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Nasdaq: China XD Plastics (CXDC)
Previously: Minority Shareholders vs. Morgan Stanley for Conflict of Interest as Fiduciary
* Case Update Oct 2019:
Morgan Stanley does the right thing and converts to common shares, cedes two board seats and quits buyout group and unfair buyout proposal. Morgan Stanley now aligned with minority shareholders, many of which invested on the back of the firm's reputation.
* Prior to Oct 2019:
China XD Plastics (NASDAQ: CXDC) is a chinese manufacturer of plastic for auto parts found in cars such as Audi, Toyota, Volkswagen as well as in local chinese brands. As fiduciaries, management and the the two board members from Morgan Stanley have a duty to act in the best interest of all shareholders by seeking to maximize the share price of the stock.
Since the February 2017 $5.21 non-binding buyout offer by CEO Jie Han (50% ownership) and Morgan Stanley (24% ownership and two board seats), however, a perverse incentive exists to see the share price of CXDC drop to entice minority shareholders to accept their offer. What used to be an active investor relations department seems a shadow of its former self before and since the offer while a near two year silence has put a price cap on the stock draining liquidity further hurting the price.
The current non-binding buyout offer is unjustified by any appraisal and represents less than 4X normalized earnings, less than 1/3 of revenue and only 50% of book value. The offer values the company at only $345 mm despite more than $1 bb in revenues. The offer is also at a third less than the $525 mm valuation at which management first accepted investor money when it listed in Nasdaq in 2009. In contrast, since then, revenues have increased 9X while normalized earnings have increased 18X to $90 mm. Similar US companies in the Russell 2000 and S&P500 as well as Chinese companies in the Shanghai Exchange trade close to 5X ($25 per share) the offer made by Chairman Han and Morgan Stanley.
Morgan Stanley, according to Reuters, has made a practice of buying out minority shareholders out of overseas-listed china companies while boasting of “…the most attractive entry prices we have seen in the last 10 years”, taking the company private and then relisting it closer to home at multiples of their initial investment. Billion dollar CXDC would be the crown jewel.
Management and Morgan Stanley board members should restart investor relations and buy back shares. If intention is to buy out minority shareholders and take the company private an independent reputable appraiser should be hired to value the company as promised two years ago. It is still time for CEO/Chairman Han and Morgan Stanley to live up to their fiduciary duties.
|Minority Shareholders||Current Shares (Approx.)||% Outstanding|
|1||Glenhill Advisors LLC||1,927,085||2.90%|
|2||Stifel Financial Corp||1,560,899||2.35%|
|3||Renaissance Technologies LLC||667,000||1.00%|
|4||Charles Schwab Corp||447,000||0.67%|
|5||Guerrilla Capital Management Inc.||389,000||0.59%|
|6||Bridgeway Capital Management LLC||358,300||0.54%|
|7||Stuyvesant Capital Management||300,000||0.45%|
|8||Top Ace Asset Management LLC||255,160||0.38%|
|9||Straus Capital Management LLC||202,500||0.30%|
|10||Teacher Retirement System of Texas||139,266||0.21%|
|Top 10 Minority Shareholders||6,306,873||9.40%|
|Other Minority Shareholders||11,567,076||17.24%|
|Total Minority Shareholders||17,873,949||26.64%|
|Founder & CEO||33,873,949||49.51%|
|Morgan Stanley (MSPEA)||16,000,000||23.85%|
DISCLOSURES: The creator of Proxy Grove is Atiq Advisors (atiqadvisors.com) an independent investment advisor whose clients are shareholders of China XD Plastics. Other participating investment advisors and/or investment management firms are in no way legally bound nor are they represented in the legal sense of the word by Proxy Grove in any way. As fiduciaries, participating firms share Proxy Grove's concern for their clients as minority shareholders of China XD Plastics. No part of the text contained in Proxy Grove should be taken to be investment advice or a recommendation to purchase shares of China XD Plastics. Proxy Grove has used conditional terms such as “could” “seem” or “may” that in no way reflect facts and are mere opinions of Proxy Grove. Readers are encouraged to fact check the contents of the China XD Plastics case which is not a case in the legal sense of the word. Any subjective judgments or opinions made regarding the unfairness or ethical character of China XD Plastics management or board with regards to the treatment of minority shareholders are only the author(s) opinions based on public information available. The text used to express the opinions of Proxy Grove is according to the colloquial usage of these words and do not qualify as legal standards in any jurisdiction. Proxy Grove has made best efforts to represent a summary of publicly available facts since China XD Plastics was listed and does not intend to present false information. Should there be any errors Proxy Grove will correct the mistakes as soon as possible upon any communication received. China XD Plastics board and management have been sent a link to the Proxy Grove website as well as all the questions posed by Proxy Grove therein through regular email as well as through www.chinaxd.net, the preferred communication channel as stated by China XD Plastics board of directors. The author(s) of Proxy Grove did not receive any compensation for expressing their opinions regarding the treatment of China XD Plastics minority shareholders.
