung Kit on 12-Feb-99, which was also the "latest practicable date" for information in the rights issue circular dated 15-Feb-99, so they didn't have long on board to reach a view. They were advised by Dao Heng Securities Ltd, while Emperor Capital Ltd advised the company. All we know about Chui Wai Kit, an accountant, is that he was a director of HK-listed LifeTec Group Ltd until 28-Jan-99 and died in 1999 at the age of 33. We know nothing about Colman Chan Chung Kit except that he was a computer software consultant.
The rights issue raised $37.4m gross and $35m net of expenses. In the announcement of results of the rights issue, it turned out that Thakral had taken up its rights after all. Apart from Mr Lam, Mr So and Thakral, who together took up 50.4% of the issue, only 1.4% was subscribed and the rest was left with the underwriters.
Two weeks later on 14-Apr-99 it was announced that one of the underwriters (unnamed) had procured Mr Y T Chan to subscribe for 17,358,000 of the underwritten shares, representing 27% of the rights issue and 10.64% of the enlarged company. The company said Mr Y T Chan did not have any representation on the board. Soon afterwards, Mr Y T Chan's holding disappeared below the 10% disclosure threshold.
Also on 14-Apr-99, Mr Chan Tak Hung (Mr T H Chan) was appointed as an executive director. Digital World's latest annual report states that "he has over 10 years' experience in the banking and commercial sectors." Apart from that, we know nothing about him. Since then, Mr Chan has gradually acquired the largest holding in Digital World and now holds around 26%.
Jun-98 and Dec-98 results
During the rights issue process, on 12-Feb-99 Digital World finally released its audited results for the year ended 30-Jun-98. They showed that the company had made $40.1m net profit, which by pure coincidence just beats the $40m profit forecast for the year made at the time of the IPO.
The new auditors gave a "true and fair" opinion but noted that there were "fundamental uncertainties" in relation to the going concern assumption. The results also stated that the accounts receivable at 30-Jun-98 had been "substantially subsequently settled" after the balance sheet date, but there had been a "significant slowdown" in collecting payment for subsequent sales and cited the "uncooperative attitude of Mr Yu and Mr Z.W. Yu", warning that provisions for bad and doubtful debts may be needed in the current year.
They weren't kidding. On 8-Mar-99 the interim results for the 6 months to 31-Dec-98 showed a loss of $51.9m, including provision for bad and doubtful debts of $58.9m. This compared with sales of $224.2m, down 46%. The group had ceased trading through the crippled South Boss, which by now was embroiled in litigation, and set up a new subsidiary to conduct trading from Dec-98 onwards.
Over two months after the interim results, it was announced on 20-May-99 that the top 5 customers of the group owed a total of $214.9m at 31-Dec-98, equivalent to 305% of net assets at that date, and none of it had been settled up to the date of the announcement. Since the annual results had spoken of receivables at 30-Jun-98 being "substantially subsequently settled", this implies that nearly all the sales in the following six months were not paid for.
Speaking to the SCMP on 24-May-99, Mr Lam denied reports that a member of management had fled after embezzling from the firm. "It's a slander. Someone may want to push the share down [to prepare] a hostile takeover", he was quoted as saying. The shares fell 30.9% to $0.197 in the two days after disclosure of the receivables.
With the interim results, the Directors announced that "in order to enhance profitability of the group" they would "explore other suitable investment opportunities in a prudent manner" and then listed a wide range of sectors including "investments in properties, infrastructure projects, securities and stockbroking, money lending and financing businesses".
Investment tip: whenever a listed company which is not a bank starts talking about getting into money-lending, you should be worried. There is almost no accountability in the Listing Rules for loans to "independent third parties", and however big those loans are, they do not require shareholders' approval and have a nasty habit of becoming unrecoverable. We have urged the Stock Exchange to amend their rules to treat lending by listed companies in the same way as acquisitions, subject to shareholder approval based on size.
On 26-Apr-99, Mr So resigned and Mr Wilson Yeung Shu Lam (Mr Yeung, formerly known as Yeung Lam) was appointed as an executive director. He is a solicitor and runs his own firm, Wilson Yeung & Co..
Options
At the AGM on 31-Mar-99, the company's share option scheme was amended so as to remove the 1-year waiting period before options granted under the scheme could be exercised. No options had been granted up to that point. In a 15-Mar-99 circular explaining the change, the board wrote:
"The Directors believe that the Proposed Alteration... will assist the Group in the recruitment and retention of high calibre executives and employees".
Who did they have in mind? Themselves, of course! On 22-Apr-99 options were granted to subscribe 16,307,500 shares at $0.12 each, exactly equal to 10% of the issued share capital, the maximum allowed under the scheme, with 25% of the options (again, the maximum allowed) going to each of Mr So, Mr Lam and Mr T H Chan, the 3 executive directors. Options are meant to provide long-term incentive for management, and are normally held for years, but not in this case! Just four days later, Mr So exercised all his options, and on 11-May-99 Mr T H Chan and Mr Lam exercised all theirs.
