Description

Disclaimer: This is a simple, but illiquid idea so it might not be worth your time at all if you’re looking to deploy say anything more than USD 50-100k per position. But read on anyway if you just like the thrill of the hunt :)

Asia Tele-Net (ATN) is a company that has a printed circuit board (PCB) business with erratic profitability. However, the true value of the company lies in the form of cash receipts from a protracted sale of its former manufacturing site in Shenzhen, an affluent city in China, which might not appear immediately obvious on screens (for e.g. on Bloomberg it appears as Other LT Assets). The existing amount of cash, net of all liabilities, is already significantly larger than the market capitalization, and will potentially grow up to 5-6x that of market cap should payment be fully received. The risk-reward is asymmetrical, heads you win big tails you might still win.

Background – lead up to current situation
Back in Sep 2011 (company announcement dated 19th Sep 2011, "Very Substantial Disposal"), a wholly owned subsidiary of ATN, called Process Automation Shenzhen Limited (PASL), entered into an agreement to sell 2 parcels of industrial land at No. 8 Industrial Zone, Bao An District in Shenzhen.

http://www.atnt.biz/fileDownload.php?newsType=announce&year=2011&fileName=en_ra_101.pdf

The reason behind the sale of the land was due to a rezoning of the Land (previously occupied as a production base of ATN) from industrial to residential by the Government of Shenzhen City, given the growth in residential demand in Shenzhen, a special economic zone in China. With the rezoning plans in place, a developer Shenzhen Warmsun ("SW") expressed interest in redeveloping the land.
PASL vacated / demolished the land in exchange for a relocation compensation of RMB 50 million, with SW redeveloping the land and transferring the title of 41,000 sqm of redeveloped property ("Relevant Property") to PASL. The title of the Relevant Property was expected to range from RMB 615-820 million.
The Land was held on the books on 31 Dec 2010 at RMB 40 million, so this transaction would have unlocked value on its balance sheet, with an estimated gain of between RMB 602 - 803 million after relevant costs.

Amendment in Jan ’17 to account for rising property prices

Fast forward years later, in January 2017, amendments were made to the terms as certain conditions had changed, most noticeably since the original 2011 agreement, property prices in Shenzhen had increased substantially across the years.

http://www.atnt.biz/fileDownload.php?newsType=announce&year=2017&fileName=e2017.01.04_ATNT%20-%20Announcement%20re%20terms%20amendment%20V6.pdf

Instead of receiving Consideration comprising
(i) a relocation compensation of RMB50 million and (ii) the title to the Relevant Property,

PASL will receive Consideration comprising
(i) a relocation compensation of RMB50 million (equivalent to approximately HK$56 million) and (ii) guaranteed cash consideration of RMB1.23 billion.
The guaranteed cash consideration will be payable by 6 tranches within 18 months after the issue of the Pre-Sales Certificate without waiting for the completion of the Re-development.

The rationale behind this change include:
i) Consideration to be received earlier.
- The title deeds would have been received by Dec 2021 at that point, after which PASL would have needed to engage a marketing team to sell the Relevant Property.
- for a business that primarily sells printed circuit boards, this wouldn't have been ideal!
- There could also have been risk of the project delaying and further pushing back the date of title deed transfer.
ii) SW would have benefitted from this arrangement by retaining title of the Relevant Property and potentially selling at a higher price.
iii) No exposure to property market
- with this arrangement, the consideration would have been definitive, without exposure to property market ebbs and flows given the consideration is now in cash.

Due to accounting depreciation of the land, the carrying value of the Land was now around RMB 6 million, as of 30 June 2016, down from RMB 40 million about 6 years ago. The gain after taxes would have reached around RMB 1.02 billion to RMB 1.22 billion.

Change in cash consideration in June 2019

There was yet another amendment made to the terms in June 2019. The primary change this time would pertain to the cash consideration, which has now been increased to RMB 2.75 billion.

http://www.atnt.biz/fileDownload.php?newsType=announce&year=2019&fileName=e2019.06.28_ATNT%20-%20Announcement%20re%20terms%20amendment%20v2.pdf

PASL will receive Revised Consideration of RMB2.8 billion which comprises of
(i) a relocation compensation of RMB50 million and
(ii) guaranteed cash consideration of RMB2.75 billion.

