Description

Opus Group (OPG.AX) is an Australian penny stock book printer trading at about 2.3x net cash and 4.5x EV/EBIT.  Recent announcements of a special dividend and application for listing on the Hong Kong stock exchange suggest that the wheels are in motion for a return of capital over the next 2-3 years that in a best-case scenario could amount to 2.5-3x of the current share price if the full value of the listed shell is realized for shareholders, generating an IRR of about 35% or better.  I think the base-case scenario where the shell value does not materialize would still generate an IRR above 10%, given a free cash flow yield of 13.5%, a 93% payout ratio over the past three years, excess cash that could be distributed, and management with a track record of creating significant shareholder value in the printing industry. The opportunity exists because the selling shareholders based in Australia likely have no knowledge of the Hong Kong-based management’s track record or the hidden value that could be unlocked if the company successfully lists on the main board of the Hong Kong stock exchange.  Based on what I know about CK Lau, the Chairman of controlling Lion Rock Group and mastermind behind this move, I would put the odds of a best-case scenario at somewhat better than a coin flip; heads you win a reasonable amount, tails you win a lot.

For background of Opus and its parent company, Lion Rock Group (1127:HK), please refer to my write-up on 1010 Printing (old company name).  The write-up covers the recapitalization and subsequent turnaround of Opus by Lion Rock starting in July 2014. In the past three years, although hopes for increased utilization of their capacity have not yet panned out, the business has stabilized and generated significant free cash flow from operations, noncore disposals, and working capital improvements.

Timeline of significant events:

Noncore Asset Sales

Prior to nearly going bankrupt, Opus rolled up several businesses related to printing.  After the recapitalization, new management determined that synergies between these divisions were very limited. In total, Opus generated A$16.5m of cash from selling noncore businesses.

October 30, 2015 – Sale of New Zealand Outdoor Media Business

http://opusgroup.com.au/InvestorCentre/Announcements/pdf-20151030.pdf

March 29, 2016 – Sale of Singapore Division, A$11.3m

http://opusgroup.com.au/InvestorCentre/Announcements/1540027.pdf

August 1, 2016 – Sale of Australian Outdoor Division

http://opusgroup.com.au/InvestorCentre/Announcements/1577924.pdf

Return of Capital

Following the noncore asset disposals and cost cutting efforts, Opus turned its focus to return on capital.  Despite the lack of liquidity in its shares, the Company was able to repurchase about 10% of its shares outstanding, some of which came from block sales.

November 7, 2016 – Share Buyback Program announced, 20m shares

http://opusgroup.com.au/InvestorCentre/Announcements/1615047.pdf

December 11, 2017 – End of Share Buyback announced, 11m shares repurchased in total

http://opusgroup.com.au/InvestorCentre/Announcements/1750907.pdf

June 14, 2018 – Special Dividend Announced, ex-date August 7, 2018

http://opusgroup.com.au/InvestorCentre/Announcements/03SpecialDividend.pdf

The ex-date for the special dividend is August 7, 2018.  The Company will pay out 13 cents per share fully franked, which will use about A$13.1m of net cash.  The Company will likely earn at least A$3m and paid out a A$1m dividend earlier this year, so net cash immediately after the special dividend is paid will be about A$14.5m.  Assuming the current market cap of A$57m, the valuation will change as follows:

After this special dividend is paid, the Company will have returned 93% of free cash flow and asset sales proceeds from the last two and a half years through regular and special dividends.  Given the Company’s strong cash position and the unlikelihood of significant acquisitions or capital outlays, I think we can expect this level of payout to continue in the future, perhaps with some lumpiness.  Assuming stable business performance, Opus should pay out at least another A$15m over the next three years, which should still generate a reasonable return for shareholders if for some reason the application for listing in Hong Kong fails.

Listing in Hong Kong

With three consecutive years of profitability and a controlling shareholder listed in Hong Kong, Opus Group has a legitimate case for leaving the ASX and relisting in Hong Kong.  The main advantage of this move is that Opus is worth more dead on the Hong Kong Stock Exchange than alive on the ASX.

