Nanpo Case Key Points for Discussion Objective: Learn about an international international IPO process involving “red chip” companies on the Stock Exchange of Hong Kong . Utilize comparables analysis and discounted cash flow techniques to value an international company. Written Assignment:
1. What did the changes Moftec implemented in 1992 permit regional Chinese companies to do? a. The foreign trade reforms implemented by Moftec were in response to policy changes in the PRC government’s economic development policy. One element element of the reforms reforms was a reorganization reorganization of the regional foodstuffs import and export companies within Guangdong. Previously under direct administration of Guangdong Foodstuffs Import and Export Corp. or Guangdong Cereals and Oats Import & Export, these regional firms including Nanpo were now granted a larger degree of autonomy in their operations and financial structure. b. The reforms “self -financing” policy permitted regional companies to retain most of their profits for their own use, whereas previously a substantial portion of profits earned by regional companies was required to be remitted to their controlling corporations. c. They were also now permitted to develop and expand new business which had had previously been restricted. This enabled enabled Nanpo to pursue market share and new projects and to consider capitalist concepts such as private ownership . 2. What were the major businesses of Nanpo immediately prior to their IPO? a. See case page 3. 3. Analyze financial trends (including growth in revenue and profitability) and summarize your major conclusions. a. x 4. What is the estimated market value of th e company’s assets based on data stated in the case (i.e., the break-up value of the company)? a. See teaching note page 3 and TN-2. 5. Reference attached excel excel template for this question. Value the company using the comparables data stated in the case. Explain which companies companies you believe are are most
comparable and what the resulting valuation range is for the company. How does the debt position of Nanpo impact your conclusion? a. See teaching note page 3 and TN-1. Also see Exhibit 7 to case. 6. Reference attached excel template for this question. Develop financial projections for Nanpo and value the company using a DCF model. Explain your assumptions, including revenue and profitability growth rates, the capital structure assumed for your WACC and the discount rate used in your valuation analysis, and your terminal value assumptions. What percentage of the company’s value is due to the terminal value in your base case model? a. See teaching note page 4 and TN-3, TN-4 and TN-5. 7. How do the valuation estimates you developed in item 5 and 6 compare to estimates developed by Mr. Tan and Mr. Yang? How do the valuations compare to the average multiple of companies traded on the Stock Exchange of Hong Kong? 8. Six weeks before the IPO was scheduled to list, Mr. Yang receives a phone call followed by a letter of interest from the President of CLP Holdings indicating interest in entering into potential discussions to acquire Nanpo (instead of the company going public). The highlights of the letter of interest are summarized below. a. Letter of interest to acquire Nanpo with a value range of $250-350M b. The final valuation would be set following due diligence and negotiation of final terms c. Transaction would be structured as a purchase of assets (cash for assets) d. Nanpo operations would generally remain in place, but would be integrated with CLP Holdings to maximize synergies between the operations. Some employee relocations were anticipated, but CLP would offer all employees positions in the new location. Mr. Yang and other senior managers would retain their positions following the merger for at least 24 months. e. CLP Holdings would agree to retire $50M of Nanpo’s debt and invest an additional $75M in Nanpo to develop the business in a manner consistent with CLP’s vision for the company. f. The letter provided for a period of 60 days for exclusive discussions with CLP and negotiation of definitive acquisition documents, during which the plans for the IPO would be put on hold g. Nanpo must sign and return the Letter of Interest within 10 work days if they want to accept the offer and move into exclusive acquisition discussions with CLP h. The letter of interest is nonbinding, and is subject to: i. Customary due diligence by CLP
ii. iii. iv. v.
