We read it in the news nearly every week: “China’s economy expanded 10.7 percent in 2006, the fastest pace in 11 years"…"China’s Industrial Production still humming along"…"How To Invest In China"…"Stock Bulls Are Back In China"etc. I have been involved in several China based companies since early 2003 and have had some great success. The country continues to be the most exciting growth economy on the globe. I firmly trust that China, as an investment opportunity, still cannot be ignored, but one must invest cautiously and with great due diligence. I have discovered an opportunity; but make no mistake, this is indeed a special situation, and I believe the future results of the company will prove to be outstanding. The company is called China Yuchai International, Limited (NYSE:CYD).
First, some background. China Yuchai International Limited is based in Yulin City, Guangxi Province, China. China Yuchai International Limited is a holding company that owns a 76.4% interest in Guangxi Yuchai Machinery Co. Ltd. It is listed on the New York Stock Exchange (since December 1994) under the symbol CYD. The company is currently majority controlled (via a “special golden share”) by the Hong Leong Asia Group based and publicly listed/traded in Singapore. The Hong Leong Group Singapore was founded in 1941 by the Kwek family and is one of the largest privately controlled business groups in Southeast Asia. Hong Leong Asia acquired majority/ownership stakes in three China businesses in December 2001. Henan Xinfei, China’s second-largest refrigerator, freezer and air conditioners manufacturer; China Yuchai International Limited, parent of Guangxi Yuchai Machinery, China’s largest independent diesel engine manufacturer; and Rex Industrial Packaging, a leading manufacturer of industrial packaging containers in China, Malaysia, Indonesia and Singapore.
For informational purposes, Yuchai was founded in 1951 and became a state-owned enterprise in 1959. In 1989, Yuchai became one of China’s 500 largest industrial enterprises in terms of profitability and tax contribution. Today, the company is the largest employer and tax revenue generator in the Yulin City municipality. In July 1992, in order to raise funds for expansion, Yuchai became the first state-owned enterprise in the Guangxi Zhuang Autononomous Region to be restructured into a joint stock company. In May 1993, to further finance expansion, Yuchai sold (Foreign) shares and became a Sino-foreign joint stock company. China Yuchai then went public on the New York Stock Exchange in December of 1994.
China Yuchai International Limited specializes in light, midsize and heavy-duty diesel truck engines and also sells diesel engines to bus manufacturers, independent truck makers, and automobile manufacturers. Other products include diesel power generators, diesel marine engines, engine parts and lubricating oils. China Yuchai has an excellent reputation among vehicle manufacturers and customers for performance, reliability and customer service. Yuchai’s primary manufacturing facilities are located in Yulin City, Guangxi Zhuang Autonomous Region in Southern China, which is approximately 280 miles west of Hong Kong. Yuchai operates 31 regional sales offices in major geographic regions in China; and with a sales force of approximately 609 persons nationwide, the company provides a comprehensive range of services to its customers, including dispatching engineers to provide on-site assistance to major customers in the resolution of technical problems. Guangxi Yuchai management strongly believes that customer service is an important part of maintaining its market competitiveness and hence Yuchai has a nation-wide network of over 1,150 authorized service stations that provide repair and maintenance services, spare parts, retrofitting services, and training to Yuchai’s customers. To ensure a consistently high level of service, Yuchai trains the technicians at each of these service stations, while owning and operating over 20 repair training centers. Yuchai promotes its products primarily through television commercials, advertisements in newspapers and industry journals.
The Company believes that its promotional works are unusual for an automotive product component company in China, but feel that these efforts lead to greater brand recognition among its customers. At the end of calendar 2006, Guangxi Yuchai Machinery had a total production capacity of approximately 300,000 units. The Company believes that its current production capacity is adequate to meet expected higher demand and unit sales from customers in the near future arising from the continued government spending on new highways and other infrastructure development projects in the People’s Republic of China.
As of Monday, June 25, 2007 the company’s shares are quoted at US$11.15 on The New York Stock Exchange. Market capitalization is US$415.5 million, a PE of 16 (trailing), a 0.47 price-to-sales ratio (trailing), book value over $9.00 and cash per share equals $2.56. Here is a quick fundamental picture of the company results the past eight years in US dollars, including the year end 2006 results (Unaudited, released on February 27, 2007):
*Note: This gross margin differs from Hong Leong Asia’s results reported on February 28, 2007. HLA reported a gross margin 22.2%, almost the same as 2005. HLA management (Singapore) explanation – “The difference is because warranty expenses were included as part of cost of sales under US GAAP results while under Singapore GAAP these were reported under selling and distribution expenses.”