1st placing
On 7-May-99, Digital World announced a placing of 32m new shares equivalent to 19.14% of the existing issued shares at $0.15 per share, a whopping 31.2% discount to the 10-day average price, raising $4.8m gross and $4.5m net. The placing was arranged by Quest Stockbrokers (HK) Ltd.
Bonus issue
On 8-Jun-99 the company announced a 5:1 bonus issue, citing the spurious reason that it:
"will provide shareholders... with an opportunity to obtain further equity participation in the Company on favourable terms"
That is utter nonsense, because a bonus issue leaves each shareholder with the same percentage of the company that they started with.
Board changes
On 14-Jun-99 Mr Lau Kit Hung was appointed as an independent non-executive director, replacing Mr Chui Wai Kit who had "passed away recently". Mr Lau is a solicitor and consultant to law firm Messrs. Stephen Lo & P. Y. Tse.
On 24-Jun-99 Mr Colman Chan Chung Kit resigned as an independent non-executive director and was replaced by Mr Kong Chung Yau, a solicitor who was then a partner of Lau, Kong & Partners, was subsequently a consultant with Francis Kong & Co. and is now affiliated with Raymond T. M. Lau & Co.
On 28-Jun-99, finance director Mr Lam resigned and Mr T H Chan became Chairman.
Disposal of South Boss
On 6-Jul-99 the Company announced it would sell what used to be its principal subsidiary, South Boss, for just $200,000, to a company called King Power Co., Ltd. We don't know who owned that, but the owner was described as being "engaged in business consultation in Hong Kong, Macau and the [PRC]". They certainly had a lot of "consulting" to do to collect those debts. In any event, the previous day, a court had made a winding up order against South Boss and appointed a provisional liquidator.
On 23-Jul-99, the stock was suspended at $0.054 and did not resume trading until 3-Jan-00.
Later, on 11-Aug-99 it was announced that prior to the sale, South Boss had assigned to a subsidiary of Digital World $117m of receivables due from 3 customers, the recoverability of which was described as "remote". So South Boss was sold with $97.9m of receivables. It was also revealed that South Boss still owed the group a further $60.8m.
Jun-99 annual results
On 26-Nov-99 the Company announced its results for the year to 30-Jun-99, a loss of $188.3m on turnover of $232.4m. This implied that turnover in the second half of the year to Jun-99 was only $8.2m. The loss included full provision for the $60.8m owed by South Boss, $152.5m for bad and doubtful debts, and $8.5m for the liability for a guarantee over a bank loan to South Boss. The group also recorded a gain of $36.3m on the disposal of South Boss, because South Boss had negative net assets. After these results, Digital World's equity had been wiped out and the group had net liabilities of $11.6m.
There had been a remarkable concentration of sales since the IPO. The 5 largest customers who accounted for all or most of the bad debts in the year to Jun-99 constituted 94% of sales, while the top 5 in the year before the IPO (Jun-97) had been only 15.5%, and the largest customer accounted for 24% (1997:3%).
The auditors considered the "inherent uncertainties surrounding the circumstances" under which the Group might survive were "so extreme" that they disclaimed their opinion on the accounts.
Investment in Sincere Wisdom
Despite the severe financial difficulties, you may be surprised to learn that during the year to 30-Jun-99, the group found $8.62m cash to spend on a 49% stake in a BVI company called Sincere Wisdom Investment Ltd (SWI). Although payment was made up front, completion was conditional on SWI setting up a wholly-owned and licensed internet content provider in the PRC which would also engage in other internet related business. At that time, foreign ownership of internet content providers was illegal and even today under WTO it is still restricted. So completion was pretty unlikely. The deal was not big enough to require disclosure under the Listing Rules, and no other information was disclosed in the accounts, but you'll find out more below, so remember that name!
At 30-Jun-99, the group had only $2.3m in cash and no bank borrowings apart from the amount due under the South Boss guarantee.
Censure of ex-directors
On 30-Nov-99 the Stock Exchange announced a censure of Mr Yu, Mr Lam and Mr So (all of whom had already left the company) for breaches of the listing rules, including late results announcements and failure to publish details of a change of use in the IPO proceeds. Well, their names were in the newspapers. That'll teach them!
Change of name
Perhaps seeking a fresh start, on 8-Dec-99 the Company announced a proposed change of name from Q-Tech Holdings Ltd to Digital World Holdings Ltd. The internet bubble was about to reach its peak.
Investment tip: any company that seeks to put words like "World", "Global", "Galactic" or "Universal" in their name is probably not a world-wide business. Be equally suspicious of words like "Tech", "Cyber", "Bio" and "Nano" and anything prefixed with "e-" or "i-".
2nd rights issue
On 30-Dec-99, Digital World announced a massive 10:1 rights issue of 12,683m shares at $0.01 each, raising $121m net of expenses. The proceeds were earmarked as to $8m to repay the bank debt, $50m "for expansion and operation of the trading business of the group" and $63m as "general working capital". The financial advisers to the company were Emperor Capital Ltd (again) and Kingston Corporate Finance Ltd. The financial adviser to the independent board committee was Hantec Capital Ltd. The issue was fully subscribed.
