Foreland Fabrictech

[d.o.g.]

As Foreland's share price has fallen to $0.12 at today's close, the 4 placees under this placement should be feeling a little uneasy now!

If they were genuine investors they should have done their homework and been uneasy a long time ago.

A look at this company's IPO prospectus and financial statements, together with management decisions, throws up some red flags:

1. Research and Development

This company supposedly produces fabric with special properties. It claims in its IPO prospectus (page 104) that:

"We place great emphasis on research and development. We strongly believe that research and development form an integral part of our business and is crucial in providing us with a competitive edge."

But on the next page we read that:

"In FY2003, FY2004, FY2005 and 9M2006, our research and development expenses were not material as our research and development activities did not require substantial capital investment."

So apparently R&D is very important and forms a key part of their competitive edge, yet they don't spend a meaningful amount of money on it. This does not make any sense at all. Either R&D is important and they spend a measurable amount of money on it, or it's not important and they don't spend much.

Since the company doesn't spend much, it seems the second case is more likely. This would also be consistent with the ~40% decline in sales in 2009 versus 2008. A company with products where R&D is crucial should not see such a steep decline in sales even in bad times.

In other words, this company's products are not as special as they claim. In the financial crisis the orders went to their bigger competitors.

2. Share Placement

The company announced a share placement on 25 May 2011 to raise SGD 5.5m, or about RMB 28.6m. But the balance sheet for 31 Mar 2011 shows no debt and a cash balance of RMB 137m. So the fundraising was a waste of time. If the company truly needed money RMB 28.6m was too little compared to the RMB 137m already on hand.

Capital expenditure peaked in 2009 and has been declining:

2006: RMB 5.8m
2007: RMB 11.9m
2008: RMB 26.5m
2009: RMB 184.4m
2010: RMB 46.7m
1Q11: RMB 3.3m

It does not appear that the company is embarking on any major investments anytime soon. So they raised money for no reason at all. The stated reason was "general working capital purposes". Post-placement they went from RMB 137 cash to RMB 166m cash. What could they possibly achieve with RMB 166m that they couldn't legitimately do with RMB 137m?

Worse, the share placement destroyed shareholder value since reported NAV per share was RMB 1.14 or about SGD 21.8 cts. There was unnecessary dilution. The chairman Tsoi Kin Chit owned 64% of the stock pre-placement and let himself get diluted to 58%. He gave away 10% of his stake to raise a tiny amount of money. This does not appear to be a rational decision.

Maybe he's amazingly naïve and has no understanding of what his shares are truly worth. Or maybe he has reason to believe the shares are not worth their current market price, and he is happy to place out new shares at the current price. Or maybe there is some other reason.

As usual, YMMV.

[dydx]

Instead of just looking at Foreland's R&D expenses in the past years and drawing a conclusion, perhaps it is more useful to take a good look into (a) the wide range of functional fabrics Foreland has introduced since 2004, and (b) the list of international technology partners Foreland has collaborated with. These info are contained in p8/9 of the latest presentation slides for Foreland's Q1-FY11 results briefing.....
http://info.sgx.com/webcoranncatth.nsf/V...200043916/$file/Foreland1Q2011PPT.pdf?openelement
We have to bear in mind that as a producer of new and different types of high-end functional fabrics, Foreland's R&D efforts mostly concern (a) trying out new chemicals or formulations introduced by its international technology partners (mostly MNCs) to come out with new types of or improved-quality functional fabrics to meet demand from their customers or the market; (b) mastering different fabrics production and processing technologies which require Foreland's workers/managers doing trial-and-error work and learning, using existing production machines/equipment; and © investing in modern or the latest production machines/equipment capable of producing higher-quality functional fabrics. We have to also bear in mind that the key quality aspects for functional fabrics include, among others, (a) product consistency; and (b) durability of the functionality and performance built into the fabrics - e.g. how long, or after how many wash, is the anti-insect function supposed to last for? The technologies behind producing high-end functional fabrics do involve quite a lot of technical knowledge and industry-specific experience.