According to the Company’s most recent annual report, (2005, the 2006 fully audited results are due by June 30, 2007) the general market demand for trucks and buses has contributed to Yuchai’s significant growth since 2001, with the continued expansion of the highways and toll roads in China. The Company expects heavy-duty trucks to become an increasingly important means of freight transportation as road conditions and infrastructure in China improve. (According to the New York Times Magazine on July 4, 2004, “China currently has more than 15,000 highway projects in the works, which will add 162,000 kilometers of road to the country, enough to circle the planet at the equator four times.” More recently, in the New York Times Magazine on July 2, 2006, “The figures behind China’s car boom are stunning. Total miles of highway in the country, at least 23,000 (are) more than double what existed in 2001. China’s first modern expressway, the Guangzhou-Shenzhen Superhighway, was built in the early 1990’s by the Hong Kong tycoon Gordon Y.S. Wu. Wu’s Superhighway was the beginning of an infrastructure binge that seems to be only picking up steam: the government recently announced a target of 53,000 freeway miles by 2035. The U.S. Interstate Highway System, 50 years old, presently comprises about 46,000 miles of roads. Some new roads, especially in the less-developed western parts of the nation, are nearly empty: China is encouraging road construction ahead of industrial development and population settlement, assuming those will follow.”). Both medium-duty and heavy-duty trucks are increasingly fitted with diesel engines because of their higher power, fuel efficiency and reliability as compared to gasoline engines. In addition, the Chinese government had announced as a policy objective in 1994 that motor vehicles weighing five tons or more should principally have diesel engines after the year 2000.
China Yuchai International, Ltd. is not without controversy. In early 2003, there were some issues within the company. These difficulties were disputes in cooperation between the Board and the minority shareholder, Guangxi Yuchai Machinery Holdings Company and its legal representative, Mr. Wang Jianming. Mr. Jianming is a product of China’s Cultural Revolution in the 1950’s, and has many friends in local government. According to the news releases, he was most uncooperative in implementing new corporate governance policies, capital expenditures approved by the Board, and the release of declared dividends.
It was also alleged that Mr. Jianming was cooperating with a Bermuda based holding company (Goldman Industrial/Coomber Investments) in accumulating shares of China Yuchai to wrestle control from the Hong Leong Asia group so that they may control the Company (Hong Leong Asia still currently holds the so-called “golden share” which gives them the right to have the majority of Board seats, and most important, it allows HLA to consolidate CYI’s results into publicly traded/listed HLA). It turns out that Goldman Industrial/Coomber Investments was the Yulin City Municipal Government. In May 2003, the CYI Board began legal proceedings against Mr. Wang Jianming to remove him from his position as the legal representative of the State Holding Company and a Director of Yuchai. At that time, the controlling shareholder, Hong Leong Asia under their then CEO, Mr. Wrixton Gasteen, filed formal complaints in London, New York, Singapore, and the appropriate Chinese authorities to resolve the above dispute. In August 2003, both sides agreed to resolve their disputes and to work together in the best interests of shareholders.
During the last quarter of 2003 and through 2004, Yuchai continued to execute its business plan – they completed their new foundry and production lines for their heavy-duty engines (6L and 6M) and total production capacity reached approximately 250,000 units across all lines. In November 2004, the Company reported its third quarter/nine months ending 2004 results; however at this juncture China Yuchai International Limited was still engaged in a vicious battle for control between its foreign shareholders, (Singapore based Hong Leong Asia, holding the “golden share”) and its minority Chinese partners, once again spearheaded by Mr. Wang Jianming. These governance issues were mildly touched upon in the January 17th, 2005 issue of Barron’s under the “Asian Trader” column written by Ms. Leslie P. Norton. Investors should read the two (2) Form 6-K’s dated November 8, 2004 and December 15, 2004 respectively, outlining in full detail the above predicaments.