No adverse change in Nanpo’s business or operations No adverse change in economic or market conditions in general the negotiation of a definitive asset purchase agreement, retention of 95% of key Nanpo employees (the list of employees would be defined during due diligence, but would include Mr. Yang) vi. final approvals by the Chinese Government, CLP Holdings and Nahum Group’s Board of Directors for the acquisition i. The transaction would be expected to close within six months As Mr. Yang reflected on these developments, he thought there would be substantial synergies between the companies, that would result in a 5% increase in revenue in the next year and additional revenue of 10% per year above his forecast thereafter. He also expected a 3% decrease in expenses (due to economies of scale) for all forecast periods for Nanpo’s P&L. The President of CLP has been clear the valuation was not negotiable outside of the stated range, and failure to enter into exclusive discussions within the 10 day time window would mean the end to discussions. While the valuation offered by CLP was somewhat lower than he had hoped for, the combination with CLP would help with Nanpo’s debt position and offer the chance for continued growth. Mr. Yang also realized that CLP Holdings had very good relationships with top officials in the PRC government, as well as at Nashum Group, and MOFTEC, so Mr. Yang did not expect any regulatory issues or concerns from the Chinese Government or from his parent company. As he mulled the latest development, he thought to himself that his parent company would be greatly swayed by his input on whether to stop the IPO process and entertain the acquisition offer or to reject the offer and continue with the IPO process. What are the pros and cons of the terms in the letter of interest? What issues, if any, need to be clarified? Should Nanpo withdraw their IPO and enter into discussions with CLP Holdings? Why or why not?
ANSWERS Q1a) This enabled the Chinese foodstuff companies to grow economically and develop the industry. They could now operate in a way that had greater control over business development decisions. This include their financial decisions in regard to the mode of financing to be used in order to keep theinr financing costs at the desired level. b) This implementation enabled these firms to increase thein retained earnings. This would not only increase their own equity base there by the balnce sheet worth, but also enabled them to ponder over the available business extension and investment opportunities as they could now exploit these opportunities as per their requirements rather than the set pattern of the controlling corporations. One element could be refinancing into the business which could help the growth percentages as a result of higher retention ratios. c) As explained in the above description , the funds that were now available from the internal sources were actually used to exploit the opportunities . using this companies were now permitted to diversify and extend market shares and persue independent projects . Q2) Nanpo’s core business was to make daily exports of food stuff to Honk Kong as it had the sole aurthority of exporting food products from Guandong to Honk Kong given by the Chinese government . It thereby also market the foodstuff companies of Guandong . Nanpo also exported other processed food products to other countries.In addition to that Nanpo also imported some foodstuff required in China from overseas countries like Australia Canada , Vietnam etc. Nanpo also imported some non-food stuff such as airconditiong etc. from other overseas companies. With the good knowledge of the Hong Kong market that Nanpo had , they also provided information of the HK markets to some state owned enterprises in Guangdong in return of information fees. Q3) Nanpo has managed to grow their turnovers marginally starting from 1991 upto the mid of 1994. From $1.5 billion in ’91 to $1.8 bn in ,93 and 1.2bn in the 6 months of ’94. The margins have been lower in 1991 (0.1%) but after the refo rms in 1992 margins have increased upto the mid of 1994 . 0.6% in ’92 1.5% in ’93 and 2.7% in ’94. These low margins are understandable as to the nature of the business but the improvement is brought about by the provisioning of greater liberty towards operations by the PRC government.
Nanpo has a heavy reliance on current assets with very few tangible assets on its balance sheet. Being an indenting or an intermediary firm this is pretty understandable as they need to focus on their current assets to match up their heavy current liability requirements. Nanpo has kept its tangible asset same as that in 1993 but has increased its investment in fixed assets in the associate firms by almost 8 %. Considering the current assets the amounts receivable , prepayments and deposits made by nanpo has climbed by a huge 137% in the first six months of 1994 as compared to the year end of 1993. This climb may have occurred due to a higher sales made on credit in the beginig of 1994. This can be translated by the high turnover in the six months of 1994. Other amounts due from related parties have also risen by almost 517% which indicates towars the loosening of the credit policy by the firm as a result of greater authority over the business management and most probably with the intent of expansion in the business as for higher intended turnover. Along with these increase in recievables there is fair increase in the cash availabity (65%). This is a good sign for the company as despite of credit loosening they have managed to increase their liquidity position . inventories have been laid off as for the delivery to the customers. Coming over to the current liabilities , the bank loans and overdrafts have been payed off by 26% but the trade creditors and payables have jumped by a heavy 225% which exceeds the increase