Yorkey Optical International (Cayman) Ltd (HK:2788) is a manufacturer of components for the camera industry listed in Hong Kong. I stumbled across the company while looking at the holdings of David Webb, a HK-based value investor and activist.
The investment thesis is quite simple.
- Yorkey currently trades at 0.81 HKD.
- Asia Optical International Ltd, Yorkey's largest shareholder, has made a privatisation offer at 0.88 HKD per share.
- David Webb can block the deal as he holds more than 10 per cent of the "independent shares".
- It's likely the offer will be increased due to Webb's blocking stake and positive developments since the offer was announced.
On December 15, following revaluation of its properties, Yorkey announced that its unaudited NAV as of October 31 was 99.45m USD (~737m HKD) or 0.94 HKD per share. By comparison, Yorkey's unaudited NAV per share at June 30 — the latest reporting period prior to the privatisation offer — was 0.804 HKD per share.
In other words:
- The current offer of 0.88 HKD represents a 6.4% discount to the company's unaudited NAV at October 31
- The revised NAV of 0.94 HKD per share represents a 16.9% increase to the June 30 asset value listed in the initial offer documents
It therefore seems highly likely Asia Optical's offer will be unacceptable to Webb, who has already threatened to exercise his veto power.
The Offeror has left room to increase the bid after Yorkey has obtained the expected valuation reports, before the offer document is posted. Webb-site Founder David Webb currently holds more than 10% of the independent shares, sufficient to block the privatisation, so let's hope that does not become necessary and the Yorkey bar is substantially raised for a happy ending.
Importantly, David Webb seems to think that Yorkey's true NAV could be even higher. He believes Yorkey's property in Dongguan, China, could be worth $30m USD based on the disclosed market value of a comparable nearby property held by HK-listed Chung's China Investments Ltd (HK:298). Jones Lang LaSalle, Yorkey's appointed appraiser, valued this property at $12.6m USD, using a "cost approach with reference to … depreciated replacement cost".
Additionally, the JLL valuations of Yorkey's Hong Kong properties are based on smaller floor areas than previously disclosed, as can be seen in the table below. I'm not sure of the reason for this, but it could be another point of contention.
The difference between the two valuations is 20.95m USD or 0.20 HKD per share. If we are to believe David Webb, even the 0.94 HKD NAV could be significantly understating Yorkey's true asset value.
There is clear strategic rationale for the acquirer:
- Asia Optical is a connected person of Yorkey's under HK listing rules, and also a major customer. By taking Yorkey private, Asia Optical can avoid regulatory issues and save on costs related to Yorkey's dual HK and Taiwan listings.
- Yorkey is stuffed full of cash. As of June 30, it had $78m USD in net cash, equivalent to roughly 0.75 HKD per share (~88% of the current 0.88 HKD offer).
- Asia Optical trades at over 2x price to book compared to Yorkey which is currently trading below NAV.
- As discussed above, there could be hidden value in the properties
Asia Optical has financing for the deal from a HK bank. Considering Asia Optical's balance sheet and Yorkey's cash pile, it's hard to see any problems arising with financing.
Since the privatisation was proposed, Yorkey has announced a profit upgrade that will be included in the scheme documents sent to shareholders. For the nine months to September 30, 2021, Yorkey is expected to record a consolidated profit of not more than $2.89m USD. Yorkey's interim report shows that the company earned only $0.79m USD for the first six months of the year, so there has been a strong uptick in business in the third quarter.
Before we look at the potential outcomes, it's important to consider the downside. Should the deal fail, I've assumed that the stock will trade at 0.50 HKD, roughly the average of the closing prices for the 180 days before the privatisation offer was announced. At that price, Yorkey seems very cheap, considering the company's cash position and the improvement in recent results. The price would represent a 47% discount to 0.94 HKD unaudited NAV per share as of October 31.
Yorkey's policy is to pay out 70% of earnings as dividends and prior to COVID the payout ratio exceeded this benchmark. In FY19, for example, Yorkey paid out 0.044 HKD per share on earnings of 0.048 HKD, a payout ratio of 92%. So you could get some dividends, too. Yorkey was also buying back shares before the privatisation was announced, which is a positive. However, it's unlikely that shareholders will see any of the cash on the balance sheet if the privatisation fails. Yorkey has continued to hold excessive amounts of cash despite repeated calls from David Webb for special dividends. Importantly, if Webb vetoes the deal, it seems to me that Yorkey will likely trade above 0.50 HKD considering there is an interested buyer. Based on all of this information, I think 0.50 HKD is a conservative estimate for Yorkey's value in the event the deal breaks.
It seems Asia Optical has scope to improve the bid and would seek to do so rather than have the deal fall through. I have outlined my thinking of the probabilities in the table below.
Based on this, we get a blended value of 0.8985 HKD per share — representing ~11% upside from today's price.
The long-stop date for the deal is April 13. If we assume the scheme consideration is paid by June 30 (six months from today) the annualised return based on the blended price would be ~22%. If we get the current offer of 0.88 HKD, the annualised return would be ~17.5%; if the deal is bumped to 0.94 HKD, the annualised return would be 32.54%. This seems attractive on a risk-adjusted basis and I've parked about 5% of my net worth in Yorkey. I'm treating the position as a cash alternative and I'd be happy to redeploy the money into a longer-term investment should opportunity arise.
Risks:
- David Webb and Asia Optical can't find an acceptable compromise
- Some legal/regulatory conditions remain to be fulfilled or waived
- Currency risk
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