Geelie Case Analysis
Dear Mr. Li, Given the recent objective of Geeli becoming the world’s biggest air-conditioner manufacture within the next five years for which Geeli needs to raise $400 million (RMB 3. 35 billion), I have looked into these areas based on the information available: 1. Current Company Position 2.
Current Industry Position 3. Financing options 4. Recommendations Current Company Position Geeli has gained substantial market share of this industry under your leadership over the last decade. With Geeli’s present book assets approaching $400 million Geeli has enjoyed a steady growth in it’s revenue and stable cash flows.Additionally, the Geeli brand is valued at $350 million by the State Finance Bureau of China. Given this brand recognition along with the quality of Geeli’s products and service and keeping in line with the company’s objective along with China’s growing economy it is indeed the right time to dominate the air-conditioning industry and further invest in homeland (China) operations.
Current Industry Position The export and domestic demand of the industry has stabilized after several years of rapid growth.This has reduced profit margins and manufactures are now competing on cost driving and profit margins which are down to 5% to 10%. This has also led to several consolidations and exits by smaller players given the number of brands have decreased from 150 in 2003 to 96 in 2004 and 69 in 2005. Price cuts from stronger players have further driven out weaker players and are generally leaving this sector. This works in Geeli’s favor as we are here to stay and expand by reducing our competition, while keeping our core values. Financing Options Equity Choices •Chinese Domestic Market •Hong Kong Stock Exchange American Deposit Receipts •Private PlacementsDebt Choices •Domestic Banks •Corporate Bonds •Foreign Banks Equity Share in Chinese Market Types of SharesClass A Shares Class B Shares Class H Shares IssuesNon Tradable Shares Quota system: scale of company chosen by government Poor corporate governance ScenarioLow expected rate of return because of limited investment opportunity in China Market highly volatile and prone to market manipulation Attempts of reform being exercised RiskRisk of permission of listing No adequate purchase of shares Less interest of investors Requirements to be listed:CriteriaChinese Stock MarketHong Kong Stock Exchange Geeli (2004) Stockholders’ EquityUS$ 6MUS$ 12MUS$ 247.
9M AssetsNoneNet Assets > US$ 50MUS$ 359. 3M Income from Continuing OperationsNoneLast Years Profit Tax cannot be lower than US$ 7MUS$ 95. 6M Publicly Held SharesNone Market value of publicly held sharesNone Shareholders Operating History3 Years11 Years (since 1994) Profitability3 years cumulative US$ 6M (last yr. US43M; former 2yrs combined US$4M)US$ 48M (2003) US$ 62. 1M (2004) Hong Kong Market in Comparison to the Chinese Market: AdvantagesSet Backs -Legal and Regulatory framework Free Flow of Capital and Information -Critical mass of professional and service providers with international standard practice -Broad investor base and international visibility -High volume of Chinese companies stock trading compared to US and UK stock markets -Closer proximity to culture, language and operations-Listings are more expensive than in US stock exchange -Valuations can be lesser than the comparing US market Equity Share in US Market (NYSE and NASDAQ) CriteriaNYSENASDAQGeeli (2004) Stockholders’ EquityUS$ 15MUS$ 247.
9M AssetsNet Tangible Assets of US$ 40MNoneUS$ 359. 3MIncome from Continuing OperationsMost recent fiscal year ;= US$ 4. 5MLast fiscal year ;= US$ 1MUS$ 95. 6M Publicly Held Shares1. 1 Million1.
1 MillionNone Market value of publicly held sharesUS$ 9MUS$ 8MNone Shareholders2000 holders of 100 shares or more400 Operating History3 YearsNone11 Years Profitability3 YearsNoneUS$ 48M (2003) US$ 62. 1M (2004) American Depositary Receipt (ADR) ADR is a stock that trades in the United States but represents a specified number of shares in a foreign corporation. ADRs are bought and sold on American markets just like regular stocks, and are issued/sponsored in the U.S. by a bank or brokerage. They can be categorized as: Level 1Level 2Level 3 -No registration required on SEC -Loosest requirements -Foreign companies may not qualify -Traded only on Bulleting Board or Pink Sheet by institutional investors -High Risk-Registration with SEC -Require less qualifications -Higher visibility trading volume -Can be listed in NYSE and NASDAQ -Partial compliance with GAAP-Primarly offered to raise capital -High compliance with GAAP -Listed in NYSE and NASDAQ -Most Prestigious amongst all three ADRs Advantages of Listing in American Exchanges:AdvantagesSet Backs -Legal and Regulatory framework -Widen the investor base which can also lower the cost of future capital -Recognition in American market and increase in company profile -Enhanced visibility of American Market Place based on relationships -Gateway for future US listings and capital formation-Higher compliance cost to the company -Requirement of board information disclosure and frequent reporting -Could reach powerful American investor losing the company’s ownership to single institution or investor -Lengthy registration process except level 1 ADRs Private PlacementsPrivate Placements are raising of capital via a private instead of a public placement.