Essentially, what occurred was Guangxi Yuchai Machinery Co., under Mr. Wang Jianming’s leadership, in March of 2004 along with Coomber (the State Holding Company/Yulin City Municipal Government) established Yuchai Marketing & Logistics Company [YMLC] to provide a comprehensive range of services to Yuchai’s customers; specifically insurance, financing, warranty servicing, and administrative and marketing services to independent Chinese truck operators. Guangxi Yuchai Machinery Co., at Mr. Wang Jianming’s direction, then loaned approximately Rmb 205.0 million (approximately $US 30 million) to this newly established subsidiary [YMLC]. This transaction was completed without CYI Board discussion or approval. Then on February 7, 2005, Singapore based management (Hong Leong Asia) filed a 6-K to announce a “new business strategy.” The Company began looking for new business opportunities to seek to reduce its financial independence on Guangxi Yuchai Machinery Co., which has historically been the Company’s main operating asset. At that time, the Directors of CYI believed that the Company’s plan for expansion could be best met through acquisition opportunities in the greater China region and elsewhere in Asia. The Board believed that acquisitions particularly in the greater China region could offer synergies with the Company’s existing operations. According to this SEC release, the Board of Directors of CYI announced that it had entered into agreements to acquire a significant stake in a China-focused electronics distribution company, Thakral Corporation Ltd. [TCL], and to raise funds through a convertible bond issue. TCL’s principal businesses include trading and distribution of consumer electronics products and accessories in China and Hong Kong; distribution of home entertainment products in China; and assembly of electronic products and electronic manufacturing services in China.
In January 2006, the Board of CYI announced their second acquisition - their intention to purchase a significant stake in LKN – Primefield (now known as HLG Enterprises), a company primarily engaged in the business of investment holding and hotel/hospitality related businesses. As of December 31, 2006 the Company owns a 36.6% stake in TCL (costing $US 50.0 million) and a 45.4% stake in HLG (costing $US 81.2 million). Also notable is the fact that the Board of CYI has obtained credit facilities during 2005 and 2006 totaling $US 180.0 million in order to implement its business and diversification plan; and has drawn down on $US 98.0 million of these lines.
On April 7, 2005, a significant milestone was reached for the Company. The Company entered into a Reorganization Agreement with Guangxi Yuchai Machinery Co. and Coomber, which was intended to be in furtherance of the terms of the July 2003 Agreement. The terms of this Reorganization Agreement, were also acknowledged and agreed to by the State Holding Company as signed by the then Chairman, Mr. Wang Jianming. This Agreement outlined a broad framework for restructuring the Company’s ownership of Yuchai. Fundamentally, the Agreement stated the transfer of the Company’s 76.4% ownership interest in Yuchai to a new company to be organized under Bermuda law (“Newco”) in exchange for shares of Newco and distribution of Newco’s shares to shareholders of the Company, subject to the successful implementation of the business diversification plan by the Company.
Also important in this Agreement between Singapore and Chinese based management was that the newly formed company, Newco, will NOT have a special or golden share structure and will strive to list on the New York Stock Exchange. Shareholders in CYI would receive shares in Newco (which will be comprised of the Guangxi Yuchai Machinery Co.’s diesel engine business, spare parts, (and possibly some others) operated and Board controlled by Chinese management), and the CYI “stub” (which will be shares in Newco, cash, and to date the stakes in TCL and HLG, operated by Singapore based management/HLA). Shortly thereafter the signing of the Reorganization Agreement, in October 2005, CYI was informed by Guangxi Yuchai that the Reorganization Agreement was delayed pending the receipt of government approvals from the relevant Chinese authorities. This delay was related to the $US 20.0 million payment due to CYI (to give up the special, golden share), as well as the spin-off of Guangxi Yuchai Machinery Co. contemplated in the Agreement. On the positive side in this news announcement was the fact that Yuchai had advised CYI that the amendments to Yuchai’s Articles of Association and corporate governance guidelines (implemented and ratified by Yuchai) had been approved by the Yulin municipal and Nanning provincial authorities but not yet approved by officials in Beijing.
Hence, both sides entered discussions to extend the anticipated completion date and termination date of the Reorganization Agreement. By the end of October 2005, shareholders were enlightened to several significant changes in the ranks of Guangxi Yuchai Machinery executive management. In this news release, dated October 31, 2005, it was stated that Mr. Wang Jianming was no longer a Director, Chairman of the Board of Directors, or the legal representative of Yuchai. Yuchai’s Board of Directors recommended Mr. Yan Ping (who, incidentally, is the son of Yuchai’s founder) to replace Mr. Wang Jianming in these roles. Mr. Yan Ping’s appointment was approved at the Yuchai Board meeting on December 2, 2005. Also in this release was a statement by the Board of CYI that they were working closely with Mr. Yan Ping and his management team regarding the status of the continued implementation of the Reorganization Agreement, including a twelve month extension for the restructuring.