in the recievables. This has to be the case as nanpo cannot provide credit facility to its customers until it delay payments to its suppliers. This however may cause the company’s credit risk to climb which may increase the required return by the probable shareholders of the forth coming Nanpo IPO. Q4) The company had an estimated market value of $452million as it was estimated to be traded at 8 times price to earnings. The earnings were estimated at $56.5 million after tax the next year . Q5&6) According to my analysis the food stuff companies are by far the better comparables as they somehow closely related to nanpo in terms of the profitability and market related risks .Of the three foodstuff companies I have considered China foods and Four seas as the better comparables . the reason behind this is that they follow on an average , closer P/E ratios to what Nanpo has been agreed upon.In addition to that the turnovers are pretty close as well specially China Foods . Based upon these factors the comparables data along with nanpos give a equity valuation ranging from around 700m to 1500m as for the different betas that the compareables have ( all
betas are under 1). This valuation range is wide as for the perpetual growth consideration i.e even a slight change in the required return brings about a good amount of difference in the terminal value of perpetuity. Terminal value has a big role to play in this scenario because the time of forecasting is a mere 6 years. The terminal value shows a huge 130 % of the total NPV. This is because the initial cashflow are negative in the present value because the high amount of expansion expenditures and working capital requirement which starts to stabilize in the later years. But this element is covered in perpetuity ,as can be seen by the terminal value. Q7) Mr Tan and Mr. Yang’s valuation show a lower equity value than the valuation done by me . The major and infact the only reason behind is that their valuation assumes a greater WACC. This comes about due to a higher estimated cost of equity, which is a result of consideration of a higher beta (1.4). They have considered this higher beta (in the shorter run ) as a result of their higher risk evaluation majorly focusing on the new arrival of Nanpo in the Honk kong stock market . As for my assumptions of a smaller beta (average comparables beta ) , I believe that Nanpo may be a new arrival as an entity but the honk Kong market already has similar Chinese companies listed on the exchange . HKSE has been a good host to such red chip companies and I believe that nanpo being a red chip company will enjoy this. Therefore I believe its best to value Nanpo as per the foodstuff comparables of which no one has a beta higher than one. As for the multiples, the HKSE has seen high P/Es historically . Considering the recent past , the P/Es have been higher than 10 and its showing a further increasing trend since the 1990,s uptil date and may well follow the route in the near future. So considering a P/E of 8 times Nanpo may succ eed in grabbing investor’s interest and the IPO may be well oversubscribed. Q8)
The terms are pretty clear as for the intent of CLP holdings. CLP is a long established company with good revenue generations however has been slow on growth . The fact that it has a solid balance sheet worth and strong background can help Nanpo’s purpose by a great deal .Nanpo intends to grow as a company which can be done with greater amount of ease when operating under a established holding company . Any hiccups be it financial , economical or legal , that come during the process of nanpo’s growth can be met by CLP which will pave the way for Nanpo. In addition to that the synergies that are going to be achieved via the acquisition will help grow Nanpo’s margins .Debt , which is one of the major concerns that Nanpo face
as to the riskiness of the firm,s operation, is also being covered to a great degree by CLP. Not only that , but investments are also being allotted which will help increase the returns , retention and growth of Nanpo. The employees are also been taken care of , which will help nanpo retain the same staff that the company is accustomed with .This will help keep the operations effective and efficient. The major drawback of such acquisition will come out to be the limitation of decision making being levied upon the original Nanpo owners. Althogh the terms seem to vague on this matter but it is easy to understand that the final decision making authority will now be with the holding company .In addition to that the initial valuation being done is way below what Yang expected to have , so this may also be a demerit of the term.
Some matters that need to be clarified start with the initial valuation range .Although CLP is very clear over the range , but there is always room for discussion and create a win win situation. Secondly the issue regarding the relocation of the employees must also be looked into in further operative detail. Thirdly and most importantly the CLP’s vision towards the acquisition must be clearified . one of the term suggests that investment may be made as per CLP’s vision , this term may act as an important bridge for Nanpo to discuss over the vision that CLP have so as to understand the nature of the relationship between the two companies in a longer term perspective. If we consider the offer , it comes from a well reputed and well established company . It is no something that doesnot require a good amount of heed . The term suggests a 60 day discussion period during which it will become very clear to Nanpo that whether they want this deal or not. For that time I believe it would be best to delay the IPO , undergo the discussion and by the end of the process Nanpo will either accept the term or will come out of it even more confident over the issue of IPO as the best viable option.