June 14, 2018 – Opus executes scheme implementation agreement to effect re-domiciliation to Bermuda with HKEx listing

http://opusgroup.com.au/InvestorCentre/Announcements/01Redomiciliation.pdf

http://www.lionrockgrouphk.com/pdf/investor/20180614/EW_Lion_Rock_-_inside_information_announcement_(2018.6.14).pdf

June 16, 2018 – Application for listing on the Stock Exchange of Hong Kong

http://opusgroup.com.au/InvestorCentre/Announcements/1811766.pdf

I would refer readers again to the 1010 Printing write-up to recall what happened the last time CK controlled two listed companies in Hong Kong:

“In August 2015, ER2 Holdings sold its controlling stake in Cinderella Media for HK$2.04 per share, triggering a mandatory takeover offer for all remaining shares at that price (was not fully subscribed as shares have traded above that price since).”

For those shares that were tendered, the new controlling shareholders restored the public float (25% minimum float requirement to stay listed in Hong Kong) by selling down part of their stake and issuing new shares slightly above the offer price.

http://www.hkexnews.hk/listedco/listconews/SEHK/2015/0709/LTN201507091057.pdf

Cinderella Media at the time was essentially a shell, as the inflight magazine advertising contracts were expiring and 1010 Printing shares had been spun out to shareholders.  However, the Company was still able to meet ongoing listing requirements due to the presence of the Recruit Magazine and website segment, a recruitment advertising business that was still generating more than HK$60 million of annual revenue and operating profit of about HK$5m.  The Company also retained an investment property carried at a value of HK$29m.

Listed shells in Hong Kong have substantial value given a low supply of clean shells and strong demand from buyers who want to list assets that may not otherwise qualify for a new listing.  However, minority shareholders almost never receive that value when there is a change of control and backdoor dealings between the buyer and selling controlling shareholder via offshore bank accounts are commonplace.  Clean shells on the Growth Enterprise Market can fetch about HK$300m while market value of main board shells can be HK$500m or higher. The sale of Cinderella Media implied a shell value of about HK$600m, assuming fair value of the investment property and 10x EV/EBIT for Recruit, and this was the only Hong Kong shell transaction I have yet to see where minority shareholders also had an opportunity to tender their shares at a fair price.  Opus Group’s current market cap is about HK$370m, so the value of the company’s listing on the Hong Kong main board alone could be worth more than its market cap.

Key Risk – Proposed Changes to SFC and HKEx Regulations

The landscape for shell companies and Reverse Takeovers (RTO) is evolving in recent years.  The SFC, the securities regulator in Hong Kong, and the Hong Kong Exchange have taken a generally negative view on shell companies and RTOs given their tendency to circumvent new listing requirements.  The HKEx is establishing a principle-based framework to bring more transactions within the scope of the RTO rules, under which they would be subject to new listing requirements. However, the HKEx has to walk a fine line not to restrict listed issuers from legitimate business expansion or diversification activities.  Past regulation has not closed the window on RTO transactions; if anything, shell values have increased moderately due to persistent demand and more restricted supply of listed shells. Proposed regulation going forward is expected to have an impact on both supply and demand, but it is unclear what the net impact on shell values will be.

The following links contain background information on the current situation, with all quoted text in italics:

July 3, 2015 – Tencent deal throws spotlight on Hong Kong backdoor listings

https://www.reuters.com/article/us-hongkong-shellcompany/tencent-deal-throws-spotlight-on-hong-kong-backdoor-listings-idUSKCN0PD01F20150703

“Nearly 140 Hong Kong-listed shell companies were bought between January 2013 and April 2015, according to a study done by Timothy Shen, chief investment officer of money manager World Tops Alliance, who wants to become a serial “shell company buyer.””

“Another equity capital market lawyer said demand for shells had gone “crazy”, adding that he is currently working on two such deals. The market rate for a shell has risen significantly in the past two years and now stands at between HK$300 million ($38.7 million) and HK$500 million, depending on the nature of the shell and its compliance history, he said.

Purchasing a shell is, however, far from straightforward and carries risk for the acquirer.

Deals have to be carefully structured so as not to trigger the Hong Kong stock exchange’s reverse takeover clause, the threshold for which depends on the nature, size, and timing of assets injected.

Deals classed as reverse takeovers must jump regulatory hurdles that are on a par with those of a normal IPO, although a reverse takeover is still considered a faster route to market.

In a statement, the HKEx said that shell purchases that do not trigger the reverse takeover clause may still be subject to “enhanced disclosure and vetting” and added that it had “conducted a number of reviews of the rules in recent years to improve the regulation of reverse takeovers and backdoor listings, and will continue to do so”.”

