PREMIUM SEARCH Search by job title, geography and build a list of executive contacts
Christmas isn't coming this year -- at least not for minority shareholders in one of the world's largest plastic Christmas tree makers. They're left with lumps of coal, while the sweets go to company insiders and Carlyle Group, a Washington (D.C.) equity-investment outfit.
Minority shareholders have a long tradition of getting shafted by controlling families in Hong Kong -- indeed, throughout much of Asia. Over the years, Hong Kong regulators have tried to stop the worst of the abuses, but to no avail. It's still "buyer beware." That's the hard lesson just learned anew by independent shareholders in Hong Kong-based Boto International Holdings.
Since Boto was founded in 1983, it has built up a commanding stake in the ersatz Christmas tree business. Tacky, perhaps. But highly profitable, too.
GIFT-GIVING. Since a 1997 IPO, Boto has returned a string of steady profits and healthy dividends to shareholders. It has kept growth up in part by balancing the seasonal Christmas-tree business with a foray into lawn furniture. A factory in Shenzhen, the manufacturing hub just across the Hong Kong border, employs 8,000 people making plastic trees and other holiday trimmings, along with the patio furniture.
This is all pretty prosaic stuff, but Boto boasts impressive numbers. Gross profit margins in recent years have been running around 40%.
Initially, Boto counted independent investor and shareholder activist David Webb as one of its biggest boosters. Webb usually plays Scrooge, excoriating companies that display weak corporate governance on his eponymous webb-site.com. But just before Christmas, 1999, in an annual "gift" to readers, Webb cited Boto as one stock to get in on. "It's not often we have anything positive to say about Hong Kong stocks," Webb wrote at the time. "But this is the season of goodwill, so we thought it would be nice to say something positive for a change."
ATTRACTIVE BUY. Though he cautioned that the Boto had gone public only two years earlier, Webb noted that it hadn't made any big corporate-governance blunders. Nor had it been seduced into any shaky dot-com, property-investment, or stock-market speculation. Finally, it didn't have a tangle of affiliations with other Hong Kong and Chinese companies -- all common land mines for mainland Chinese investments.
Selling at less than five times earnings, and with a juicy 10.7% dividend yield, Boto looked like an attractive buy, Webb declared. And he was so sure that he was putting his own money in. (Webb declines to say how much -- only that it was enough money to kick up a fuss, given his differences with the direction now taken by Boto.)
The business has done well -- maybe too well. Thanks to Boto's big dividends, the total return since the end of 1999, just after Webb wrote his piece, until immediately before the Aug. 19 shareholder's meeting, has been 75%. During that time, the benchmark Hang Seng index has fallen 35%. So Boto has been a massive outperformer.
TAKING IT ALL. With such mouth-watering returns, management decided that the only thing more fun than making Christmas trees would be owning the company outright again. Boto Chairman and founder Michael Kao owns 57% of it. At the beginning of April, Kao and Boto's top execs proposed buying out the entire manufacturing operations at a discount to the price the shares were then trading at. Rather than making a general offer to buy the whole company, which would have required a substantial premium to the underlying share price, they launched a complex transaction that reduces the listed company to a shell of its former self.
Carlyle Group, which counts among its advisers former President George Bush and several of his top aides (Bush had no involvement in this deal, however), partnered with Boto management in an attempt to do a leveraged buyout that would see them squeeze virtually all the value out of the company for themselves.
The deal required the new owners to put a mere 20% cash down. The rest is being financed with debt -- a bargain, given today's low interest rates. One leveraged-buyout specialist with knowledge of the deal says Carlyle is privately bragging that the debt would be paid off in three years. Neither Carlyle nor Boto returned phone calls seeking comment for this story.
AMENDED OFFER. But shareholders and independent accounts reckon it's virtually a steal for Boto management and Carlyle. The Carlyle team is providing the financing in which it will buy a juicy business for less than seven times last year's earnings, according to documents filed in connection with the deal.