The stock began trading again on 3-Jan-00 after a 5-month suspension.
More on Sincere Wisdom
More information now emerged on that investment in 49% of SWI which was mentioned in the Jun-99 results. The rights issue announcement said SWI was incorporated in Apr-99, and the vendor was a company called Global Eagle Investments Ltd (GEI), described as an "independent third party" which owned the other 51%. No ownership details were given, but Webb-site.com can reveal that, by 13-Jan-00, GEI was a wholly-owned subsidiary of - guess who - Styland - which mentioned it in an announcement that day.
The acquisition of SWI had still not been completed, and the deadline was 31-Mar-00. In the end, it was scrapped and the money was refunded in Jun-00 without interest.
More Options
One of the advantages of a constantly expanding share capital is that you can keep on raising the number of outstanding options to go with it. On 5-Jan-00 options were granted over 316,831,682 shares at $0.01 each (as adjusted for the rights issue) all of which were exercised on 8-Mar-00. So much for long-term incentives.
Regulatory note: there is no way for investors to know how many options are outstanding at any given time, or the terms thereof. There should be.
SFC launches enquiry into share dealings
On 24-Jan-00, Digital World announced that the SFC had commenced an enquiry under Section 31 of the Securities and Futures Commission Ordinance into dealings in the shares. In the 15 trading days since the shares were released from suspension on 3-Jan-00, volume had totalled 158% of the issued shares, and the price had risen from a pre-suspension $0.054 to $0.42, valuing the near-bankrupt company at $533m before the rights issue took effect.
Did the SFC suspect manipulation? No outcome of the investigation was announced.
New directors
On 16-Feb-00, Mr Wong Shu Wing (Mr Wong) and Mr Richard Lum Chor Wah (Mr Lum) were appointed as executive directors. According to the rights issue announcement, Mr Wong was General Manager of Sunwave Holdings Ltd, a member of a group which specialises in the trading of integrated circuits, computer peripherals and telecommunication products. He would be responsible for the sales development of Digital World.
Mr Lum was an executive director of Dransfield Holdings Ltd until 18-Jul-01. He also acted as an independent non-executive director of Companion Building Material International Holdings Ltd from 16-May-00 and its affiliate Skynet (International Group) Holdings Ltd from 5-Jan-00, leaving both on 7-Mar-02. He is also a non-executive director of Innovative International (Holdings) Ltd and a director of Dah Hwa International Holdings Ltd.
2nd placing
You might think that the company now had enough money, but on 7-Mar-00, just a week after completion of the rights issue, Digital World announced a placing of 500m shares (equivalent to 3.58% of the existing issued shares) at $0.049 each, raising $23.9m net of expenses. The placing agents were TIS Taiwan International Securities (HK) Ltd (TIS) and Ever-Long, a wholly-owned subsidiary of Styland.
The proceeds were to be used as "general working capital" and "as reserve for identifying and investing in any investment projects." None had been identified at that stage.
3rd placing
Not content with that, on 20-Mar-00 the company announced another placing, again through TIS and Ever-Long, of 700m shares (equivalent to 4.74% of the existing issued shares) at $0.032 each, raising $21.5m net of expenses. This time the placing was "funding for potential investment in high-tech related projects and general working capital." Again, no particular projects were under negotiation.
Dec-99 interim results
On 30-Mar-00, Digital World announced a 75% drop in turnover to HK$56.8m for the six months to 31-Dec-99. It had given up trading TVs and was trading computer motherboards and peripherals. Net loss was HK$2.6m.
On 5-May-00 Mr Yeung resigned after just over a year as an executive director.
4th placing
On 8-May-00 the company announced a placing of 1,590.249m shares (equivalent to 9.32% of the existing issued shares) at $0.022 each, through 6 placing agents, an unusually large number, raising $34m net of expenses, again for "funding the potential investment in high-tech related projects opportunities". Again, no negotiations had been carried out, but heck, you never know when the money might come in handy. This placing exhausted the remainder of the 20% general mandate to issue new shares, which was approved along with the 2nd rights issue in an SGM on 8-Feb-00.
Star on Board
On 24-May-00 Michael Lai Tin Ying (Mr Lai) was appointed as an executive director. According to the next annual report, Mr Lai had joined the group in Mar-00 and "is a well-known composer and movie star" with over 35 years' experience in the entertainment industry in Hong Kong. Mr Lai is also known as Michael Lai Siu Tin, although the report doesn't mention this.
It later emerged in the annual report that Digital World had acquired 70% of Michael Lai Production Holdings Ltd (MLPH) "the promotion specialist for the enormous PRC market", the remainder being held by Mr Lai. No details of the deal were disclosed. According to the report, MLPH entered into an agreement with China Performing Administration Center (CPAC) to set up Michael Lai Cultural Promotion and Production Co Ltd (MLCPP). The report stated that MLCPP's partnership with CPAC facilitates the granting of needed permits and documents for the promotion of entertainment shows and concerts in the PRC.