Most noteworthy in this release was the statement by Mr. Yan Ping that Chinese stakeholders and management, under his leadership, seek to work closely and cooperatively with CYI with respect to the future operating management of Yuchai in accordance with international corporate governance practices. On December 5, 2005, both sides agreed to extend the Reorganization deadline to December 31, 2006. It became clearly evident by the end of 2005 why Mr. Wang Jianming was dismissed. He had entered into agreements without discussing their details with the corresponding Chinese government authorities as well as granting the unapproved loan to Yuchai Marketing & Logistics Company. CYI, as a result of Mr. Wang Jianming’s corporate actions, took a write-down of the loan amount for fiscal 2005, which resulted in dramatically lower earnings (for 2005).
On November 30, 2006, CYI released a 6-K report outlining another extension to the Reorganization Agreement. The report stipulated that the new deadline for the completion of the Reorganization will be extended from December 31, 2006 to June 30, 2007 (for the US$20 million payment to HLA) and a June 1, 2007 deadline for the repayment of the Rmb 205 million loan. This extension was signed by all parties. Most recently, on June 6, 2007, CYI and Guangxi Yuchai Machinery Company have agreed to extend the maturity date for the repayment of the Rmb 205 million loan due to Yuchai from YMCL from June 1, 2007 to May 30, 2008. This loan bears an interest rate of 6.57% per annum and is secured by guarantees from Coomber and the State Holding Company.
This brings us to present day with the Reorganization deadline imminent (June 30, 2007). There were a few reports in the Chinese press during the latter part of 2006 of whether or not both sides will go forward with the restructuring at some point. It is my belief that Mr. Yan Ping would like to go forward with the restructuring at a future time, implement a dual listing for “Newco” (either on the Hong Kong Stock exchange or the Shenzhen/Shanghai A market) and New York Stock Exchanges; and he may be currently searching for a strategic, long-term investor for Guangxi Yuchai Machinery Co. Incidentally, back on November 8, 2006, Yuchai Group sold a 43.3% stake in Yuchai Engineering Machinery Co. to H&Q Asia Pacific for US$45 million. This Yuchai Group subsidiary manufactures a full line of excavators and has a five year history of profitability. Yuchai Group held talks with more than twenty bidders including China Everbright Group and Singapore’s Temasek Holdings. The H&Q Asia Pacific Chairman, Mr. Ta-lin Hsu commented, “This company is quite well managed and very profitable so we never felt the need for big control….In two to three years, a domestic or overseas IPO is a definite possibility.” The head of greater China for H&Q Asia Pacific, Mr. Andrew Kuo, made appealing comments such as, “The China excavator industry is growing at 30 – 50%....The United States and Europe are the two markets for Yuchai to focus on…The Middle East is another one they are looking at.” Mr. Kuo also stated, “H&Q will facilitate closer co-operation between Yuchai Engineering and China Yuchai, including more diesel engine transactions.”
For further information, please view H&Q Asia Pacific’s website. While Yuchai Engineering Machinery Co. has no impact (unfortunately) on publicly traded China Yuchai International, Ltd., I thought it important to include in this commentary as it illustrates the financial sophistication of Yuchai Group, under its new Chairman, Mr. Yan Ping. Further, Mr. Yan Ping is known as a progressive reformer in China’s economic circles and has made enormous progress at Yuchai. He has implemented Sarbanes-Oxley reforms, international corporate governance and accounting practices. He has allowed more transparency into Yuchai’s businesses by leading the above developments and by enhancing the company website (www.yuchai.com ). Under his leadership in 2006, Yuchai Group has been recognized as a top brand in the Chinese 500 Machinery Company rankings. In July 2006, Yuchai moved up 12 slots in this brand ranking from number 37 to number 25. Mr. Yan Ping has also led the way for Yuchai in its environmentally friendly policies in adopting the Euro III and Euro IV standards for Yuchai’s diesel engines.
As I approached the middle of the first quarter of 2007, I began to conclude that Singapore based management (Hong Leong Asia), which continues to hold the special/ “golden” share, were not acting in the best interests of shareholders. They manage their investment in Guangxi Yuchai Machinery Co. from Singapore (1,500 miles away) and they rely on four financial controllers located at the Yuchai plant in Yulin City to accomplish this, while receiving millions of dollars in fees each year. Most requests by US based shareholders, like myself, to establish an Investor Relations Department at Guangxi Yuchai headquarters, assist Guangxi Yuchai Machinery Co. in utilizing the international capital markets to help grow their top and bottom lines/make strategic acquisitions, implement earnings conference calls, and provide US shareholders with better transparency into the company had all been ignored.
