Recommendation for CAAS: Strong sell.The stock surge of CAAS has been established on the expectation that the company will go private. While to my research, the expectation is highly likely to fall through and I recommend to short.
CAAS announced in May that its Board of Directors received a preliminary non-binding proposal letter from its Chairman, Mr. Hanlin Chen, to acquire all the outstanding shares of common stock of the company not already beneficially owned by Mr. Chen for US$5.45 per share in cash. The offer was revised in August that the deal would be completed through a company owned by Mr. Chen and his wife with target price being the same. One thing about the non-binding proposal is the huge uncertainty to close the deal as the due diligence process can reveal additional information about the company; the other thing for non-binding offer is the funding plan that sellers usually outline to prove the transaction can be completed. In this case, Mr. Chen would pay $75.2million in cash to complete the deal while nothing was mentioned in the offer about the financing issue. Assuming Mr. Chen has sufficient cash, the escalated capital regulation in China has made it almost impossible to exchange RMB to USD to reacquire the shares. There were already several well-known investigations by the Chinese government into multinational companies who have been active in oversea M&A deals this year. It is said CSRC (China Securities Regulatory Commission) isn’t supportive of “go-private” and we are all aware political risk can affect Chinese companies more than others.
The analysis above was based on the assumption that Mr. Hanlin Chen has enough cash for the transaction, but does he really have?
Surprisingly, besides CAAS, Mr. Hanlin Chen has been involving in the management of 31 other companies, and even plays a key role in most of them. For example, Mr. Chen is the legal representative for Shanghai Hongxi Investment & Development Co.,Ltd, Shiyan Jiulong Automobile Spare Part Co.,Ltd, Xiamen Qiaolong Industry & Trade Development Limited Company, Hubei Henglong Automotive System Group Co., Ltd. and etc. I’m wondering how Mr. Chen deals with conflicts of interest when some of his other companies are also in the automobile industry, and how Mr. Chen divides his effort when his other companies are so diversified in industries like investment, materials, real estate, petit credit, microchips manufacture. Also, even CAAS has been profitable, the company never issued dividends to its investors, so where did Mr. Chen get the money for his business investment empire? Is it possible CAAS’s asset has been moved to his own pocket? If it is true, what about the interests of others investors of CAAS?
Looking deeper into his companies, something more interesting showed up. Jingzhou Henglong Real Estate Co., Ltd, of which Mr. Chen is the largest shareholder with 26% of the shares, has experienced serious cash flow problems. The company invested 4billion RMB in a residential development project called Henglong Four Seasons and hasn’t finished the construction on time because of financing issues. The company was sued by the condo buyers and was required by the court to deliver the condo within three months and pay the compensation fee with interest loss, or the contracts will be invalid. It’s hard to imagine how Mr. Chen has cash to buy CAAS when another firm of his is so desperate for money to deliver the project.
The financial reports revealed the cash and cash equivalents of CAAS decreased by 30% from 2015 to 2016. The investing cash flow increased by 62.5% from 2015 to 2016 and the pace continued in 2017. Besides CAAS dramatically increased its bank and government loan in 2017, which is 5 times as last year according to the quarterly report. Where is all the money going? Wish it’s not Mr. Chen’s own pocket.
To conclude, Mr. Chen’s non-binding proposal couldn’t show enough sincerity to complete the deal. Combining the evidence of his other firms, it’s probably just a gimmick