New Finance Director
On 31-Jul-00 Yuen Chi Ho (Mr Yuen) was appointed as an executive director. According to the next annual report, he joined the group in Jun-00, is a qualified accountant and responsible for the accounting and finance functions of the group.
3rd rights issue
On 3-Aug-00, Digital World announced a 2:1 rights issue of 34,117m shares at $0.0065 each, raising $210m net of expenses. For every 10 shares taken up, the holder got 2 bonus warrants - or 0.4 warrants for every old share held. The warrant subscription price was $0.007 per share exercisable from 13-Oct-00 to 12-Oct-01. As a result of the rights issue, the Company had 51,175m shares in issue, which may be some kind of record.
The financial adviser to the Company was First Securities (HK) Ltd and the Lead Manager was Ever-Long, which is owned by Styland. The financial adviser to the independent board committee was Hantec Capital Ltd, reprising their role from the 2nd rights issue. In the final result announced on 16-Oct-00, the rights issue was only 69.3% subscribed and the rest was left with the 12 underwriters.
The planned use of proceeds was:
"$80m... for the expansion and operation of the telecom business of the group... $60m for the acquisition of a company which operates a Wireless Application Protocol in the PRC and... $70m... as general working capital."
What telecom business? You may well ask, since this was the first mention of it we can find.
CWAP.com
On 7-Aug-00 Digital World announced it would spend HK$75m in cash for 80% of a BVI company called Ancora Worldwide Ltd (Ancora), at the same time revealing that it had already bought 20% of Ancora for $20m in May-00 from Mr Kevin Ngai Kwok Kin (Mr Ngai). The final 80% was sold by Mr Ngai, Mr Xu Qing and Mr Zhang Zhi Ling in unspecified proportions.
The announcement referred to a valuation by LCH (Asia-Pacific) Surveyors Ltd (LCH) for 100% of Ancora at 29-May-00 of HK$103m, and stated that Ancora owns and operates the first Chinese Wireless Application Protocol (WAP) portal, cwap.com. The valuation was based on "the cashflow projection and the business plan of Ancora and comparison with the telecommunication industry". At the time of the announcement, Ancora did not even have any management accounts, let alone audited accounts.
Backdated valuation
In the shareholders' circular of 25-Aug-00, the letter from the board again referred to that valuation "as at 29-May-00", but we note that the valuation date in the LCH report was two months earlier, at 31-Mar-00. The NASDAQ index was 43% higher on 31-Mar-00 than on 26-May-00, the last trading day before the old valuation date, and NASDAQ stocks were widely used in the LCH valuation methods. No explanation for the date discrepancy was given.
Accounts
According to the report by accountants Lai & Lai, the principal asset of Ancora was a computer system with a book cost of HK$4.000m and intangible assets with a book cost of $6.000m at 30-Jun-00, for a total of exactly $10m. It was not disclosed whether Ancora built the portal from scratch or acquired it ready-made, but either way, it had only operated the assets since about 31-Mar-00, because the amount of depreciation recorded was only 3 months' worth. In view of the precisely round numbers, it is likely that Ancora acquired the assets on a ready-made basis.
Ancora had only US$100 (HK$780) of share capital, and the HK$10m investment cost was funded by an interest-free loan from an unnamed shareholder. Total turnover since incorporation to 30-Jun-00 was $7.33m, representing "advertising fee income received and receivable", of which $5.15m had been paid. The customers were not named. Operating and admin expenses, excluding depreciation, were $1.365m, none of which had been paid. All the revenue so far, save for $0.020m in cash, had gone into repaying shareholder loans, leaving $4.871m outstanding.
Despite never having paid any expenses up to 30-Jun-00, by the time of the circular, Ancora had "60 to 70 staff".
Although the users of the portal were "mainly in the PRC", the announcement said "Ancora has not required (sic) to obtain license and approval by the relevant authorities of the PRC for the aforesaid acquisition by [Digital World]." The circular claimed that "the principal operation of Ancora is in Hong Kong and Macau". As we said earlier, foreign ownership of content providers in the mainland was then illegal and is still limited, so the legal alternative is to operate Chinese web sites from HK or Macau. One curious fact: Ancora's registered address on its domain record is in Beijing.
So there you have it - buy or build a portal for $10m, start operations, and 3 months later it is worth $103m and sold for $95m. LCH discarded the "cost approach" in its valuation report, stating:
"the Cost Approach does not take into consideration the stunning market potential and future growth of Ancora's services, Ancora's business model, and the impact of its management's abilities".
The financial adviser to Digital World on the transaction was again First Securities (HK) Ltd.
BSPN (Riverhill) - non-disclosure
On 7-Sep-00, Digital World announced that back on 27-Jun-00 (3 days before the year end) it had spent $30m cash for 5% of a BVI company called Cyber World Technology Ltd (Cyber World), which "due to oversight of the Directors" it had failed to mention until now, breaching the Listing Rules as the deal amounted to more than 15% of the Company's net assets.
Cyber World owned 100% of Beijing Spatial Port Network Technology Ltd (BSPN), a PRC company incorporated on 15-Jul-99 and "engaged in the field of geographic information system, global positioning system, remote sensing and internet related services".