January 20, 2017 – Recent Developments in Corporate Transactions Involving Shell Companies Listed on the Hong Kong Stock Exchange

https://www.omm.com/resources/alerts-and-publications/publications/recent-developments-on-corporate-transactions-involving-shell-companies-listed-on-the-hkse/

“Key Considerations in Structuring Corporate Transactions for Shell Companies

·         Do not ignore or under-estimate the principle based test

·         There is no one single factor or threshold in determining whether the size of a transaction is extreme

·         Disposal of unwanted assets shall only be carried out at an appropriate time

·         Changing the shell company’s business gradually through a series of small scale acquisitions, business combinations and organic expansions could be the way forward”

“Without doubt, backdoor listings will continue to be an important part of the corporate finance activities in Hong Kong. The horrendously long queue of companies waiting to complete their A-share listings in the PRC will continue to provide incentives for PRC entities to seek a backdoor listing of their businesses on the HKSE. Notwithstanding the issues and considerations discussed above, the HKSE is not deterring valid and legitimate transactions but it will be vigilant in screening out those transactions that cannot meet the applicable requirements in its continued attempt to maintain market quality and protect shareholders’ and investors’ interests.”

July 16, 2017 – Shell companies are bad for Hong Kong’s market reputation, SFC chairman says

https://www.scmp.com/business/banking-finance/article/2102708/shell-companies-are-bad-hong-kongs-market-reputation-sfc

“During a recent meeting between the SFC and China Securities Regulatory Commission (CSRC) chairman Liu Shiyu, the Chinese regulator expressed concern about so-called “con stocks” (千股), which are penny stocks that go through repeated splits to raise more funds from investors, even though the company does not have any profitable business.

These schemes have caught many mainland investors unaware, resulting in lost investments. Tong has said he wants to crack down on such stocks and activities.

“The SFC is opposed to these activities,” Tong said. “Stock listings should be aimed at raising funds to expand businesses. Shell companies should not be listed as they are bad for the reputation of the Hong Kong market.””

August 2017 – Delisting “Shell” Companies in the Main Board

http://www.onc.hk/en_US/delisting-shell-companies-main-board/

“With the Stock Exchange extending its scrutiny to Main Board companies, it is evident that robust efforts are being made to cleanse the Hong Kong stock market of “zombie stocks” and shell companies. The Stock Exchange’s actions are in line with its vision to raise the standards and quality of Main Board and GEM issuers as indicated in the Stock Exchange’s consultation paper published in June 2017, “Review of GEM and Changes to the GEM and Main Board Listing Rules”.  The Victory Group incident serves as a reminder for listed companies to ensure compliance with the continuing obligations under the Listing Rules and the GEM Listing Rules, such as maintaining a sufficient level of operations and public float, to avoid falling victim to delisting proceedings.”

June 30, 2018 – Hong Kong exchange explores rule change to curb back-door listings, formation of shell companies

https://www.scmp.com/business/banking-finance/article/2153181/hong-kong-exchange-explores-rule-change-curb-back-door

“As part of its crackdown, the HKEX proposed banning listed companies from major disposals of business or assets within 36 months of a change of control.

The bourse will also tighten its review on new buyers to make sure they are qualified, in a bid to prohibit low-quality companies from gaining access through the back-door channel instead of an initial public offering.

“Our proposals are targeted at shell activities and seek to address specific identified issues. They are not intended to restrict listed issuers from legitimate business expansion or diversification that are part of the issuers’ business strategies,” Graham said.

“We are mindful of the impact of the proposed changes to the continuing listing criteria on a limited number of issuers. Under the proposals, there will be a transitional period of 12 months for those issuers to take corporate actions to comply with the rules as amended.”

The Securities and Futures Commission issued a statement supporting the HKEX proposal, saying it was in line with reforms in recent years, including rules designed to curb sharp share price movements of GEM stocks on their trading debuts and highly dilutive capital-raisings that are prejudicial to minority shareholders.

“We will continue to focus on behaviour in the listed market which is harmful to the investing public. We will not hesitate to step in at an early stage under our ‘front-loaded’ approach where we see misconduct or other serious issues which justify intervention under the Securities and Futures Ordinance,” said Ashley Alder, chief executive of the SFC.”