Boto shareholders would see their company reduced to a shadow. After they protested loudly when the proposal was first announced, an amended offer agreed to leave one-quarter of the manufacturing operations with the listed company, so investors will still have a minor share in the profits. But the only wholly owned operations would be a share in a money-losing computer-animation business run by the Boto Chairman Kao's 25-year-old son, Francis Kao.
After an independent-shareholder outcry led by Webb, Boto management and Carlyle in early July took the unusual step of sweetening the deal by leaving a rump 25% of the manufacturing operation and offering to pay 7% more -- what Webb calculates were the profits earned in the extra three months it took to do the deal. Even then, an independent financial adviser hired to look at the terms recommended that shareholders vote against it, noting it still wasn't a very attractive offer for them.
STUFFED BALLOT BOX? Hong Kong regulators require independent financial advisers to review deals. But these advisers are usually lapdogs of the companies that hire them. Indeed, no "independent" adviser has recommended against any Hong Kong deal for more than a decade. So the decision by Anglo Chinese Corporate Finance to advise against this one was a shocker.
The controversy came to a head on Aug. 19 at a contentious shareholders' meeting, where the restructuring deal narrowly passed by a vote of 53% to 47%. Webb claims that his side, which included investment giant Templeton Emerging Markets Group, lost only because the Hong Kong stock exchange and its listing committee allowed parties linked to Boto's management to vote along with other shareholders. Webb claims that three-quarters of the independent votes were against the proposal.
Boto management insists it won fair and square. "Our shareholders have shown solid support for this good deal," Michael Kao declared in a statement.
Bottom line: Minority shareholders in one of the hundreds of small-cap companies that epitomize Hong Kong's gritty entrepreneurial edge got muscled aside. And the Stock Exchange of Hong Kong aided and abetted the power play.
MORE SUITS NEEDED. If the Boto deal had closed in the U.S., you can bet that a shareholder lawsuit would be in the offing. Hong Kong, however, doesn't allow class-actions. It doesn't allow contingency fees. And losers must pay opponents' court costs. The U.S. may have too many shareholder suits, but Hong Kong doesn't have enough -- and authorities are determined to keep it that way.
Indeed, Andrew Sheng, head of the Hong Kong Securities & Futures Commission, in the midst of the Boto battle recommended that if investors didn't like what was happening, they could simply sell their shares. That kind of thinking will ensure that Hong Kong shares continue to trade at a discount to their first-world peers.
The Boto slugfest wasn't the only example of official market stumbles. In late July, regulators released a plan to delist the cheapest penny stocks that trade on the Hong Kong exchange. Predictably, investors panicked, and the market crashed. Regulators then quickly scrapped the plan, setting off a intense round of finger-pointing that has only made matters worse. It was an ignominious ending to the first month of Hong Kong Chief Executive Tung Chee-hwa's new ministerial-accountability system, which was designed to improve the efficiency of Hong Kong's government.
HARDLY WORLD-CLASS. Hong Kong wasn't built in a day. And this thriving financial center won't be torn down by the events of the past few weeks. Moreover, there are some positive signs, like a new securities regulatory code, that recently passed the Legislative Council. But the overall assessment must be this: Hong Kong is moving far too slowly to make its financial markets world-class.
And despite the proud breast-beating of its senior officials, no one seems to have the will to take the tough political steps needed to transform Hong Kong into a transparent market model for the world, especially in the wake of corporate and market scandals in the U.S. Time-worn habits of favoring insiders reflect an old-style mentality that still needs to be scrubbed clean.
Clifford is Hong Kong bureau chief for BusinessWeek. Follow his China Journal columns every week, only on BW Online Edited by Douglas Harbrecht
Get BusinessWeek directly on your desktop with our RSS feeds.
Add BusinessWeek news to your Web site with our headline feed.
Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video.
To subscribe online to BusinessWeek magazine, please click here.
Copyright 2002, by The McGraw-Hill Companies Inc. All rights reserved.
Printer-Friendly Version
