Essar Energy and Camkids – spot the connection

Essar Energy (ESSR) is a FTSE-250 Indian oil company where minority shareholders are none too happy about a proposal from the majority owners (the Ruia family) to make a bid for the company at 70p. It floated at 420p in 2010 on the London Stock Exchange and joined the FTSE-100, but it has shown substantial losses in the last two years. Standard Life has described the move as “cynical opportunism” and seem to believe that the offer undervalues the future prospects of the business. The share price has been as low as 55p recently.

It was interesting to attend a presentation by Camkids (CAMK), a Chinese footwear and garment company, last night (17/2/2014) at a Mello event. Camkids is like many Chinese companies listed on overseas markets (in this case AIM) in that it now looks remarkably cheap on fundamentals, but buyers are still not in the market for the shares.

Here’s some of the key numbers: Forecast p/e of under 3 and forecast dividend yield of over 6%. The company has positive cashflow with RMB 294m in the bank (that’s £30m at the current rate of exchange equivalent to almost half the market cap). In addition it is growing quite rapidly and has a high return on capital. With a growing market for high quality children’s wear to the booming middle-classes in China (and a policy of only one child per family which might soon be relaxed), it looks well positioned. But since mid 2013 the share price has been heading downhill. Why?

The presentation by non-executive directors Jacques-Franck Dossin and Richard Sweet was competent, although it would have been good to have some samples of the companies products available. But it was when the questions came that doubts started to creep in. Here are some of the questions and answers (summarised and paraphrased for brevity) with some comments added:

Question: Has the Chairman or other directors bought shares in the company recently? Answer: No but having directors acquire shares may be seen as fine in some countries but we were advised it was not appropriate in the UK. Comment: I think this is referring to the grant of options or shares to non-executive directors as part of a remuneration package. But there is surely nothing to stop them buying shares in the market. It is generally a good idea for all directors to hold shares, but non-executives should not have such a large holding that it would prejudice their independence.

Question: Why were credit terms extended to 120 days? (this arose after it was pointed out that the debtors figure was very high (RMB 317m on annual revenue of about RMB 900m). Answer: This was necessary due to responses from competitors. Comment: this seems to be a common problem in Chinese companies. High debtors not just damage cash flow even if extending credit terms keeps the customers happy – it creates a very substantial risk of future write offs.

Question: What language is used in board meetings? Answer: both English and Chinese, but an interpreter is also available. As one of the directors said, “it’s a challenge”. It seems not all the non-execs speak any Chinese and the Executives are not all competent in English. Board meetings are generally held by telephone conference call, apart from the one held at the time of the AGM (which is in China). Comment: this must be an exceedingly tortuous process.

Question: Why did the company list (and a relatively small amount of shares placed)? Answer: It is important to be a listed company in China. Helps brand/company awareness.

Question: Why did the company list in the UK? Answer: There weren’t many options. Had looked at Hong Kong, but there was a long queue there.

Question: What is the dividend policy? Unable or unwilling to state.

Before summarising the reasons why investors may be wary of this company (as were many at the presentation), it’s worth looking at how this company stands up on the AIM Company Scorecard that ShareSoc issued in 2012 as an aid to investors (see  https://www.sharesoc.org/investor-academy/advanced-topics/aim-company-scorecard/if you wish to do a full analysis of this company). Note: this has been done without even reading the AIM prospectus as it would clearly not score highly anyway.

This company fails on the following questions:

1. Do the directors control less than 35% of the shares? No, the Executive Chairman holds 66%.

2. Is there an independent Non-Executive Chairman? No, there is an Executive Chairman.

3. Is there a majority of non-executives on the board? No, it’s 50/50.

4. Is the company registered in England or Scotland? No it’s registered in Jersey.

5. Is the company not registered in a tax haven such as the Channel Islands….? No its registered in Jersey.

6. Does the company hold its General Meetings at a convenient time or location? No – they are in China.

7. The company has a USP or substantial barriers to entry from competitors in the markets in which it operates? No, there were certainly no obvious barriers given in the presentation.

So in summary the Executive Chairman, Mr Zhang Congming, holds 66% of the shares and is likely to have control of the board. As with Essar, this puts him in position to dominate any “corporate actions”, which may or may not be in the interests of minority shareholders. This writer from past negative experiences of such situations simply does not invest in companies of this structure. The fact that Camkids is based in a remote country with historically lax standards in the business arena does not help either and for the private investor who cannot easily meet the key player and converse with him in English, it’s surely one to avoid. That might help to explain why the share price is in the doldrums.

The organiser of this meeting, David Stredder, did have one suggestion to tackle the above issues. That a “roadshow” for investors to visit Camkids and other Chinese companies be organised, at the expense of those companies. That might give investors more confidence, and would make an interesting trip. But it would not tackle the other issues given above in respect of Camkids.

Reminder: these blog posts are the personal views of the author alone.

Roger Lawson