CRE (291 HK): Playing Devil's Advocate - An expensive way to get a cheap beer!

Hop on a plane and fly to somewhere you don't need to go. They will give you a free beer.
It is usually cheaper to stay home and buy the beer yourself.

The China Resource Enterprises (291 HK) restructuring situation is complicated. The basic deal is that CRH buys all but the brewery assets from investors, CRE then pays a huge dividend (HKD 11.50/share), then CRH conducts a tender offer to buy ~21% of the remaining float (10% of shares out) at HKD 12.70 a share. Investors then are left with what I will call NEWBREWCO, a pure-play brewery which is China's largest by volume. You can read about the basics in the piece by Jon.

Let me preface my comments by saying that I think this deal is great value...

For the buyer. Hint: That's not CRE holders or buyers.

THIS DEAL HAS ISSUES REGARDING PRICE AND ECONOMICS. GIVEN THE OWNER EFFECTIVELY CONTROLS MANAGEMENT AND THE BOARD, THIS COULD BE CONSTRUED AS A POTENTIAL GOVERNANCE ISSUE.

The SOE parent is proposing to buy 72% of the December 2014 equity at a 20% discount to book and effectively zero premium to market. This Binding Proposal is being put to shareholders. CRE Directors should be asked, just one month after the release of 2014 accounts, how they could possibly support a deal which means a 20% write down of equity (or a 54% write down to goodwill) on the Disposal Assets and sale at 0.8x book, when

1. That level is for full control of those consumer assets, at a price cheaper (in PBR terms) than 98.6% of Southbound-eligible non-financial stocks' at announcement (and 99.7% of SHCOMP trades at a PBR > 1),
2. that level is for a package of branded consumer goods purveyors, in a newly resurgent Chinese stock market, with a government bent on supporting a resurgent Chinese consumer, and is being bought 10% off a 52-week low, down 20% from a year earlier, when H-Shares are up 45% and Shanghai is up 100% over that same year.
3. And CRH is asking CRE shareholders to pay for that, when it is CRH management, ownership, and board, which are responsible for the business underperformance.

...but it will be put to shareholders instead. Because most of the directors were put in place by the buyer. The stock has popped 50% but investors should look closely at the deal and its details.

SECOND POINT: THIS DEAL HAS ACCOUNTING VISUALISATION ISSUES.

The deal is equity-dilutive to NEWBREWCO holders. A nice special dividend is dangled in front of investors and then NEWBREWCO takes a 50% write down to its pro forma equity.

Look at the pretty birdy... WHACK!

Then investors have to deal with consolidation accounting of Minority Interest. This sounds technical and lots of people will say "aaah... it all comes out in the wash". Well... maybe... But if it does, that might be bearish. Beware the forward valuation differentials!

CONCLUSIONS:

• There are economic issues that should be questioned. I think because of the control that these can be construed as potential governance issues.
• The residual asset has accounting events and future valuation visualization issues you should be aware of.
• This is NOT a "Done Deal" yet. Investors who look closely could object. The IFA could easily say this deal is "Neither Fair Nor Reasonable" and proxy advisors could agree. The risk on this deal is quite binary.