HPJ - Highpower International

[writser]

Another sketchy Chinese merger for those who are interested.

 

Highpower International, or HPJ, is a microcap (~$70m mcap) Chinese manufacturer of batteries. The market has long been super skeptical of HPJ, hence the ridiculous current valuation (5x earnings, 0.9x book or whatever). In June 2018 the company received a preliminary proposal from the CEO to take the company private at $4.80. Again, the market was super skeptical and shares traded down to as low as $2.40 in the space of a few months. Chinese preliminary proposals are very risky though, as Chinese buyers often seem to have a different opinion of what 'preliminary proposal' entails than other market participants and often opportunistically lower their bid, cancel their bid or wait for a few more years to smoke out minority holders (I've been burned by that before). Flash forward a few months: there is now a binding proposal on the table. Yet even shortly after the binding proposal was issued shares traded as low as ~$4.25 or a ~13% spread, before trading up to the current ~7% spread. The deal is expected to close in Q3 2019. Obviously, given the current spread and expected timeline, your IRR would be fantastic.

 

At this point I assume a few readers get itchy and want to scream: "They are Chinese, don't trust them! It's a fraud!". I would advise them not to buy this stock.

 

Anyway, is this a fraud? It's often hard to do any due diligence on these small Chinese companies, so of course I can't say I'm sure. One bad thing is that they've never paid out a dividend, so even if they make a profit, US shareholders don't get a share of the pie. Another thing to note is, that as a battery seller, they've been visiting lots of trade shows the last decade. At least we can verify that they actually had booths at these shows: link, link. And we can see that somebody actually built some of these booths: link. Their products also seem to be available at globalsources: link. So, maybe their financials are overstated but at least this seems to be a real company that has been spending money on tradeshows for over a decade. If they did so in a ploy to lure me into this company then, well, they deserve my money :) .

 

Now, onto the buying agreement. Insiders own ~32% of shares outstanding. They partner up with Essence International Capital, a financial firm that has been working on a lot of small IPO's in Hong Kong (link). The plan makes sense: ignore American shareholders for a few years, buy the company from exasperated shareholders on the cheap, possibly relist in Hong Kong or China a few years down the road. Common playbook for Chinese companies trading in the US. There is even a nice reverse termination fee: the acquirers have to pay $4.73m (section 9.03c) in case they breach the agreement or can't finance the deal within three days of all closing conditions having been met. You don't even see that in a lot of US mergers. I guess it's no big deal given that it is a pretty big firm that just has to raise ~$50m.

 

Vote required: a majority of the unaffiliated shares. Might be a problem, but the vote requirements are as low as they come and I guess many shareholders will eagerly get rid of this dog that has traded as low as $2.50 a few months ago.

 

Maximum number of dissenting shareholders: 10%. There's been a trend lately of shareholders of these Chinese takeunders dissenting (example). There's a risk that something similar will happen here but I judge that risk to be acceptable because 1) this is a microcap company so it will be difficult for dissenters to get a large stake and the risk/reward of litigation is perhaps less attractive and 2) so far, these cases have always been settled. The dissenters make some noise, the acquirers give them some extra money and everybody is happy (except for the small shareholders who get shafted).

 

All in all, this looks like a hated Chinese microcap that has been shafting US shareholders for a decade and is now trying to go private at a very cheap price, probably with the goal of relisting for double/triple the valuation in Hong Kong or China. Not the prettiest stock ever but I think the acquirers have the incentives to get the deal done. There is a definitive agreement, a nice reverse termination fee and they expect the deal to close in a few months. As for why the stock is trading at such as juicy spread: this deal is below the radar, US investors are skeptical (racist bias?) about anything Chinese (just read any message board about this stock), and it's a microcap company with low volume.

 

I bought ~2% position last week around ~$4.33. Bit larger than I usually size these Chinese mergers but I thought the spread at that time was way too big and this actually doesn't look too shaky to me. Of course I wouldn't recommend going all-in and this will probably blow up in my face. Also, it's been trading up the past few days and the risk/reward at $4.50 is obviously way worse than at $4.35.

