It shouldn’t come as a surprise that I’m yet again investing some money in a Chinese company that is going private since I believe this is currently still an attractive corner in the merger arbitrage market. The company in question is China Energy, and they are going private in an unusual way: they are cashing out non-insiders at $0.14/share using a 1-for-12,000,000 reverse split. With the shares trading at $0.13 you are looking at a potential 7.7% return in what I perceive to be a low risk transaction.
China Energy is a tiny company with a $5.88M market cap, and actually buying shares might be one of the more difficult parts of this going private arbitrage. The CEO, Wenxiang Ding, owns 59.9% of the company and is expected to own the whole company after the reverse split since no-one else owns 12 million shares or more. The transaction is already approved by shareholders (read: the CEO) and the cash for the split will be coming from the the company’s balance sheet. China Energy expects that it will need to spend $3 million to complete the reverse split while there is $33 million in cash on the balance sheet.
I can hear you thinking: $33 million in cash and a $6 million market cap? This can’t be real! And that certainly could be the case here, we might be looking at fake financials. But at the same time I do think this transaction is highly likely to close. The CEO has been increasing his ownership stake in the company since 2011 using a share transfer agreement. The price paid is not disclosed, but I’m betting that there is some value left in China Energy Corp and that the CEO is going to get it at a bargain price.
The valuation report included in the proxy statement that is supposed to explain why $0.14/share is a fair price is a fun read. After using a 25% discount rate (!) for the expected cash flows from the company they added another 97% discount on top of this as an adjustment for “foreign currency controls imposed by the Chinese government”. Just shows you how you can get any number you want if you need a fair value appraisal for something.
Investors in China Energy Corp. have been screwed since they invested in the company, and I expect that the proposed transaction is just the icing on the cake where the CEO takes the remaining value at a bargain price. Because of this I actually expect that this deal is going to happen, and that the current spread between the market price and buyout price offers an attractive return. But if you would ever meet Wenxiang Ding: I recommend keeping a close eye on your wallet…
Long China Energy Corp.