Hanfeng Evergreen Inc (TSE:HF)

Don’t be put off by the name. Yes it’s Chinese but this Canadian stock is an interesting special situation. It is being taken private by its CEO in a process that began in January. The take out price is CDN$2.25 while the market price at the time of writing is $1.66. That represents a potential 36% return. Shareholder approval has already been given, however a last minute change to the terms of the deal has been requested.

The companies filings can be found on SEDAR and its website is here.

The company

First a little overview of the company. Hanfeng Evergreen is a leading producer and supplier of value-added fertilizer solutions in select emerging markets. It is one of the largest producers of slow and controlled release fertilizer in two of the world’s most significant agricultural markets: China and Indonesia. As the first company to introduce slow and controlled release fertilizers into China’s agriculture market, Hanfeng has established itself both as a market leader and innovator.

Hanfeng markets a number of value-added fertilizer solutions including single and multi-nutrient slow and controlled release (“SCR”) fertilizers, and customized SCR. Compared to conventional fertilizers, SCR fertilizers have properties that improve fertilization effectiveness and efficiency, increase crop yield, and reduce the impact on the environment.

In addition, as of Q2FY12, the Company also began to produce a new hybrid custom product, which is an SCR product with nitrogen enhanced coated urea (“NE”) formulations added to it (the “New Hybrid Product”). This customized product solution was created in response to further field trials and customer feedback for a single application product.

The latter product has been a failure and in Q2FY13 it had customers return the products as they were not fit for purpose. It took big write downs on inventory and assets in the business.

The deal

Let’s move onto the real story here, the privatisation. The companies filing in February contains all of the details so I will copy and paste the relevant parts (filing here).

Over the past 18 months, emerging market issuers (including Hanfeng) have come under increasing regulatory scrutiny in response to public questions and concerns involving Canadian public companies with significant business operations in emerging markets. On July 5, 2011, the OSC announced the commencement of a regulatory review of selected emerging market issuers. Hanfeng was among those issuers. Although to date, no particular concerns have been expressed or findings have been made in respect of Hanfeng, such review is ongoing and has required the investment of significant time on the part of management and the Board of Directors.

On September 19, 2012, the Board of Directors met (without Mr. Yu – CEO) and, following discussions, determined that it was desirable to authorize the formation of a special committee comprised entirely of independent directors to review and consider the strategic direction of the Corporation and explore ways in which to enhance shareholder value. At that meeting, the Special Committee was formed, comprising Messrs. Loudon Owen (Chair), Edwin Nordholm and David Thomson, each of whom was determined to be an independent director of the Corporation.

On October 1, 2012, Mr. Yu, the President and Chief Executive Officer of the Corporation and the holder of approximately 20.4% of the outstanding Shares, approached Mr. Owen to express his interest in exploring a possible privatization of the Corporation in the form of a negotiated transaction. Over the course of that week, Mr. Yu engaged in discussions with Mr. Owen for the purpose of exploring whether the Corporation would be interested in pursuing a potential transaction and on October 8, 2012, Mr. Yu expressed his interest in exploring a privatization at a price of $2.00 in cash per share on certain proposed terms and conditions, including the right to negotiate on an 28 exclusive basis and the reimbursement of expenses. Over the next several days, Mr. Owen engaged in discussions with Mr. Yu about the terms and conditions of his proposal following which, on October 24, 2012, Mr. Yu delivered a written, non-binding proposal to take the Corporation private and pursuant to which he proposed to increase his non-binding proposal to $2.20 in cash per share. The non-binding proposal did not include any right to negotiate on an exclusive basis or to be reimbursed for expenses.

During the week of December 3, 2012, Mr. Owen travelled to China for the purposes of conducting site visits of the Corporation’s operations and production facilities. During that trip, Mr. Owen met with the Chief Executive Officer of Beidahuang (who account for over 70% of Hanfeng revenues) who advised that it was in the process of negotiating with competitors of Hanfeng for the purpose of potentially securing alternative sources of fertilizer and that it had not yet made a decision whether to renew its contracts with the Corporation and on what terms, if any.

On December 19, 2012, the Special Committee met and, after having interviewed several potential candidate advisors, engaged Deloitte as its independent financial advisor and concluded that Deloitte was qualified and independent of Mr. Yu.

On December 28, 2012, Agrium (who own 20% of Hanfeng) agreed with Mr. Yu to tender its Shares to a take-over bid or vote in favour of an alternative form of transaction subject to certain terms and conditions.

Due to the position of Beidahuang, the special committee did not deem it appropriate to solicit other bids for the business as they feared this would prolong the process and would result in Hanfeng losing its business with Beidahuang which would be severely detrimental.

During the weeks of January  representatives of Deloitte travelled to China for the purposes of conducting due diligence investigations, including site visits of the Corporation’s operations and production facilities, interviews with the Corporation’s local management and with Beidahuang, and performing financial and valuation analysis of the Corporation. Mr. Owen and the Chief Financial Officer of the Corporation also travelled to Indonesia to conduct site visits and due diligence. Beidahuang indicated that it will not purchase fertilizer from Hanfeng unless Hanfeng is a private company. Deloitte also advised that representatives of Beidahuang had expressed an interest in Beidahuang potentially making a further investment in Hanfeng following the completion of Mr. Yu’s privatization proposal.

On January 29, 2013, following further discussions and negotiations, Mr. Yu agreed to increase his price per share from $2.20 per share to $2.25 per share.

Mr Yu plans to purchase the company using a $85m loan from a Chinese bank and $20m of his own money. But the deal has been delayed as he would like a strange change to the terms for Chinese shareholders, see the details here.

This deal is now 5 months past when it was supposed to close. There is clearly something slowing this down and the market doesn’t believe it will go through.

Deloittes valuation

Lucky for us, Deloitte has already come up with different valuation metrics which we can use to value the company. Page 83 of the Management info (filing here). They valued it in the range of $1.94 to $3.02 and used a liquidation scenario in there as well.

One thing to note though is this statement in the report.

Based on our discussions with management and the Special Committee that nothing has occurred or is pending to February 9, 2013 which has not been disclosed to us, and which could reasonably be expected to materially effect the Valuation as at December 31, 2012 and the Fairness Opinion as at February 9, 2013.

A few days after February 9th the company reported results which contained huge writedowns of property and inventory due to the problems with their joint venture as explained previously. Would Deloitte have been aware of these and accounted for it? I don’t know.

But Deloitte does give us its method for calculating the net realisable asset value. If I use the same % of assets realisable as they did against the new balance sheet I get a lower limit liquidation value of $1.03.

Conclusion

All parties concerned here want this deal to go through. Shareholders stand to lose out substantially if it doesn’t as Hanfeng loses its biggest customer. The CEO owns 20% of the company and another company owns another 20%. They too do not want this deal to fall through. And Hanfengs biggest customer wants to make an investment once it is a private company. I have no idea why they don’t enter into a consortium to bid for this, but they could do in future if the loan arrangements to the CEO fall through.

There is a downside though if this deal doesn’t go through and that is the risk on the table. If the deal doesn’t go through the share price could fall below the liquidation value I calculated of CDN$1. There is a little too much downside risk here for me, but it could present a good buying opportunity in the future.

Disclosure: No position