The value of Cyber World was estimated by Sallmans (Far East) Ltd, an "independent professional valuer" at RMB720m (HK$673m) on 5-Jun-00. Despite this, the unaudited management accounts of BSPN for its first 14 months amounted to a net profit of HK$9.7m and net assets at 31-Jul-00 were in the same amount.
The vendor, a BVI company called Zelma's Co Ltd (Zelma), which owned 40% of Cyber World prior to this deal, was 35% owned by Mr He Xiao Feng, 35% by Mr Liu Wei, and 30% by Mr Yick Chong San.
The rest of Cyber World was owned by "independent third parties" as to 40% by Global Eagle Investment Ltd (GEI) and 20% by Cyber City Technology Ltd. While the announcement doesn't mention it, readers who have followed us this far will recall that GEI is owned by Styland. In fact, GEI acquired this 40% stake from Zelma in a deal announced on 13-Jan-00 for $148m, implying a value of $370m, which is what LCH (yes, them again) said it was worth on 30-Nov-99. So in just 6 months, the value had gone up 82%!
For those readers who follow the GEM (both of you), BSPN was floated as the main subsidiary of Riverhill Holdings Ltd (Riverhill, 8127) on 1-Jun-01 - but that will have to wait until a future article. Digital World ended up with 14,313,725 shares (3.45%) in Riverhill, worth $8.59m at the IPO price of $0.60. They were not subject to lock-up and may have since been sold; an unquantified loss provision was made in the Jun-01 results.
Regulatory note: It is often impossible for investors to know which investments have been reduced in value and by how much. Listed companies should be required to identify the investment, amount of provision, and resulting carrying value where each provision amounts to a material percentage of net assets - say 3% or more.
But before we leave Riverhill, there's one more connection we should make. Did you click on our link to Ancora's cwap.com? If so, then you should have noticed that Ancora is, according to that record, located at the Beijing head office of Riverhill's BSPN. It seems like the two are not complete strangers!
Jun-00 annual results
On 23-Nov-00, Digital World announced its results for the year to 30-Jun-00. Turnover was HK$93.8m, implying that the second half was just $37m, and net profit was $3.56m. The largest customer accounted for 69% of sales and the top 5 (or fewer) accounted for 100%, while the largest supplier accounted for 71% of purchases and the top 5 (or fewer) accounted for 100%. So although Digital World was still in the "trading" business, it was more of a pipeline than a trader. The ultimate extreme would be to have 1 customer and 1 supplier, at which point you are just a booking vehicle.
Purchase of Info-car.com (UVEAC)
Speaking of vehicles, the results revealed that Digital World had purchased a company called United Vehicle Exchange Auction Centre Ltd (UVEAC), which purportedly ran a site called Info-Car.com, although today that site is just a holding page registered by someone else. No details of the acquisition were disclosed. The main lines of business "include the trading of auspicious number plates, the provision of car related news and the trading of first- and second- hand cars in Hong Kong", including "hassle free parallel imports of new and used vehicle".
Investment in Inworld
The results announcement also revealed that Digital World had acquired 3.05% of a company called Inworld Holdings Ltd (IHL) "which is operating four Chinese language information and entertainment content platforms". No details of the transaction were given.
Again, GEM followers may recognise this - it was floated as Inworld Group Limited (Inworld, 8100) on 31-Dec-01, and we'll dig deeper into that one in a future article. What you need to know now is that its Chairman is Mr Ngai, who you will recall was one of the vendors of Ancora, and Inworld's largest shareholder is Styland, with 32.5% post-IPO.
The Inworld prospectus dated 18-Dec-01 reveals that Digital World paid HK$14m for the 3.05% stake (5 out of 164 shares in IHL), purchased from Inworld's CEO Mr Chan Wai Lun (Mr W L Chan) on 27-Jun-00, just 3 days before Digital World's year-end and the same day that it bought the 5% stake in Cyber World. So Digital World had spent a total of $44m in one day on companies related to Styland, and shareholders had no idea.
The prospectus also tells us that Mr W L Chan purchased 9 shares in IHL at $555,555 each on 15-May-00. This implies that six weeks later, when Digital World paid $2.8m per share, the value of this start-up had increased 405%! However, two months after that, Styland paid Mr Ngai a cool $107.8m cash for 45 shares of IHL, an average of $2.40m per share.
Swap 3.05% of Inworld for 10% of West Marton
Digital World did not keep its IHL shares until the IPO. According to the Inworld prospectus, on 15-Aug-01, Digital World sold its shares in IHL to Mr Ngai in exchange for "a 10% shareholding interest in a group of companies engaging in the development and operation of e-commerce portals".
There was no disclosure by Digital World of this deal at the time, but Webb-site.com found a reference in the material contracts listed in the back pages of a rights issue circular dated 22-Feb-02, which mentions the swap agreement with Mr Ngai dated 10-Aug-01 and names the new investment as 85 shares in West Marton Group Limited (West Marton).