Morgan Stanley converts to common shares and pulls out of unfair buyout group.
Proxy Grove reaches more than 4 mm. minority shareholders representing 6% of CXDC and close to the 6 mm. shares needed to block any unfair buyout proposal.
CXDC receives $135 mm. loan from bank consortium including Industrial and Commercial Bank of China, the world's biggest bank in assets.
CXDC is on track to more than $1.5 mm in revenues and more than $100 mm in earnings while company trades at less than $150 mm. valuation.
Since listing in 2009 and accepting investor money at a more than $500 mm valuation, China XD Plastics management has let the price decline by more than 80% at one point. In the mean time revenues have increased 9X to $1.2 bb while normalized earnings have increased 18X to $90 mm. It is time for management and the board to live up to the fiduciary duty of maximizing shareholder value they assumed when they listed in NASDAQ. In the meantime minority shareholders wait for
a fair buyout offer.
Share price of $1.32 values the company at $87 mm or approximately 1X normalized earnings. China XD Plastics has $60 mm in the bank and in October secures a $289 mm loan form China Construction Bank, the second biggest bank in the world in assets. Management states they will use the funds to retire more expensive debt and continue funding aggressive growth plan. No word about their buyout intentions.
China XD Plastics does not buy back shares even when the stock drops as low as $1.32 in December. Drop is on irrational sell orders, volumes and ask prices given thin market and do not seem consistent with profit maximizing sellers.
China XD Plastics seems to have pulled back investor relations completely letting the stock price languish. The company has not participated in any investor conferences since 2015, has cut down on discretionary press releases since 2016 and has withheld Sichuan expansion plans that could have
benefited the stock.
Nearly two years pass since minority shareholders are promised a Special Board Committee that will establish a fair value or justify pre-existing non-binding unfair offer of $5.21. In the mean time the $5.21 price places a ceiling on the stock while silence drains interest and volume further hurting the price.
Offer represents a small premium to market price but values the company at only $345 mm (fully diluted basis). This is less than a third of previous year revenue of $1.2 bb, 4.5x earnings and half of book value. Minority shareholders balk at low price as similar US companies at Russell 2000, S&P500 and Chinese companies at Shanghai Exchange trade at $1.67 bb or $25 per share. $25 is 5x the price offered to minority shareholders and inline with the returns Morgan Stanley can expect by relisting CXDC in Asia.
After failed efforts to improve market perception of the company founder, Chairman and CEO Mr. Jie Han (50% ownership) grows disillusioned with valuation and gives up on the US stock market. Along with Morgan Stanley (24% ownership) test the waters with an informal non-binding low-ball offer to buyout minority shareholders 26% stake at $5.21 per share.
Five years have passed since Morgan Stanley invested in convertible preferred shares. China XD Plastics has met all milestones to force the conversion to common shares at $6.25 as contemplated in the investment agreement but is given a pass without explanation.
CFO of China XD Plastics takes investors calls and answers questions openly while investor relations department does all it can to pull apart from frauds. Activities include road shows and a 3 day investors day for analysts and shareholders with presentations and a tour of the facilities and headquarters in Harbin China.
In the mean time China XD Plastics, a growth stock by any measure, continues to outperform financing expansion by raising $150 mm in bonds from western institutional investors including UBS and again Morgan Stanley. The offering is led by Fidelity Investments and is the first US bond issue by a chinese industrial plastics company.
Internet algos pick-up on blog claims driving a flury of “Have you been injured in a car accident?” type adds in yahoo finance. Headlines promote law firms that source business through bots and get picked-up again by more algos reinforcing the perception of wrong doing in a clear case of
guilty until proven innocent.
Morgan Stanley strategy is helped by retail short selling practice riding on the coat-tails of reputable and legitimate forensic accounting activists. Short seller blogs poorly researched report with typos and unsubstantiated outlandish claims that have to be taken back but not before profiting from shorting the stock.Photo: flickr.com
“Morgan Stanley (MSPEA) delisted Sihuan Pharma from Singapore in late 2009 before relisting the company in Hong Kong in November 2010. The firm has not fully exited, but expects to make around 8 times its initial investment when it does, said the source with knowledge of the firm, who declined to be named as details of the funds were private”.
20% returns produced by "textbook case of the profits Morgan Stanley has earned buying out overseas-listed China companies" at low-ball prices including Noah Education Holdings Ltd, Sino Gas International Holdings Inc. and Ping An Insurance Group, taking them private and then relisting them closer to home at market values.
CEO of Morgan Stanley MSPEA III fund Chin Chou, commenting on the strong performance of MSPEA I, II and III funds:
"...most attractive entry prices we have seen in the last 10 years”. A source with knowledge of the firm puts net returns above 20%.
Investment grants Morgan Stanley two out of nine board seats. Despite the scrutiny and vote of approval by Morgan Stanley shares trade at less than four times earnings.