The sale of a security is normally done by a brokerage firm to a small number of private investors. Due to this mechanism the disclosure requirements are less and there is no registration required which makes the process much faster compared to the options of raising equity. Even though private placements are very new in China and only being legislated in 2005, it is expected to double by 2008. AdvantagesSet Backs -Easy and less time consuming -No Strict Compliance as listing -Less number of share holders Allows company to be in a private status -High level of secrecy -Option of choosing investors who are aligned with the company-Lack of suitable investors -Opportunistic behavior by selling to interested party in large profits -Lack of funds -Little recognition than other public offerings Debt Options When China joined the WTO in 2001, its banking sector was in a very weak state, troubled by a serious non-performing loans (NPLs) problem. Thus, numerous measures like a large sum of government funds (roughly 20% of China’s GDP in 2004) have been provided to resolve the NPLs problems.Since 2003, China Banking Regulatory Commission (CBRC) was established to strengthen bank regulation and this has improved performance due to foreign competitors, lower transaction cost & easy administrative procedure for obtaining the loan with added tax saving.
While Geeli has limited debt on its balance sheet there are still drawbacks with these options as emphasized below: Domestic Banks – Drawbacks •Government Policy dictated lending practice and most loan went to state owned enterprise. Though measures initiated but still a very high rate of Non-performing Loans (Example: Industrial & Commercial Bank of China (ICBC) had bad debt ratio of 19. 46% compared to 2% for world leading Banks). •NPLs accounted for 26% of China’s total bank loans in 2002. •High Credit Officer’s risk (PBOC) due to individual accountability.
•Lending highly discouraged to SME and private sector. •Chinese government’s over-protection of domestic banks lead to lack of competition. •The ‘‘Big Four” state-owned commercial banks were less profitable, less efficient, and have vey poor asset quality •Weak enforceability of the contract obligations No clear body of laws ruling business disputes •Poor corporate governance contributed to bad lending practice and resulting in new NPLs, fraud for instance, in 2005, CBRC involved misused funds of US$ 93. 7 billion. In connection to these funds, 13 exposed 1,272 criminal cases and disciplined 6,826 banking staff, including 325 senior managers.
Corporate Bonds – Drawbacks •To curtail the defaults on bond issue, Government imposed stringent issuance requirements and required bank guarantees. •There was a lack of information disclosure to investors. Administrative allocation of quotas was often used as a relief measure for financially distressed enterprises. •Administrative pricing of corporate bonds and price controls failed to reflect risks, thereby preventing effective risk management by issuers and investors. The Bankruptcy Law did not provide investors with effective liquidation as a form of recourse in the event of default. The residual assets – and even the issuer – could often simply disappear without going through legal procedures.
Priority was given to the unemployed people instead of the creditor. The absence of a credit rating system made it impossible for investors to obtain a clear idea of risks. Foreign Banks – Drawbacks •Foreign banks may provide additional benefits of financial advisory service, asset management and insurance but there were only 71 banks with total assets of US$84. 5B compared to the China’s banks who were holding more then $4 trillion consumer savings. •On average, their NPLs are lower than 3 %, have better corporate governance, better risk control, and good access to international markets.
Strong regulation binding the foreign banks by the Chinese acts. •Foreign exchange loans accounted for just 20% of total foreign exchange loans in china Recommendation Given the above options of raising capital with the help of the table below we can do some comparisons: Financing OptionsAvailabilityRecommendedRemarks Chinese Domestic MarketNoYes-Freezing of IPO from 2005 to Aug 2006 -Non tradable shares -Quota System Private PlacementYesNo-Opportunistic behavior -Below the standard Hong Kong Stock ExchangeYesYes-Expensive -Low Valuation -Exposure to the world markets Close to home ADRYesYes-Sound, Legal and regulatory framework -Lower the costs of future capital -Access to high caliber institutional investors Debts – Domestic BanksYesNo-Non-Performing Loans -Not Well established banks -Poor Financial derivatives Debts – Corporate BanksYesNo-State regulation of price -Absence of credit rating -Lack of information disclosure Debts – Foreign BanksYesNo-Strict Banking Regulation -Less economic of scale Even though debt is obviously an cheaper option and easier source of funds for Geeli, debt is not available easily due to poor banking facilities.Thus it is recommended to raise capital either via public offering in well regulated environment like Hong Kong Stock exchange or the American markets using level 3 ADRs as Geeli fully complies and meets all these listing requirements. Both these markets can offer large amount of available capital from big investors who would be keen in investing in an emerging economy like China and Geeli given its track record. This would also increase the image of Geeli as a global leader in this industry which is aligned with it’s vision and also facilitate easy access for any further funding’s from these International markets.