And what is West Marton? Sometimes, you just know where to look. We turn to Styland's annual report for 31-Mar-01 and find that at that date, West Marton was a 90% subsidiary incorporated in the BVI, then with HK$468 (US$60) of share capital, which Styland had acquired for $120m cash on 31-Oct-00. Styland never actually announced that deal, as it was less than 15% of the latest net assets of $999m. However, the back pages of a recent Styland circular dated 5-Jul-02 name the vendor as Fu Tsin Man and the agreement was dated 10-Oct-00. We don't know anything about Mr/Ms Fu Tsin Man.
Styland's annual report barely mentions West Marton, stating only that it has a wholly-owned subsidiary called E-Union Information Science & Technology (Shenzhen) Co Ltd. A search of the web finds only one reference - a site called Chineseyes.com, which appears to be a mainland portal. Click on a province and look at the bottom of the page, which attributes the site to E-Union. Based on the webmaster e-mail address, the site appears to be managed by Inworld. The only advertising on the site appears to be an inactive rotating banner for several companies, all of which were mentioned above: Styland, Ever-Long, BSPN, MLPH, and Info-Car.com (which dates it, because Info-Car.com is defunct). The domain record of Chineseyes.com records Inworld's Mr Ngai as the administrative contact.
The annual report of renren Holdings Ltd (Renren, 0059) for the year to 31-Dec-01 shows that during 2001, Renren acquired 10% of West Marton, which by year-end had US$850 of share capital, for a cash consideration of $10m. The deal was not announced so we don't know who the vendor was.
Jun-00 annual report
The annual report and accounts contain some additional surprises; first, Johnny Chan & Co had resigned as auditors and were replaced by Deloitte Touche Tohmatsu; again, this was unannounced. Second, apart from the $44m last minute binge on Cyber World ($30m) and Inworld ($14m), the accounts disclosed that Digital World had spent $28.596m on listed equities in HK, including - guess what - a 3% stake in Styland. This holding was disclosed under the obscure s129(2) of the HK Companies Ordinance because it amounted to more than 10% of the Group's gross assets of $198m. The market value of the listed investments, including Styland, had fallen to $17.58m by the year end.
We also found that Digital World had quietly begun its money lending business. Receivables included secured loan(s) of $28.43m at Prime+2%, and unsecured loan(s) of $2.63m at 9.75%. The identity of the borrowers was not disclosed.
The only two subsidiaries known to be acquired in the year to 30-Jun-00 were 100% of UVEAC and 70% of MLPH. The annual report shows that acquisitions of subsidiaries cost $15.25m in cash, for which the group acquired net liabilities of $237,000. In net asset terms, that's money for nothing.
Share consolidation
On 15-Feb-01 Digital World announced an 80:1 share consolidation. If you Ignore the opportunity to take up rights issues, after two consolidations and a bonus issue, every 400 shares at the IPO was now reduced to 3 shares in the company.
In an major snafu, the auditors Deloitte Touche Tohmatsu signed off on an adjustment to the warrant exercise price from $0.007 to $0.07 per share, and it wasn't until 9-Apr-01 that the company announced they had got it wrong, and the adjusted price should be (of course) 80 times the old exercise price, or $0.56 per share. Meanwhile, as the annual accounts later revealed, an alert warrant holder had spotted the gaff and exercised warrants to buy 400,000 consolidated shares for $28,000 rather than $224,000! The warrants were (at $0.56) out-of-the-money so no others were exercised during the year to 30-Jun-01.
Dec-00 interim results
On 26-Mar-01, Digital World announced a net loss of $18.8m on turnover of $60.2m for the six months to 31-Dec-00. This included a "provision on some of its investments in view of the market perception and the diminishing valuation of portal companies" in the amount of $25.5m. "Yet, the management would like to emphasis that those investee companies are operating at a profitable and improving angle".
The interim report showed that non-trade receivables, presumably comprising loans to third parties, now amounted to $79.5m, and still no explanation was given.
Regulatory note: the skimpy "condensed" interim accounts under HK's Listing Rules don't allow us to analyse the changes in investments.
The report showed that on 3-Jul-00, the first day of the new year, the company had acquired 95% of Pastena Worldwide Inc. for $2m. We don't know what that is. The report also showed that on 25-Nov-00, Digital World had sold 100% of a BVI company called Solar Top Group Ltd for $13.8m cash, a gain of $3.822m. This implies a purchase cost of $10m. This BVI investment holding company was acquired in Mar-00 and our best guess is that this was the holding company of UVEAC, which was no longer mentioned in the report. No disclosure on who bought Solar Top, which had contributed to Digital World no revenue and a consolidated loss of $0.414m in the six-month period.
If Solar Top was indeed the holding company of UVEAC, then that implies that the 70% stake in entertainment promoter MLPH, being the other subsidiary acquired in the year to 30-Jun-99, came at a price of $5.25m.
The interim report also contains some entertaining appraisal from the management, telling us that after the share consolidation, the net assets per share are around $0.46, a premium of 291% over the market price of $0.158 on 23-Mar-01. "The Company is extremely undervalued". We were told that MLPH "is also progressing smoothly". On the strategy front, they wrote:
"Instead of running blindly after those "bubble" companies , the management has clearly identified the following strategies:
* fundamental; and
* inter-related for synergy possible."