Most of Foreland's large capex in FY08-FY10 went into constructing the new and much bigger plant located in Andong Industrial Area, Jinjiang City, Fujian Province (see p12 of the latest presenation slides). In FY09-10, Foreland also invested in a few new production machines in the existing older plant located in Dongshi Town, Jinjiang City, Fujian Province (see p11 of the latest presentation slides).

While the just completed share placement does not appear very well-conceived, we have to bear in mind that the 45.0m new shares amounted to just 9% of the enlarged capital base - i.e. having a 9% dilutive impact on ownership and earnings for all the shareholders before the placement. By looking into the background of the 4 placees - including Asdew Acquisitions P/L (owned/controlled by Alan Wang, ex-stockbroker in Kim Eng): 24.5m shares; and Han Seng Juan (ex-stockbroker in UOB Kay Hian): 15.0m shares - I think it is quite clear that they are opportunistic in their approach, and have chosen their target well - Foreland is a clear 'recovery play', and the counter is clearly under-priced when compared with Foreland's current revenue/profit trajectories and much higher NAV/share. Whether the 4 placees intend to hold their shares as a longer-term investment, I don't know; but just looking at the background of the 2 of them, I would guess that chances for some good market activity on Foreland - when the right catalyst events happen in the future - are more than fair.

We should not judge Chairman Tsoi Kin Chit's decision agreeing to have the share placement so negatively. Foreland still needs to incur quite a lot of capex in the new plant located in Andong Industrial Area for further capacity increase. Bearing in mind Tsoi has been taking his dividends in scrip, his interest in Foreland should go up again after the payment of the latest Rmb0.02/share Final dividend for FY10. As someone unlikely to be savvy in investing, I really suspect Tsoi had succumbed to persuasion from some 'bad' advisor(s) into doing the share placement.

[dydx]

AmFraser has just issued a report on Foreland dated today (17Jun11) with a 'Buy' recommendation and a Fair Value estimate of $0.215 for the counter....
https://www.amfraser.com.sg/gcsg/downloa...062011.pdf

The report is based on a recent visit to Foreland's factory in Fujian by AmFraser's research team. Today, AmFraser has also issued a separate report entitled "China Textile Industry".....
https://www.amfraser.com.sg/gcsg/downloa...062011.pdf

[banker]

Executive Chairman Mr. Tsoi is selling 30.8 million shares..

"One of the major investors who will be taking up 20 million Shares, is the sole owner of one of the top ten customers of Foreland Fabrictech"

The 20mii mark is less than 5% of total shares. a) No reporting is required under substantial shareholders change b) no undertaking on the min holding period

His expectation is right....
"Additionally, I expect the Share Placement to increase our free float and potentially increase trading liquidity of our shares.”

http://info.sgx.com/webcoranncatth.nsf/V...200399EC2/$file/20110617_Chairman_Placement_press_release_Final.pdf?openelement


Until seeing this announcement, I was in "emotional dilemma" as I admire the analysis of both D.O.G and dydx.

[d.o.g.]

Mr Tsoi claims that:

"the primary consideration for this Share Placement is to enable us to forge a closer relationship with one of our major customers whom we consider as a long term strategic investor who sees growth potential in our industry as well as Foreland Fabrictech.
...
Additionally, I expect the Share Placement to increase our free float and potentially increase trading liquidity of our shares.”

Of the 30.8m shares being sold, 20m are going to the sole owner of a top ten customer. If forging a closer relationship is truly the intention of both seller and buyer, then the 20m shares will become a long-term holding and will not actually increase the free float nor the trading liquidity.

Only the 10.8m shares sold to other parties will actually increase the free float and (maybe) improve trading liquidity. 11m shares is an approximate 2% improvement in free float. I am not convinced this will meaningfully improve trading liquidity.

I wonder why the buyer is paying a 33% premium given that he could easily buy the shares in the open market over several weeks. He only needs to instruct his broker to buy for him, setting pricing and volume limits. The stock trades a few hundred thousand shares a day, and this year there were days when volume was in the millions. Since there are about 500m shares outstanding, after buying 20m shares he will only reach 4% and not have to disclose.