On the date of this announcement, PASL had already received the relocation compensation of approximately RMB50 million. The guarantee cash consideration of RMB2.75 billion would be payable in 6 tranches, and the original additional cash consideration of RMB 1.23 billion would no longer be due to PASL. WS had advised that they were still in the process of applying the Pre-Sales Certificate, which was a prerequisite for the original RMB 1.23 billion additional cash consideration. With this revised agreement, PASL would no longer be required to monitor the progress of the Pre Sales Cert application.

The trade off was that PASL would receive a higher consideration, but timeline to receive the consideration would be extended. The RMB 2.75 billion consideration was based on the market value of the Relevant Property, which was at RMB 2.11 billion, but RMB 0.64 billion higher to compensate for the additional timing. PASL continued to benefit from exposure to rising property prices even though the 1st amended agreement had changed the Relevant Property title transfer to a cash consideration. The revised cash consideration would be carried on the balance sheet at fair value after discounting future cash flows, which on 31st Dec 2018 was deemed to be around RMB 888 million (HKD 1.07 billion). This was purportedly the final change.

Amendment to repayment dates in Sep ‘19

Another update on 27th Sep 2019. To avoid month end cut off issues and year end closing dates, some amendments were made to the repayment dates and amounts due for each date, but the total consideration remained unchanged.

http://www.atnt.biz/fileDownload.php?newsType=announce&year=2019&fileName=e2019.09.27_Circular%20for%20EGM.pdf

SW not unable to pay on time due to deteriorating property market, HKD 200mn deposit pledged

On 31^st December 2021, a further announcement was made. PASL would have received a guaranteed cash consideration of RMB 800mn in 2022. However, SW communicated to PASL that it would not be able to pay the 4^th and 5^th tranche of the consideration on time.  In view of the expected delay in repayment, SW agreed to pay HKD 200mn as security to its repayment obligations. If SW indicates, or there is evidence, that indicates the RMB 800mn due on or before 30^th Nov 2022 cannot be repaid, this additional security will be applied as partial settlement.

Most recent update, and management’s view on SW

The latest update was on 16^th May 2022. As of the Second Revised Supplemental Agreement A, PASL is entitled to default interest (RMB 5.75mn up till this date), and SW has provided additional security to PASL to secure repayment obligation for the remaining outstanding amounts. SW agreed to provide a 1^st legal charge for 7,922 sqm of office space as security for all outstanding amounts of the consideration for the period 16^th May 2022 to 5 Jan 2023. The Pledged Property was valued at approx. RMB 238,710,000 as at 16 May 2021 by an independent valuer.

SW had indicated to PASL that they have not issued any overseas bonds, are not subject to credit crunch, and unlike other tier 1 property developers, does not have many outstanding development projects which will require huge funding requirements. They indicated to PASL that they would be looking to raise additional funds by a) selling office/shop space from Longhua project, b) borrowing from banks, c) seeking repayment/assets from debtors, d) completing development project in 2023. ATN has guided that SW believes more time is required for them to formulate a revised repayment time, and they will seek additional securities in the form of cash or assets, though nothing conclusive has been determined yet, while emphasizing that they have co-operated with SW for more than a decade and except delays in approvals from local authorities in the past due to policy changes, SW has so far honored all agreed terms.

Timeline of cash receipts

The revised repayment dates and amounts are as below, in RMB.

6th Jan 2020 --> 400 mn
6th Jul 2020 --> 600 mn
5th Jan 2021 --> 200 mn
30^th Nov 2022 à 800 mn
5th Jan 2023 --> 750 mn

Total: RMB 2.75 bn

Why is this compelling?

As of time of writing, RMB 1.2 billion has been received by PASL/ATN, with RMB 1.55 bn still pending and on track to be received.

http://www.atnt.biz/fileDownload.php?newsType=announce&year=2021&fileName=e2021.08.31_Interim%20result%20announcement.pdf

As of 31^st Dec 2021, ATN’s balance sheet looks like this.

Bank deposits + bank balances and cash à HKD 1,214,650,000
Total liabilities --> HKD 556,696,000

Cash net of all liabilities stands at HKD 657,954,000.

