Monthly Archives: January 2013

ShangPharma (SHP) going private

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ShangPharma announced at the end of December that it has reached a definitive merger agreement for a going private transaction. The company intents to pay shareholders $9.00 per ADS (minus a 0.05$ ADS cancellation fee) and expects to close the transaction in the first half of 2013. With the shares currently trading around $8.57 a successful transaction would generate a 4.4% return. This is certainly above average, but is it also above average risky?

Going private transactions in China

I wrote a few paragraphs about this subject in my post on Nuokang, and I’m not going to repeat that. One interesting thing to note is that all going private transactions mentioned in that post have been completed successfully with the exception of Nuokang itself, but that’s not a surprise since this was the only deal that was scheduled to be completed in the first quarter of 2013. So far the Nuokang deal also seems to be progressing as planned, and I expect it to close this month shortly after the extraordinary general meeting of shareholders on January 15. Even the Fushi Copperweld (FSIN) deal closed last year.

ShangPharma Corporation

The obvious question to ask when looking at something Chinese is, “is it a fraud?”. The most important check is in my opinion looking at the history of debt offerings, equity and insider sales. If you want to defraud investors you need to sell them something first.

ShangPharma went public (prospectus) at the end of 2010. The company sold 3.2M ADSs at $15, raising $44.6M after fees and insiders sold 2.6M shares for a $36M payday. Before the IPO directors and executive officers owned 74.9% of the company, and after the IPO this percentage dropped to 55.8%. Since then there were no big changes in the ownership structure: today directors and executive officers as a group own 55.5% of the company. The company never issued debt, and last year both the company and the CEO bought back stock. So while the IPO created a nice payday there isn’t a pattern of insiders trying to sell whatever they can to outsiders suckers.

Related party transactions (or other significant transactions) also deserve to be examined. Because once you have raised cash from shareholders you need a little bit of creativity to let it disappear. With most of the cash that was raised in the IPO still on the balance sheet there doesn’t seem to be a big problem in this area. I would have liked to have seen a bit less related party transactions though: I would guess that ~10% of revenue is paid to suppliers that are related to the CEO.

One thing that is good to see is that the financials aren’t great. If the numbers aren’t real, why would you report declining income and declining margins? At the same time the numbers are still good enough that you would think that the buyers are getting a good deal at the offering price. That’s of course also important: you want that the buyers are motivated to complete the deal, otherwise you risk that they find an excuse to walk away.

So ShangPharma passes my “is it real” smell test, but that’s not the only thing that could stand in the way of a successful transaction: most notably financing and shareholder approval could be an issue. Based on the proxy statement released by the company those two risks seems to be quite small. The buyer group does have financing available, and they also have enough voting power to approve the deal. The buyer group controls 66.9% of the outstanding shares while 66.7% of votes are required to approve the transaction.

Conclusion

The possible return of this merger arbitrage deal is limited, but I think the same can be said about the related risks. I don’t think the deal is significantly more risky than the average deal, yet at the same time the market is offering a significant above average return. That sounds like a good combination to me. Making a 4.4% return in three months time isn’t bad.

Disclosure

Long SHP & NKBP

2012 Year in review

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Reviewing the performance of something that contains a lot of luck and variance is always difficult. Evaluating your capabilities as a poker player based on just 10,000 hands is not going to tell you a whole lot, and the same can be said about looking at investment results with a one year time frame. But at the same time you can’t ignore results. If you are losing a lot of money it’s probably time to rethink what you are doing, and if you are making money it’s a bit more likely you are doing something right.

That’s probably all you can conclude when looking at investment results. As a poker player you can calculate a confidence interval around the realized win rate reasonable accurate assuming a normal distribution. When looking at a small sample size you find that the interval is huge, but at least you know how much uncertainty there is in your results. The same can not be said about investment results. You don’t know the underlying distribution of the stock market, you don’t know what the variance is and you don’t know how many ‘independent’ bets you really made. Getting good results when you invest in ten different companies in ten different countries and ten different industries is way more relevant than getting good results when investing in ten Italian banks (to name something random).

So keep the above in mind when looking at the 2012 results of my value picks:

Ticker Purchase Date Entry* Sell Date Dividend Exit** Return
TLI.L Nov 21, 2012 42.50 – – 47.75 12.35%
CDU.LS Sep 27, 2012 22.00 – – 22.00 0.00%
AIG Sep 10, 2012 33.26 – – 35.30 6.13%
RELLA.CO July 19, 2012 32.20 – – 37.20 15.53%
ORGN.PK May 10, 2012 1.45 Aug 28, 2012 0.38 1.45 26.1%
CNRD.PK Mar 29, 2012 16.50 – 2.00 18.50 24.24%
SODI.OB Mar 26, 2012 3.09 – – 3.45 11.65%
DSWL Mar 6, 2012 2.11 – 0.27 2.40 26.54%
SALM Feb 21, 2012 2.65 – 0.14 5.46 111.32%
IAM.TO Jan 24, 2012 0.59 – 0.05 0.48 -10.17%
ARGO.L Jan 3, 2012 14.69 – 1.30 12.50 -6,06%
URB-A.TO Nov 28, 2011 0.89 Oct 25, 2012 – 0.90 1.12%
0684.HK Nov 16, 2011 2.07 – 0.15 2.26 16.43%
ASFI Nov 7, 2011 7.98 – 0.14 9.51 20.93%
Average 18.87%

* Entry price or closing price 2011
** Exit price or closing price 2012

Think it’s obvious that I can be pretty happy with 2012. The stocks listed above aren’t my complete portfolio nor do I buy equal weighted positions. Thanks to various special situations that mostly worked out favorable the real result is actually a little bit higher despite an undisclosed position that managed to lose ~80% of market value.

While the short-term results are nice I think it’s way more important that I can look back at some of my older write-ups, and spot multiple mistakes. I learned a lot last year, and that counts for way more than the realized performance. Hopefully next year I will be able to look back at my more recent write-ups and say almost the same. I would like to see a declining trend in the frequency and the significance of my mistakes :). It’s my intention to do at least once a year a thorough review of my positions, so you can expect some fresh write-ups on my older positions in the near future. If possible I try to do this after the company released their latest annual or quarterly report so in practice it might be a bit earlier or later than a year after the initiation of my position.

Disclosure

Long everything in the above list, except the positions marked as sold.