Time to close compulsory acquisition loophole that helps lowball privatisation offers succeed

DUTECH Holdings is one of those companies investors barely notice until it is too late.

Two weeks ago, the company's chairman and CEO Johnny Liu, through his privately-held TSI Metals HK, unveiled a voluntary cash offer at S$0.40 per share.

The stock, which had closed at S$0.25 before the announcement, jumped 60 per cent when the trading halt was lifted.

Is the game over? While the offer price for Dutech was a steep premium to its market price, it actually values the company at only S$142.6 million.

This is equivalent to 9.4 times the company's reported earnings of 73.3 million yuan (S$15.2 million) for 2020, and about 67 per cent of Dutech's net asset value (NAV) of 1.02 billion yuan as at Dec 31.

Dutech also happens to be sitting on a lot of cash - which is ironic given that it is in the business of producing safes and cash handling systems.

As at Dec 31, the company had a net cash position of nearly 367.4 million yuan. This is equivalent to more than 53 per cent of Dutech's current market value.

It is no wonder that Dr Liu wants to wrest the company from the hands of public shareholders.

Before his offer was unveiled, shares in Dutech were trading at less than six times its 2020 earnings and at a 58 per cent discount to NAV. More than 85 per cent of its market value was backed by cash.

Yet, unless a determined group of minority shareholders bands together to resist the offer, it seems likely that Dr Liu will succeed in taking Dutech private.

In the first place, Dr Liu already owns 152.4 million shares in Dutech - or some 42.76 per cent of the company - through a privately-held company called Spectacular Bright Corp.

His brother Liu Bin, who is executive vice-chairman of Dutech, owns a further 56.3 million shares - or 15.79 per cent of the company - through a privately-held company called Willalpha International.

Both Spectacular and Willalpha have already agreed to accept the offer. This immediately gives the offeror a total of 208.7 million shares in Dutech, or 58.54 per cent of the whole company.

Exploiting a loophole

More importantly, the offer appears to be structured in a manner that will enable Dr Liu to reach the compulsory acquisition threshold more easily.

Under Section 215 of the Companies Act, an offeror can exercise the right of compulsory acquisition once it obtains 90 per cent of a target company's shares that it and its related companies did not already own.

The wording of the law, however, enables individuals who are controlling shareholders of listed companies to have the shares they own count towards the 90 per cent acceptance threshold by setting up a special purpose vehicle to make the offer.

In the case of Dutech, the offeror - TSI Metals HK - is a Hong Kong company that was incorporated only on April 9, 2019. It has an issued share capital of HK$50,000 (S$8,540). Dr Liu is its sole shareholder and sole director.

To reach the 90 per cent threshold, the offeror needs to obtain only 112.2 million Dutech shares on top of the shares owned by the Liu brothers.

For the sake of illustration: if the Dutech shares held by the Liu brothers were not allowed to be counted in reaching the 90 per cent acceptance threshold, the offeror would have to obtain 133 million shares from minority shareholders, instead of 112.2 million shares.

In effect, the offeror would have to obtain nearly 95.9 per cent of the company's outstanding shares, not 90 per cent, before being able to exercise its rights of compulsory acquisition.

Big shareholders gain

This compulsory acquisition loophole is more potent the higher a controlling shareholder's stake in the target company.

For instance, in the case of Top Global, another listed company that is in the process of going private, controlling shareholder Sukmawati Widjaja held 86.77 per cent of the company before the offer. Her son Hano Maeloa held a further 0.19 per cent.

On May 24, the offeror - a company called SW Investment, which is wholly owned by Sukmawati Widjaja - said it had obtained 90.28 per cent of Top Global's outstanding shares.

Having breached the 90 per cent threshold, the offeror also said it would exercise its rights of compulsory acquisition.

If Sukmawati Widjaja and Hano Maeloa's shares in Top Global were excluded from the calculation, the offeror would have needed to obtain almost 98.7 per cent of its total outstanding shares before exercising its rights of compulsory acquisition.

Rule change required

Many market watchers will probably agree this compulsory acquisition loophole negates an important protection for minority shareholders.

In fact, the Companies Act Working Group (CAWG) set up by the Accounting and Corporate Regulatory Authority (ACRA) in 2018 to review several areas of the Companies Act has recommended changes to address the loophole.

Specifically, the CAWG wants to exclude from the calculation of the 90 per cent acceptance threshold shares held or acquired by corporate entities controlled by the transferee.

Other recommended exclusions include shares held by a person who would ordinarily act in accordance with the directions and wishes of the transferee; a person who is party to a share acquisition agreement with the transferee; and close relatives of the transferee.

Yet, there is no certainty that these recommendations will be accepted by lawmakers. And, even if they are, it could be more than a year before they are implemented.

According to a 2019 report from the CAWG, the Ministry of Finance (MOF) did not accept a recommendation back in 2011 that shares held by "associates" of an offeror be excluded from the calculation of the 90 per cent acceptance threshold.

The MOF argued then that the existing provisions had not given rise to any particular concerns. Moreover, the change would make it more difficult for an offeror to obtain full ownership of the target company, especially if the offeror already has a large stake in the company when the offer is made.

In my view, the MOF should review this position and take into account the large proportion of listed companies that are now trading below their book values.

One key reason listed companies are being prised from public investors at less than their full value is that many corporate boards have not done enough to unlock value - for instance, by distributing idle cash and offloading underperforming assets.

And, when privatisation offers are made, these same do-nothing directors rarely make a serious attempt to solicit alternative deals.

With such effete guardians of their interests on the boards of listed companies, minority shareholders need greater protection under the law to ensure they are not preyed upon by controlling shareholders.

• Note: The Mark To Market column will take a break for two weeks while the columnist recharges.