Is the cash really there?

Some companies are sitting on a huge pile of cash, but there's still no sign of dividends
By TEH HOOI LING
SENIOR CORRESPONDENT

BASED on its latest available financial statements, that would be for the quarter ended Sept 30, 2008, C&G Industrial had a cash balance net of debts of about 408 million yuan. That worked out to cash per share of 0.87 yuan, or about 19.4 cents. As of yesterday, the manufacturer and distributor of PET chips and yarn products for the textile industry in China last changed hands at 8 cents a share.

Meanwhile, China's largest nylon manufacturer Li Heng's cash net of debts per share worked out to 23.6 cents. The shares last traded at 20.5 cents.

China Paper, which manufactures and distributes mixed-pulp based paper products to over 320 publishing houses, printing companies and other paper distributors throughout China, had 18.5 cents cash and no debts on its balance sheet as at end September 2008. Its share price, as of last Friday, was 16.5 cents.

At least in the former two companies, business prospects have taken a turn for the worse. Both have issued profit warnings. But for China Paper, its business seems to be still holding up well, based on its last financial reports.
Is the market being irrational? Well, maybe, maybe not!

As a head of research from a local broking firm quipped when asked to comment on the seemingly bottomless pit that China stocks are sinking into: 'All didn't do well in the results so far. Some are sitting on such embarrassing amount of cash, but there's still no sight of dividends for some. This raises the question: 'Is the cash really really there?' The Satyam Syndrome can be deadly if not treated early!'

Well even if the cash is there, if shareholders can only see and not touch, and worse still if investors can only watch while management fritter away the cash in unwise investments, then there are ample reasons for investors to place a discount on the cash.

Take the case of AEI Corporation. The manufacturer and trader of aluminium extrusion sections, metal materials and other related products, which was listed on the main board of Singapore Exchange in 2004, has been in a cash flow positive business. As at June 30, 2008, it had cash of $26.8 million, and no debts. That's down slightly from $28.5 million cash in the beginning of the year. The cash worked out to be about 10 cents per share.

Seeing such a clean balance sheet, and a business that, albeit small, was generating positive cash flow, some value investors no doubt would have been tempted to buy the stock. And to be fair, the company did pay out dividend of about one cent a share every year since it was listed in 2004. One cent, on its initial public offering price of 28 cents, worked out to a dividend yield of 3.6 per cent a year.

With over 200 million shares outstanding and a dividend payout of one cent a share, the total payout amounted to over $2 million a year. According to the group's cash flow statements, it generated cash of $10 million from its operations in 2007 and $3.5 million in 2006.

But the unfortunate part is how the management had decided to do with the cash that it had opted to retain.

In June 20, 2007, AEI granted Hoi Po Metal Manufacturing a convertible loan sum of HK$20.49 million ($4 million). Hoi Po owns Dongguan Gaobao Aluminium Mfy. Co and Dongguan Gaobao Aluminium Melting & Casting Mfy. Co. The former is engaged in the design, manufacture and sale of aluminium products and the latter in the melting and casting of aluminium products.

The proceeds of the convertible loan are for Hoi Po to acquire plant and machinery and its other working capital purposes.

The aim of granting the convertible loan is so that AEI, at its option, can acquire an equity stake in Hoi Po. That investment, according to AEI, would allow it to access Hoi Po's product design, mould making and extrusion technology. This would provide it a lower cost platform to expand its own production capacity. The rationale made sense.

Nine months after the convertible loan agreement, AEI announced that instead of converting the loan into shares in the capital of Hoi Po, it had on March 26, 2008, entered into a non-binding memorandum of understanding with Hoi Po to set up a joint venture company to manufacture and sell aluminium products in China. The joint venture company, however, would buy over the assets of Hoi Po's two subsidiaries. The assets, however, were mostly mortgaged to various financial institutions in Hong Kong and in China.

Two weeks ago, AEI announced that the global financial crisis had affected the proposed joint venture's business prospects. And because its offer to purchase the assets for the joint venture from the Hong Kong and China financiers at a discounted rate were unsuccessful, it has decided not to proceed with the joint venture.

It is now rigorously pursuing its claims against Hoi Po to repay the convertible loan of about $4.04 million. Until the amount is recovered, AEI said it has provided for impairment of the total outstanding convertible amount in the year ended Dec 31, 2008.

Ok, as mentioned, the initial rationale for making the convertible loan made sense. The current financial crisis was not anticipated. So it is indeed excusable that the deal didn't work out as planned. And the benefit of the doubt is given to the management for having done the proper due diligence before making that $4 million convertible loan.

But the second investment done by AEI is more perplexing. In July 2008, AEI said it had entered into another convertible loan agreement, this time with M2B World Asia Pacific.

The loan amount was US$2.5 million, from July 8, 2008 until July 7, 2010. And M2B is an Internet TV operator whose business model was unproven and which had yet to make any sustainably decent profits.

What's an aluminium extrusion company investing in an Internet TV operator? And worse still, M2B was actually to be injected into Auston in a reverse takeover deal. After evaluating the deal, the Singapore Exchange rejected the proposal of the reverse takeover in January 2008, presumably because SGX didn't think the M2B business model was viable.

So what's AEI doing extending a convertible loan to M2B after it was denied entry into the Singapore bourse by SGX?

AEI said the convertible loan, should it decide to convert, would 'allow it to diversify its investment portfolio and give it an opportunity to participate in the growing new media broadband industry'. Furthermore, the convertible loan would provide it an enhanced yield of 5 per cent per year, it added.

As of today, it is not known how M2B World Asia Pacific is doing. But in an environment where even the most established of businesses are struggling, it in inconceivable that one with an unproven business model can do well.

So given the management's rather questionable decisions, it is no wonder that AEI is trading at 6 cents compared with its cash per share of 10 cents a share.

But even for big companies with a large cash pile that we know with a great degree of certainty is there, there is no guarantee that the management will not try to be too clever with the management of their cash pile.

A case in point is Venture Corp. This week, the contract manufacturer reported an applaudable set of results. Adjusted for one-off items, net profit for the whole year registered a decline of 10 per cent to $280 million, not a bad performance at all when compared to the dismal results of its peers.

The drag - its fourth quarter net profit declined 94 per cent to $5 million - was due to an additional provision of $58 million for impairment in collaterised debt obligations (CDOs) that it bought in 2004.

Venture had bought CDOs in 2004 to improve returns on its cash pile. The CDOs held by Venture were worth about $209 million in late August last year. The current value, as at end December, was $18.8 million.

What business does an electronics manufacturer have investing in derivatives? The consolation is Venture has been managing its core business well, and has been pretty generous in distributing its cash as dividends as well. It declared a 50 cents dividend, or 12 per cent yield compared to its recently traded share price. And it's been doing that for the past four years. Which is why investors were cheering it yesterday, sending the stock 7.3 per cent higher despite a totally depressing day in the stock market. We're sure Venture has learnt its lesson.