June 29, 2018 - Exchange seeks view on proposed rule changes relating to backdoor listing, continuing listing criteria and other rule amendments

http://www.hkex.com.hk/News/News-Release/2018/180629news?sc_lang=en

“The Exchange is applying a three-pronged approach in curbing shell activities: first, tightening its suitability review of new applicants to address concerns on shell creation through IPOs; second, enhancing the continuing listing criteria for listed issuers to deter the manufacturing and maintenance of listed shells; and third, tightening the RTO Rules to prevent backdoor listings particularly those involving shell companies,” said David Graham, HKEX Head of Listing.  “While shell activities are limited to a small segment of our market, they undermine investors’ confidence and overall market quality. At this point there is a need to formalise our guidance into the Rules, and to make Rule amendments to address some issues in a more effective manner.”

“Series of transactions and/or arrangements - Include transactions and/or arrangements that are in reasonable proximity (normally within 36 months) or are otherwise related, and may include changes in control/ de facto control, acquisitions, disposals or termination of the original businesses, and in some circumstances, greenfield operations or equity fundraisings related to acquisitions of new lines of businesses.

The entire series of transactions and/or arrangements would be treated as if it were one transaction (consequently, a disposal may trigger an RTO ruling on a previously completed acquisition in the same series, or a number of smaller acquisitions may form an RTO).”

“II.       Proposals relating to continuing listing criteria

The proposed amendments to the continuing listing criteria aim to address specific concerns about some issuers that attempt to maintain the listing status by holding significant assets or investments, rather than operating businesses that have substance and are viable and sustainable in the longer term:

(a)      Amend Rule 13.24 (sufficiency of operations)               

Requires a listed issuer to carry out a business with a sufficient level of operations and assets of sufficient value to warrant its continued listing (and not sufficient operations or assets set out in the current Rule).  This excludes any securities trading and/or investment activities (other than a Chapter 21 investment company). A listed issuer would not meet this Rule if it does not operate a business that has substance and/or is viable and sustainable.”

Potential Impact of HKEx Proposals on the Value of Opus Group as a Hong Kong Listing

The HKEx Proposals, once implemented, will impact both supply and demand of listed shells for RTO activity.  On the supply side, it will become more difficult for shells to stay listed as issuers will be required to maintain both a business with a sufficient level of operations and assets of a sufficient value, rather than one or the other as the current rule states.  On the demand side, the proposals broaden the scope of what constitutes an RTO. Most importantly, a string of transactions over a period of 36 months can now be considered as part of a single transaction, which makes it more difficult for issuers to inject assets without appearing on the Listing Committee’s radar for “extreme transactions” and triggering either an application of the RTO rules or requirements for enhanced vetting and disclosure.

If we apply the new HKEx proposals to the Cinderella Media transaction from 2015 to the present, the good news is that it does not appear that the transaction would qualify as an RTO or extreme transaction.  We believe that CK was very careful to find a trustworthy buyer who intended to operate the listed vehicle in such a way that would not attract regulatory scrutiny or negatively impact his own reputation. Following the change of control, Cinderella Media (now KK Holdings) acquired a train media company with exclusive rights to sell and place advertising on the interior and exterior of 22 trains operating on the Guangzhou-Shenzhen High Speed Rail line.  Given the size and nature of this acquisition, it qualified as “legitimate business expansion or diversification.” It’s notable that despite what must have been a significantly narrowed pool of buyers, Cinderella Media was still able to secure an above average offer price for the listing.

http://www.kk-culture.com/?page_id=82&lang=en

Opus Group will have no problem maintaining listing status with a comfortably profitable business and a net cash position.  It’s likely that a broadened definition of what constitutes an RTO will soften demand for listed shells, but it’s unclear that this will result in lower shell values, given the increased restrictions on supply.  In the case of Cinderella Media, a buyer with no intention of testing the exchange’s limits on extreme transactions was still willing to pay a premium of HK$600 million. Following the special dividend in August 2018, Opus will have a market capitalization of HK$290 million, which arguably undervalues the business and excess cash on the balance sheet alone.  Any shell premium that can be realized in a timely fashion would be icing on the cake. The challenge will be to find the right buyer with a strategy that will not trigger the RTO rules, which relies largely on CK’s Rolodex. Given his track record of pulling rabbits out of his hat, I think it’s more likely than not that a deal gets done. In the meantime, shareholders should enjoy a pretty attractive dividend yield.

A successful deal here will also have very positive implications for the listed parent, Lion Rock Group (1127:HK), which also looks quite cheap here.  If there is not sufficient liquidity in Opus shares, I would recommend using Lion Rock to fill out a position.

Catalyst

Special Dividend in August

Successful listing on HKSE by end of 2018

Potential realization of shell value in 2-3 years

High FCF yield and high payout ratio, potential for distribution of excess cash