Shares outstanding stands at 426,463,400, with a share price of HKD 0.92 on 23 Aug 2022, which brings the market capitalisation to HKD 392,346,328.

This does not include the unreceived cash consideration from WS of RMB 1.55 billion (HKD 1.87 billion). The statutory tax rate for Hong Kong companies is 16.5%. Applying the whole amount would result in a cash consideration net of tax of HKD 1.56 billion. If SW defaults, there will be an additional RMB 238mn (appraised value) in pledged assets.

If we add this to the current cash pile, it will likely grow to around HKD 2.7 billion, with a net cash value of close to HKD 2.17 billion, though this simplistically assumes no cash burn from present till early 2023, which will be addressed a little later.

So at present, the value of the company is likely to be 70% higher than the current market cap, without ascribing any value to the future cash consideration.
With the additional consideration included, we could be looking at a company that probably is worth >5x more than the current market cap by Jan 2023.
Even then, this attributes $0 of value to the existing PCB business, which although unprofitable, still had a topline of HKD 335mn in 2020.

What’s the catch?

Is the operating business losing money? Regarding the cash burn point above.

Let's take a look at the annual profit before tax figures from 2013-2020.
*PBT figures are used because the cash consideration is subject to tax and can't be adjusted properly, plus the purpose is just to illustrate whether the underlying operations of the business are profitable or not.

*Adjustments are made with comments at the side.
*Links to AR 2013-2020 below

2013: HKD 11.7 mn
2014: HKD 11.4 mn
*2015: HKD 29.5mn --> minus non op gains of HKD 19.157mn = HKD 10.343mn adj PBT
- Relocation compensation income was HKD 59.96 mn, with corresponding demolition costs of HKD 40.803 mn, so non-operating profit of HKD 19.157mn has been stripped
*2016: HKD 1,049,799 mn --> minus non op gains of HKD = - (HKD 27,251 mn), negative
- gain on recognition of the cash consideration, HKD 999,560mn and gain on disposal of subsis HKD 77,490
*2017: HKD 280.54mn --> minus non op gains of HKD 194.704 mn = - (HKD 27.95 mn), negative
- gain on FV changes in cash consideration, HKD 194.704 mn, interest income from cash consideration of HKD 113.786mn
*2018: HKD 136.407mn --> minus non op gains of HKD 217,.567mn = - (HKD 81.16mn), negative
- gain on FV changes in FV cash consideration of HKD 57.258mn, interest income from cash consideration of HKD 160.309mn
*2019: HKD 834.05mn --> minus non op gains of HKD 946.0mn = -(HKD 111.95mn), negative
- remeasurement of consideration of HKD 607.9mn, change in FV cash consideration of HKD 128.744mn, interest income from cash consideration of HKD 209.352mn
2020: HKD 242.712mn --> minus non op gains of HKD 279.801mn = -(HKD 37.089mn), negative
- interest income from cash consideration of HKD 279.801mn

2021: HKD -1,080.234mn -> add back ECL from write down of HKD 1,320.614mn, subtract other inc HKD 273.714mn = -(HKD 33.3mn)

Some small adjustments might have been omitted, but bottomline is the underlying operations have been profitable from 2013 to 2015, but turned unprofitable from 2016-2021. Annual losses span from HKD 28mn to HKD 112mn.

However, important thing to note is that the net cash amount significantly dwarfs the annual run rate. At current market cap, and assuming the steepest loss in 2019 continues, it would take perhaps 4-5 years for market cap to roughly equal the net cash amount, and this also completely ignores the HKD 1.87 bn that is still due to PASL/ATN. The margin of safety in the price appears large.