Perhaps forgetting that he had just written down the cost of investment in bubble companies, Chairman T H Chan, now in full command of his literary skills, wrote:
"Humbly speaking, the path is not simple...Hong Kong lacks of technology people...the management would remain prudent in...avoiding over-sketching the available manpower that may result in insufficient control".
Mr Chan apparently saw progress where others saw red ink, writing:
"the management... is proud to report that the Group, under the current management, has picked up again its momentum. We are confident that the business outlook of the Group is even more promising."
Investment in Digital Nunet Exchange Ltd
The report also mentioned an investment in 55% of Digital Nunet Exchange Ltd (Dnunet), a "Greater China Internet Data Center provider", a joint venture with Nunet Inc "with the full support from Telhope Information Development Co Ltd, a leading [PRC] telecom runner." No financial terms were disclosed. From it's web site, Nunet appears to be an Internet service provider based in Pennsylvania, USA. Dnunet was granted an ISP license by the HK regulator on 16-Jul-01.
Exit Mr Wong
On 30-Apr-01, Mr Wong resigned after 14 months as an executive director of Digital World.
A little wine?
Just remember, you are now looking at a technology company. So on 21-Jun-01, Digital World announced it was buying 8% of a BVI company called Well Pacific Investments Ltd (Well Pacific), which had an 85% stake in a PRC company called Siping Wei Da Transportation Co Ltd (Wei Da) which in turn owned Lisy County Wei Da Tian Yuan Wine Limited Company (Tian Yuan), which was "principally engaged in the manufacturing of Chinese white wine."
The owner of the other 15% of Wei Da was "an independent third party". The vendor of the 8% stake in Well Pacific was another BVI company, an "independent third party" whose warrantor and "major shareholder" was a person called Wang Yan. No other information on Mr/Ms Wang was given. Digital World paid $9.98m for the 8% stake, comprising $4.4m in cash and 18.6m new shares at $0.30 each. At the same time, another "independent third party" bought an 8% stake for an undisclosed price, leaving the vendor with 84%. Digital World wrote:
"The principal activities of Wei Da include the provision of transportation service in the PRC and Wei Da will focus on developing intelligent goods transportation system using internet and computer technology".
Digital World also obtained a 1-year option to acquire a further 35% of Well Pacific on the same terms.
Another breach
On 16-Oct-01, Digital World announced it had again breached the Listing Rules, this time by failing to disclose a loan of $5m to a director of a subsidiary of MLPH made on 1-Mar-01 at 5% p.a..
Jun-01 annual results & report
On 18-Oct-01 Digital World announced a net loss of $74.1m on turnover of $81.3m for the year ended 30-Jun-01. The loss included a provision for impairment of long term investments amounting to $50.0m (up from $25.5m in the first half), as well as provision for loss of "other receivables", presumably from its money-lending business, of $36.4m, made in the second half.
Money lending - Digital World Finance
Digital World's non-trade receivables (net of provisions) now amounted to $59.2m, including interest-bearing secured receivables of $36.7m and unsecured receivables of $15.95m at rates ranging from 5% to 18% p.a..
In the annual report, the Chairman blamed the loan losses on:
"over-lending to some reputed persons on a "name" basis or against securities. The value of which have deteriorated much faster than anticipated",
Needless to say, they didn't disclose the names they'd been lending to or what stocks they'd been lending against. However, we can give you a flavour of the sort of loans they have been making since then, because there has been one dealing disclosure in which Digital World Finance Ltd (the lending subsidiary) on 11-Apr-02 obtained security on 3,963m shares of Renren to a company called Rich Delta Development Ltd, owned by the Chairman and controlling shareholder of Renren. The share mortgage was discharged on 3-Jun-02 and guess who the shares were pledged to that day? The answer is Ever-Long Capital Ltd, a subsidiary of Styland.
In fact, Ever-Long Capital was already familiar with this customer, because on 3-Dec-01 the lender was granted a second mortgage over 5,202m Renren shares by the same party, which was released on 29-May-02.
Mr T H Chan, Digital World's Chairman, was appointed as a non-executive director of Renren on 26-May-01 and resigned 11-Apr-02. We'll tell you more about Renren in a future article.
Advertising & entertainment
As regards the new subsidiaries, the segmental information showed that "advertising" (presumably Ancora's cwap.com) had contributed revenue of just $3.770m (all in the first half of the year) and a loss of $0.624m - remember this was a $95m acquisition! Meanwhile, "provision of entertainment services" (presumably MLPH) contributed revenue of $1.072m and a loss of $0.899m.
Dealing
Digital World had also been busy in the market, recording purchases of "other investments" (meaning not long-term) of $72.1m and sales of $60.8m, and recording an overall loss on other investments of $11.0m.
Investment in Taiwan
Digital World's annual report also revealed a $10m deposit paid for a 12.5% interest in an unnamed private Taiwanese company, in a deal due to complete in Nov-01. No further mention has been made of it so we don't know whether the deal completed.