[Foreign Tuffett]

Bumping this as I think it's a good idea. If the CEO is trying to screw over foreign shareholders, acquiring the company at a large premium to market price is a decidedly odd way to go about doing so.

 

If the CEO wanted to screw over shareholders he could just ignore them completely, then sit back and laugh as the share price withers on the vine.

 

Similarly, if the company is largely a fraud, entering into a definitive agreement to buyout outside shareholders for cash doesn't make much sense.

 

 

 

 

 

 

 

 

[Foreign Tuffett]

Q2 earnings are out. Sales up ~ 17 %, gross profit up ~62%, income from operations ~doubled (all Y/Y).

 

https://ir.highpowertech.com/press-releases/detail/581/highpower-international-reports-unaudited-second-quarter

 

OK, I think I get why the CEO wants to buy out the company. On that note: "The transaction is expected to close during the fourth quarter of 2019, pending approval by Highpower stockholders and satisfaction of certain other closing conditions."

[Foreign Tuffett]

It is a little disappointing that expected transaction close is now Q4 instead of Q3. Not a shock though, since definitive proxy has not been filed yet.

[writser]

Yeah the delay is a bit unfortunate. Seems like a very 'lucky' timed offer indeed!

[writser]

Finally an initial proxy statement (link). Good sign.

[writser]

Had a quick glance at the proxy.

 

Roth noted that, although the selected transactions were used for comparison purposes, no business of any selected company was either identical or directly comparable to the Company’s business. Accordingly, Roth’s comparison of selected companies to the Company and analyses of the results of such comparisons was not purely mathematical, but instead necessarily involved complex considerations and judgments concerning differences in financial, technological and operating characteristics and other factors that could affect the relative values of the selected companies and the Company.

 

Roth noted that the EV to LTM EBITDA multiple for the Merger at the Per Share Merger Consideration was below the low end of the range of the EV to LTM EBITDA multiples for the comparable transactions. Roth also noted that the price to LTM earnings multiple for the Merger at the Per Share Merger Consideration was below the low end of the range of the price to LTM EBITDA multiples for the comparable transactions. Roth noted that it conducted a market check at the direction of the Special Committee, and no party contacted by Roth expressed an interest in pursuing an acquisition of the Company.

 

No shit, at a TTM P/E of 6.8x :) . But of course Roth concluded in the end that this was a very fair transaction.

 

Notable that Essence refused to put the reverse termination fee in an escrow account and insisted on the < 10% dissenters closing condition.

 

Apart from that I didn't see anything exceptional. Looks like this is cruising to completion but there's always the China buyer risk and the dissenter risk. I still think the spread is juicy for a small position.

[writser]

New preliminary proxy is out. Most of the blanks were filled in and there is now a record date (16 September) and a meeting date (29 October). That's reasonably quick. Still preliminary though, so no guarantees. Also there is a new equity commitment letter: Essence International created a new vehicle in which private investors can invest that will hold HPJ. I.e. they are selling their exposure and are now a backstop rather than a primary buyer. So even more certainty regarding financing.

 

Apart from large dissenter lawsuits I see absolutely no reason why this deal wouldn't go through. As of September, 11 the company hasn't been notified of any lawsuit. And even if there are large dissenter lawsuits I think there's a large chance the matter will be settled and the deal will still go through. I think the large spread (7% upside for a few months) is mostly explained by the fact that this is an illiquid microcap and that US investors are paranoid (racist?) about any Chinese deal since the fraud spree a decade ago. Still a ~2% position for me and I still like it quite a bit.

[porcupine]

Voted for. Looks like this is going to happen.

 

Nice find, Writser.

 

 

[writser]

Yeah, it seems to me that the only bump in the road could be a large group of dissenting shareholders and that looks increasingly unlikely. So it basically looks like a done deal to me. On the other hand, shares traded as high as $4.74 yesterday or close to a 1% spread. So, not much risk but not much reward either. At this point I'm basically indifferent about selling vs. holding. I trimmed my position.

[writser]

Closed out my position today.