AR links from 2013 - 2021
http://www.atnt.biz/fileDownload.php?newsType=report&fileName=annual_e0679_2013.pdf

http://www.atnt.biz/fileDownload.php?newsType=report&fileName=e00679_AR.pdf

http://www.atnt.biz/fileDownload.php?newsType=report&fileName=e00679_AR2015.pdf

http://www.atnt.biz/fileDownload.php?newsType=report&fileName=e2017.04.28_Annual%20Report%202016.pdf

http://www.atnt.biz/fileDownload.php?newsType=report&fileName=e2018.04.27_Annual%20Report%202017.pdf

http://www.atnt.biz/fileDownload.php?newsType=report&fileName=e2019.04.30_Annual%20Report%202018.pdf

http://www.atnt.biz/fileDownload.php?newsType=report&fileName=e2020.04.29_Annual%20Report%20for%202019.pdf

http://www.atnt.biz/fileDownload.php?newsType=report&fileName=e2021.04.29_Annual%20Report%20for%202020.pdf

http://www.atnt.biz/fileDownload.php?newsType=report&fileName=e2022.04.29_Annual%20Report%20for%202021.pdf

Why does this mispricing exist?
Some possible reasons I could think of:

i) Very illiquid shares
- the Chairman of the company, Lam Kwok Hing, owns a significant amount of shares, deemed to be interested in 273,391,167 shares, or approx 64.11% of shares outstanding.
- the stock has very thin liquidity. For e.g. in the month of August 2022, only 219k shares changed hands. That’s about HKD 204,180 in total transaction volume.

ii) the Cash Consideration has been hidden in balance sheet and does not screen well
- the cash consideration is being carried on the balance sheet under 'Deferred Consideration' ("DC")
- this is sort of unique and does not fit well into standardised stock screens.
- as aforementioned, on platforms like Bloomberg, the DC is placed under Other LT Assets.

iii) Shareholders weary
- the disposal of the Land had started in 2011, and it has been a full decade since.
- Shareholders could have turned weary from years and years of changes / amendments.

Main risks are credit risk of WS and non-return of capital to shareholders
i) Credit risk of WS
- one of the most obvious risks would be WS' inability to pay the remaining DC.
- however, should the remaining DC not be paid, the amount of net cash ATL is sitting on now already constitutes a large margin of safety at almost twice the market capitalisation

ii) Controlling shareholder turns out to be a crook
- the controlling shareholder is Lam Kwok Hing, Wilfred, who owns 64.11% of shares as aforementioned
- he is currently an executive director at Hong Kong Finance Investment (HKFI). ATN entered into a loan facility agreement with a wholly-owned subsidiary of HKFI, for an amount of HKD 130 mn (HKD 55.5mn drawn as of 31 Dec 2020), bearing interest at prime rate of around 5%, earning interest income of around HKD 3 mn annually for 3 years until Oct 2022. So far, this arrangement appears to be at arms length and nothing nefarious, with ATN also making some loans externally to independent 3Ps to earn interest on its large cash balance.
- in addition, he is a Justice of the Peace in Hong Kong as a 'non-official JP', which are in essence titles of honour meted out to community leaders.
https://www.info.gov.hk/jp//en/JPList_g_31b.htm
- not to be confused with another director at Heng Tai Consumables who has the same name but different person

iii) further delays
- there have been a few delays in the past, though in ATN's favour giving the rising property prices in Shenzhen
- however obviously China’s going through some property market turmoil right now
- Note that previous payment milestones have been performed duly so far.

- Also, Shenzhen is a developed area now and no longer the backwater it used to be

iv) Resource mismanagement
- Cash means for nothing if the company decides to destroy value by using it in unmeaningful ways.
- Currently, the company holds about HKD 33mn of trading debt instruments and 26.8mn in other trading investments in various listed companies. Although this amount isn't huge relative to cash balance, there are at least some questions regarding the necessity of such equity investments.
- Should ATN decide to hold onto their cash hoard without finding suitable investments, and yet decide not to pay it out as a special dividend, this could be a bad use of liquidity. Other issues that could happen would be investing the proceeds into unrelated businesses where the executives have no proper understanding/expertise. 1 potential reinvestment avenue could be the acquisition of an alternative manufacturing site, which I believe would be unwise to reinvest in an unprofitable business.
- I believe this to be the largest risk of this investment idea. Although the company has a history of paying dividends, there is no knowing what the next step would be, and the risk of not paying out excess liquidity should be considered by the investor, and hence sized accordingly in one's portfolio. Unfortunately I've not been able to get hold of management to understand the intentions better.

Catalyst

- Fulfilment of payment milestones.
- Special dividend. Should the business decide to pay out a special dividend, that would very likely unlock value.