On 30-Nov-01 Mr Yuen, the finance director, resigned after 16 months in the job.
International Capital Network
Although Digital World did not announce it, the IPO prospectus of GEM-listed International Capital Network Holdings Ltd (ICNH, 8004) dated 20-Nov-01 states that on 10-Nov-01 Digital World acquired shares in ICNH for $12m, or an average of $0.477 per share, for a stake of 7.85% post-IPO. That troubled company deserves a whole article of its own, so you'll have to wait for that.
For now, we'll tell you that the IPO took place at $0.84 per share and now the shares trade at $0.138. ICNH owns International Capital Network Ltd (ICN), an SFC-registered financial adviser. The vendor of the shares to Digital World was Ms Leung Yuk Kit, one of the founders of ICNH. In subsequent events, Styland confirmed in an announcement that she was an assistant to the financial controller of Styland and resigned in Jul-99.
In ICNH's prospectus, a "Hong Kong listed distributor of technology products" was listed as the client in ICN's first two transactions ever. The first, mandated on 10-Aug-00, was the sale of a minority interest in a wholly-owned subsidiary for a success fee of $0.8m, while the second, mandated two days later, was advice on a rights issue, for a fee of $0.2m. At least in the second case, the unnamed client must have been Digital World, as the dates of announcement and circular match with the 3rd rights issue described above, for which Ever-Long was the Lead Manager. Ever-Long was also Lead Manager of ICNH's IPO.
Fourth rights issue
On 17-Jan-02, Digital World announced its heaviest rights issue yet, of 7,246m shares on the basis of 11 new shares for every share held, at $0.015 per share, an 85% discount to market, raising $105m net of expenses. Of this, $55m was for "general working capital" and $50m for "future investment opportunities...in the technology industry and divisified (sic) the investment portfolio... into any project with expected good returns". In other words, they had no plans for the money.
The issued was arranged by Ever-Long, the lead manager was Luen Fat Securities Co Ltd and they and 13 others, including ICN, underwrote the issue.
Chairman Mr T H Chan agreed to take up his rights to 18.73% of the issue and underwrite a further 11.2% of the issue, which if fully taken up would raise his stake to 29%, just below the takeover threshold. In the final result, only 54.73% of the provisional allotment was taken up by shareholders, but there were excess applications from other shareholders (including Mr T H Chan) for a further 56.29% and as a result the issue was fully subscribed and his stake increased to 26.06% of Digital World.
After the issue, there were 7,904m shares in issue, but remember there has been a cumulative 400:3 consolidation, so in IPO terms this is equivalent to 1.05 trillion shares.
Dec-01 interim results
On 21-Mar-02, Digital World announced a net loss of $38.1m on turnover of $33.2m for the six months to 31-Dec-01. The loss included a realised loss of $14.9m on investments, another provision for impairment of long-term investments of $15.9m.
Non-trade receivables had grown from $59.2m six months earlier to $105.9m, reducing cash and bank balances and deposits to just $36.2m, despite that $105m rights issue which closed on 15-Mar-02.
On the segment analysis, turnover from advertising and design services, presumably by Ancora, was just $0.244m, recording a loss of $4.763m. Provision of entertainment services, presumably MLPH, recorded turnover of $0.536m and a loss of $0.531m. Meanwhile Dnunet, the data centre business, got up and running in the 4th quarter and contributed turnover of $0.215m and a loss of $1.815m.
Penny stock
If Digital World's stock chart were a cardiograph, you'd be looking at a dead patient. It flatlined on 20-Mar-02 at the $0.01 minimum allowed by the Stock Exchange trading system, and apart from 5 days in May, it has been stuck there ever since, with no bid. In these circumstances, the only way to trade below $0.01 is manual matching through a broker. The Stock Exchange should have exercised its power under paragraph 30 of the Listing Agreement to require a consolidation proposal for the stock, but has apparently failed to do so. The Exchange has failed to require consolidations in several other cases, and as we have said before, they should intervene long before stocks get to this level, not wait until they hit $0.01.
Coming soon
If you've read this far, then you have seen a complex jigsaw of interlocking transactions in which hundreds of millions of dollars have passed in rights issues and placings from shareholders into Digital World and out again in the form of highly priced acquisitions and investments, many of which involved Styland (a company which is similarly fond of rights issues) as a fellow investor, while Digital World has also generated a whole pile of bad loans to "reputed persons".
In our next (and shorter) episode, we'll take you through the makings of one of the GEM stocks in this puzzle, and show you how to spin up a track record that will get you past the listing committee faster than you can say "Worldcon".
© Webb-site.com, 2002
Organisations in this story
- GET Holdings Limited
- Good Resources Holdings Limited
- INTERNATIONAL CAPITAL NETWORK HOLDINGS LIMITED
- JOHNNY CHAN & CO. LIMITED
- RIVERHILL HOLDINGS LIMITED
- Skyfame Realty (Holdings) Limited
- STYLAND HOLDINGS LIMITED
- Wisdomcome Group Holdings Limited
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