While I do not have any proof of nefarious intent, it seems highly unusual for any sensible person, whether a bona fide businessman or a stock market investor, to voluntarily pay a 33% premium. If anyone can put forth a few good reasons, I would like to hear them.

Note that in some cases there are valid reasons to pay a large premium, for example:

1. Takeovers, where getting control allows operational changes; or
2. There is a side letter that provides for unusually favourable business terms in future

#1 is not happening in this case. It has not been disclosed whether #2 is in operation. If #2 is the case, the terms might be injurious to the company as to pricing, credit terms etc. Only time will tell.

As usual, YMMV.

[dydx]

In trying to understand the latest share placement - 30.8m Foreland shares at $0.16/share - by Chairman Tsoi, we have to assume Tsoi and the few "strategic and sophisticated investors" involved (as placees) are not stupid, because (a) the placement price is at quite a large premium (33.33%) over the last done share price of $0.12, and (b) the total sum of $4.928m involved is quite large, by the norm of investment in quoted shares by individuals. While the sum involved is quite large for Tsoi as well, we should be willing to believe that he is doing the placement not primarily becuase he is in need of the money, as presumably, as an alternative, he could quite easily raise $5.0m from borrowings by pledging a portion of his Foreland shares.

We should also assume that the placees in this case must be mindful of the valuation of Foreland as a business and as a stock, at the least based on the current reports written by quite a few stockbrokers. Likely they have also toured Foreland's factory in Fujian and held lengthy discussions with Tsoi and his management team to review the company's latest financial results and expansion plans. Therefore, we can reasonably assume they have made careful and informed decisions in buying into Foreland.

Based on Foreland's transaction volume in the last 3 weeks (since 30May11), it would have been quite difficult for someone rich-enough to pick up or accumulate 20.0m shares, without pushing up the share price. It is also entirely possible that the placees already hold some shares in Foreland. Whatever it is, we can quite safely assume that the placees know Foreland as a business and Chairman Tsoi enough, to want to make a serious personal investment in the company in a share purchase deal with Tsoi, driven partly also by a business relationship with Foreland and/or a personal friendship with Tsoi.

[dydx]

I checked, and since Foreland's IPO in Apr07 at $0.21/share, Chairman Tsoi had bought Foreland shares from the open-market in 3 separate occasions -
- On 20Aug07, he added 650 lots at an average $0.396/share...
http://info.sgx.com/webcorannc.nsf/Annou...endocument
This shows Tsoi was an inexperienced investor then, probably became over-enthusiastic when he saw Foreland's share price going up when the business was booming before last global financial crisis.
- On 28Jul08, he added 88 lots at an avearge $0.19659/share...
http://info.sgx.com/webcorannc.nsf/Annou...endocument
- On 29Jul08, he added 190 lots at an average $0.19947/share...
http://info.sgx.com/webcorannc.nsf/Annou...endocument

Based on the above, can we say that Tsoi is making a small 'sacrifice' when he agreed to sell 30.8m Foreland shares at $0.16/share to the few "strategic and sophisticated investors" in the private share placement concluded on 17Jun11?

[d.o.g.]

we should be willing to believe that he is doing the placement not primarily becuase he is in need of the money, as presumably, as an alternative, he could quite easily raise $5.0m from borrowings by pledging a portion of his Foreland shares.

According to the 2010 Annual Report, all of Mr Tsoi's shares are held in the name of UOB Kay Hian Nominees Pte Ltd. As such, it is entirely possible that he has already pledged some or all of his stake to borrow money. The SGX does not require any shareholder to declare whether there is a lien against his shares.

Based on Foreland's transaction volume in the last 3 weeks (since 30May11), it would have been quite difficult for someone rich-enough to pick up or accumulate 20.0m shares, without pushing up the share price.

