How a mainland firm may be laying ground for Digital China bid

May 26, 2016 16:31
Digital China's chairman Guo Wei (R) is no longer the firm's largest shareholder. Photo: HKEJ

The Shanghai-Hong Kong Stock Connect has disappointed many observers as the trading volumes generated by the cross-border bourse link have fallen short of expectations.

Right now, the program is coming under scrutiny for another reason: the possibility that it may help a mainland state firm to launch a hostile takeover for a Hong Kong-listed entity.

The target firm is Digital China Holdings (00861.HK) and the possible acquirer is CRG Banking Equipment (002152.CN), a Shenzhen-listed state enterprise.

CRG, which is involved in ATM machine manufacturing, has started amassing shares of Digital China since March.

As of May 20, it has accumulated an 11 percent stake and become the Digital China's single largest shareholder.

Digital China, the nation's largest distributor of IT-related products, was formerly a unit of Lenovo Holdings (03396.HK).

In 2000, Lenovo's founder Liu Chuanzhi decided to spin off the IT service unit and seek a separate listing in Hong Kong. He handed over the new firm to his close aide Guo Wei.

The shareholding structure of Digital China was extremely fragmented. Chairman Guo, who was the largest individual shareholder, held just 8 percent stake. 

This has helped CRG, an entity affiliated with Guangdong provincial government, to now replace Guo as Digital China's largest shareholder.

CRG, which has a market capitalization of around 24.8 billion yuan, is said to have spent more than 1 billion yuan to buy up Digital China shares.

And there are reports it has readied ammunition of another 2 billion yuan to boost its stake further and possibly launch a takeover bid.

There is speculation that the Stock Connect program is being used to build up the stake in the Hong Kong-listed firm.  

Digital China has seen its share price surge by 15 percent since last week, and its market cap is around HK$5.8 billion.

CRG, with its deep pockets, can easily collect 30 to 40 percent stake in Digital China.

It's not hard to figure out why Digital China is seen as a good acquisition target.

Like many other small and mid-cap Chinese firms, Digital China has been out of favor in the Hong Kong market. It currently has a price-earnings multiple of just 8, while the price-to-book ratio is below 1.

However, the stock has been coveted by mainland investors since the launch of the Stock Connect.

Digital China has been trying to transform its business, focusing on things such as smart cities, big data, FinTech, cloud systems and rural e-commerce.

The company has ventured into the new businesses a couple of years ago. Though the moves have yet to yield results, mainland investors are chasing the firm as it is seen as having "hot ideas". 

In that sense, Digital China is considered to be a hidden gem in the eyes of many Chinese investors. If the company lists in the mainland, there is a feeling that its market cap could be more than 10 times the current level in Hong Kong.

CRG currently has a P/E ratio of 23 times. The company is said to be aiming to lift its market cap to over 10 billion yuan by acquiring Digital China and benefiting from the latter's "hot ideas".

Interestingly, Digital China divested some IT distribution business early this year, and has no business conflict with its former parent Lenovo, which now holds 5 percent stake.

This article appeared in the Hong Kong Economic Journal on May 26.

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal columnist