I wrote in September that China Energy finally completed a reverse split to go private, and I expected that to be my last post about the company. But with every passing day since – without cash in my account – I started to wonder if I would actually get paid. With the shares suspended for trading you can’t do anything else than wait, and that finally paid off today.
Since starting this blog I haven’t had a single investment blow-up in my face, but this is not a sustainable track-record. It’s inevitable that some day I’ll buy something that will be a (near) zero, and that’s something that I try to keep in mind when I size my positions. Buying losers is part of the game: you just have to make sure that you aren’t betting the proverbial house. While it would of course have been unfortunate if China Energy would have been a zero it wouldn’t have blow a hole in my portfolio. It would just have shaved a couple percentage points off my return year to date.
This time really no position in CHGY anymore
I entered my position in China Energy almost exactly 6 months ago, and yesterday the reverse split was executed which can only mean the money is finally on it’s way to my account. I have mixed feelings about this outcome. I will realize an absolute return of roughly 7.5% which isn’t a whole lot given how long it took, and the fact that it certainly wasn’t a risk-free transaction. My thesis that the initiation of the going private process would only make sense if they indeed wanted to go through with it proved to be correct, but at the same time China Energy must be by far the most sketchy company I have ever invested in.
I doubt that any real alpha was created by participating in this transaction, and I think the easy money has mostly been made in the game of Chinese going private transactions. The majority of the companies that were real (or at least had some value) and had the capability to go private have done so by now. I’m still long WSP Holdings; this position luckily offers way more return potential, but it’s also a hairy situation. Wouldn’t call it easy money.
Technically still long China Energy Corp. until the cash hits my account
I entered my position in China Energy Corp. at the end of March with the expectation of making a low risk 8% return in a couple of months. The completion of the going private transaction is going slower than expected, but the transaction seems to be on track. The company filed a form 15-12G last week terminating the registration of the shares with the SEC while the reverse stock split was executed more than a month ago. So the going private transaction at $0.14/share is at this point in time really a done deal, but the shares are still trading unchanged around $0.13/share.
The fact that the shares are still trading after the reverse stock split was effectuated more than a month ago is normal I think for these kind of transactions. I owned a few shares of AssuranceAmerica in the beginning of this year. In this case the reverse split was effectuated on March 11, the form 15-12G was filed on March 26, the shares stopped trading almost a month later on April 16 and the money hit my account on May 10. If China Energy Corp. would follow a similar timeline you are looking at a ~6.5% return in ~six weeks time. That’s pretty attractive if you ask me, so I decided to buy a few more shares today.
Long China Energy Corp.
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.