Anyone wanting to be a long term investor should be willing to take his time to buy the shares. After all the key buyer is a top 10 customer - he's not going away anytime soon.

we can quite safely assume that the placees know Foreland as a business and Chairman Tsoi enough, to want to make a serious personal investment in the company in a share purchase deal with Tsoi, driven partly also by a business relationship with Foreland and/or a personal friendship with Tsoi.

I personally try not to make any assumptions when I invest. Rather, I look at the facts and see what they imply.

The facts of the matter are:

The company held its IPO in Apr 2007. It sold 93.3m new shares and 22m vendor shares at $0.21. It raised RMB 86m in net proceeds. Mr Tsoi was a vendor and sold 10.5m of his shares in the IPO.

After IPO Mr Tsoi bought 928k shares on the open market for $313k total (average of $0.337). His last purchase was in Jul 2008, of 190k shares at $0.19947. He took his 2008 dividend in scrip, adding 9m shares at $0.078, at an implied cost of $720k. So his investments were about 10m shares for about $1m.

After IPO Mr Tsoi sold 2m shares twice (total 4m) to key managers as part of the Share Option scheme. Both times he sold the shares at $0.21 each.

As of 10 Mar 2011, all of Mr Tsoi's 290m shares were held by a nominee, with no disclosure whether they had been pledged to raise cash.

The company did a placement on 25 May 2011 of 45m shares at $0.1235, raising $5.58m or RMB 29m. The balance sheet of 31 Mar 2011 showed no debt and cash of RMB 137m.

Mr Tsoi is now selling 30.8m shares for $4.9m total. The buyers are paying a 33% premium. One of the buyers is a top 10 customer.

Let's look at the investments and divestments by Mr Tsoi since the IPO.

IPO:
sold 10.5m shares at $0.21 = $2.2m

Share Options (transfer to management):
23 Nov 2007: sold 2.06m shares at $0.21 = $432k
31 May 2008: sold 2.06m shares at $0.21 = $432k

Placement:
17 Jun 2011: selling 30.8m shares at $0.16 = $4.928m

Total proceeds from divestments: 45m shares for $8m

Total amount spent buying shares (open market plus scrip):
20 Aug 2007: bought 650k shares for $257k
28 Jul 2008: bought 88k shares for $17k
29 Jul 2008: bought 190k shares for $38k
29 Jun 2009: scrip dividend 9m shares @ $0.078 (implied cost $720k)

Total cost of investment: 10m shares for $1m

The amounts of money in each direction do not support a view of Mr Tsoi being very enthusiastic about his company. Note that because the share options came from his stake, 2 things occurred: 1) minority investors were not diluted, and 2) Mr Tsoi received the money, not the company.

can we say that Tsoi is making a small 'sacrifice' when he agreed to sell 30.8m Foreland shares at $0.16/share to the few "strategic and sophisticated investors" in the private share placement concluded on 17Jun11?

I will play the Devil's Advocate here.

Can we say that Tsoi's attempt to drive up interest in Foreland by buying shares worked since he spent $1m to buy 10m shares but will now be able to sell 30.8m shares for $4.9m?

As usual, YMMV, caveat emptor, do your own homework, etc etc.

[banker]

I've no answers for these questions.

1) The company did a placement on 25 May 2011. These strategic investors and 'key customer' could be allocated the placement shares. What an after thought to sell his own shares?

2) What is so spacial about his own shares which demand a premium of 33% when the new 45m shares were placed at $0.1235?

3) Why the 'key customer' conveniently choose to buy less than 5% of total shares?

4) It may be a time consuming a process to accumulate the 20-30mil shares from the market. But for the other investors who would be taking a portion of the remaining 10mil shares, it would be much cheaper to collect the few mil shares from the open market at a lower price. Why these people paying a higher price?

[freedom]

why did the key customer buy 20 million share from the chairman at a 33% premium a month later rather from the company?

if I were a key customer, even if I could not demand a discount, at least I would ask for the same price as the placement a month earlier. It is not like I were buying more share than the previous placement. especially, it only happened a month earlier

It does not look like a rational decision of the key customer. or is it a "real" key customer?