Source: CXDC Presentation
Morgan Stanley’s biggest Asia private equity fund MSPEA III with $1.5 bb in assets recognizes an opportunity. After exhaustive due diligence given negative connotation of chinese reverse mergers invests $100 mm through convertible preferred shares.
Investment must be converted for 25% of the company at a $400 mm valuation ($6.25 per share) against milestones. 27% of the MSPEA III fund is funded directly by Morgan Stanley with the rest coming from clients.
Dark shadow is cast over the whole space with the market reasoning all chinese reverse mergers are frauds. Bloomberg Chinese Reverse Merger Index CHINARTO drops 60% in
full scale contagion.
Allegations break out over inflated revenue, value of facilities and inventory turnover at chinese reverse merger companies Sino-Forest Corp, China Forestry Holdings and Orient Paper Inc.
China XD Plastic listing is through the considerably less expensive “reverse merger” modality whereby companies merge with an already listed company. Warren Buffett’s Berkshire Hathaway listed though a reverse merger.
China XD Plastics lists through a reverse merger on NASDAQ in 2009 with revenues of $135 mm and net income of $5 mm raising $15 mm at a $525 mm valuation. The company raises $20 mm more in October 2010 at a PE ratio of 10X with a float of 30%. More than 300 chinese firms list in the US
through reverse mergers.
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China XD Plastics has grown revenues at 9X since listing in 2009. This is a 27% growth rate per year for the past nine years. During this time chinese national financing policy has focused on state run companies, which comprise around half of the economy. Despite CXDC raising capital through bond and equity offerings in the U.S, it has always been at absurdly high rates reflecting the tarnished chinese reverse merger sector and not China XD Plastics fundamentals. In 2014 the company reduced a Fidelity Investments led $350 mm bond offering by half given sky-high rates of 11.75%. Financing has always been the bottleneck at CXDC and is the main reason why the buy-out has stalled. Once financing for the buy-out is secured, a valuation based on a discounted cash flow model could be ready within a week.
While scaled-down investor relations activity could have this effect, it was not the intended goal. The main reason for scaling back presentations was the price and liquidity of the stock. Price and liquidity had dropped below the threshold at which institutional investors would have shown interest. At that point it did not make sense for management to participate in conferences to promote the company. A second reason was the founder growing disillusioned with the markets ability to value the shares fairly. A buy-out offer was to follow.
$5.21 per share price was a simple back-of-the-envelope calculation based on a premium to the market price at the time. The rationale being that if the market believed the company was worth the traded price offering a premium represented goodwill on behalf of Mr. Han and Morgan Stanley and would entice minority shareholders.
Mr. Han and Morgan Stanley have promised a valuation by a reputable firm is to follow. Financing the buy-out is currently the bottle neck not the valuation.
Buying back shares after the $5.21 offer would have influenced the price of the stock at a time when the market was evaluating the buy-out. Currency controls in china also hinder the company from buying back stock. As with scaled-down investor presentations, the intention of the company, or in this case, inaction, was not meant to depress the price of the stock.
According to company by-laws and the law of Nevada, where the company is registered, Mr. Han and Morgan Stanley could not force the buy-out and delist unless 90% of all shares are in agreement. If the threshold was met, however, minority shareholders holding out would be forced to sell and Mr. Han and Morgan Stanley would be free to list again in Asia at market prices if they chose to do so.
Mr. Han and Morgan Stanley currently have 73% of the 67,448,841 shares with Mr. Han owning 50% (33,574,898) and Morgan Stanley owning 24% (16,000,000). This means more than 65% of the 17,873,943 minority shares remaining would have to approve the $5.21 offer or any future offer that improves upon this price. Looked at from another perspective, 6,744,884, or 38% of minority shares, can block the buy-out and seek a higher offer. In the past Morgan Stanley has had to improve on their offer to entice minority shareholders to sell their US listed chinese companies.
China XD Plastics offered Morgan Stanley two out of eight board seats in exchange for a $100 mm investment in preferred D shares back in 2011. The only difference between preferred D shares and regular shares is that the former have first claim on any dividends distributed. The preferred D shares where convertible to regular shares at $6.25 (16 mm shares) if China XD Plastics met certain performance benchmarks, which it did and then some. Had the benchmarks not been met Morgan Stanley could have demanded a 15% annual return on their investment in cash or additional shares but that is no longer the case. As a show of goodwill for being a long-tem investor, China XD Plastics did not force the conversion, which would have required Morgan Stanley to relinquish their two board seats. Instead, China XD Plastics has extended their conversion window until January 1 2022.
The extension was granted on march 11 2019 and so is not completely clear yet as to the implications on the pending buy-out. On the surface there appear to be no implications. We will seek clarification from the company in the coming days.
While forcing the conversion of the preferred D shares would have made the shareholder structure of China XD Plastics simpler and therefore more attractive to investors having Morgan Stanley onboard should have been a net positive for the company. Morgan Stanley’s vote of approval will likely be recognized as such if China XD Plastics re-lists in the chinese-A-share market in the near future.