I had made several efforts over the years, in speaking to the Chief Financial Officer of CYI/HLA, Mr. Philip Ting, to persuade his management to be more cooperative in communicating with shareholders. For example, on Tuesday, October 3, 2006, in The Business Times Singapore, there was a brief article on Hong Leong Asia and Mr. Ting was quoted as saying, “long-term fundamentals remain intact” and “at HLA’s major subsidiary – CYI, China’s largest independent manufacturer of diesel engines – previous issues are past and gone.” After this article surfaced, I wrote to Mr. Philip Ting and requested they release this press article to US shareholders and this idea was rebuffed. I also inquired in the past, specifically the times when the stakes in Thakral and HLG were being acquired, why didn’t they ask (US based) shareholders to vote on these purchases and the overall “China diversification plan.”
My last attempt to implore CYI/HLA management for better communication/transparency with US shareholders occurred on February 5, 2007 when I briefly spoke to Mr. Philip Ting to confirm the earnings release date for 2006 year end results. I encouraged him to mention in the release the current great working relationship between HLA and the new Guangxi Yuchai Chairman, Mr. Yan Ping, including all of Mr. Yan Ping’s recent corporate efforts (implemented all Sarbanes-Oxley rules and regulations, streamlined Yuchai’s corporate structure to decrease bureaucratic waste and inefficiency, cost cutting efforts, and his pledge to work closely with CYI/HLA management), provide shareholders with more detail on Thakral (name some of the exclusive brands that they distribute; HLA has replaced its entire management team and is making efforts to return the company to growth and profitability) and HLG Enterprises (provide the names and locations of their hotel properties in China, Vietnam, and Malaysia; mention the “Equatorial” brand), and of course a full update on the Reorganization. Once again, my suggestions were disregarded.
At this juncture, I would like to mention the reported results by CYI on February 27, 2007 and Hong Leong Asia on February 28, 2007. CYI’s 6-K 2006 year-end unaudited report, is a plain, 11-page release with limited commentary. In HLA’s release, there are two sets of documents. One provides a 15-page, full year unaudited financial statement with dividend announcement with extended commentary and another providing a 16-page elaborate slide presentation. I am aware that HLA’s business is extensive, but it is now clearly apparent that Hong Leong Asia’s management is only concerned with Hong Leong Asia. I would like to point out that in the Hong Leong Asia commentary on page 10 of its results, HLA reports that Yuchai’s gross margins were 22.2% versus the previous years 22.4%. On HLA’s slide presentation pages 9-11, you see a full breakout of Yuchai’s diesel engine unit sales with bar and pie graphs. I was extremely disappointed with HLA’s response to the difference in reported margins and their overall methods of presenting results; – it is very clear that they use the less stringent Singapore GAAP accounting rules to show better results for HLA; and hence I question their credibility to do what is best for US based shareholders.
It is my firm belief that CYI/HLA management is stalling the Reorganization for several reasons. First, China Yuchai International has bestowed over 50% of Hong Leong Asia’s overall revenue and profits the past several years and they are concerned, when the Reorganization is complete, that they will not be able to fully consolidate the “New” company’s results into HLA. Second, I believe HLA would like to use the cash generated by its main operating asset (Guangxi Yuchai) to refurbish and expand their HLG properties; I believe a better use of CYI’s cash would be to pay dividends to shareholders, and buy back stock. And finally, if the Reorganization proceeds (implementation by June 30, 2007), this will not be enough time to restructure/turnaround the Thakral electronic distribution business. One or any combination of these three I emphatically believe, would cause HLA’s stock in Singapore to plummet. As investors, I think we would all agree that it is difficult to “serve two masters.”
Due to the above developments at the Company, I decided to write and send to the Board, my shareholder activist letter on April 30, 2007, urging to make changes for the benefit of all shareholders. I received their indistinct response on May 9, 2007; and sent my subsequent reply on May 13, 2007.
The Company was due to report Q1 2007 earnings on May 14, 2007, but these results, according to Singapore based management, have been deferred due to a change in auditors in December 2006 (SEC filing dated May 15, 2007).
Recently, I have been drawn to other financial websites in order to discover newsworthy milestones for the company. I encourage interested investors to view Financialrealtime.com and Zacks.com. As you can clearly see, the Company is doing very, very well and achieving the goals of the Chinese Chairman, Mr. Yan Ping. None of these above news items, company milestones, or my activist correspondence to the company have been disclosed to the market newswires or to shareholders. And the question still remains…Why isn’t Singapore based management/Hong Leong Asia making the effort to announce these (and past) company milestones? Why aren’t they acting as a value added partner to their main operating subsidiary, Guangxi Yuchai Machinery Company Limited, which generates a majority of Hong Leong Asia’s revenue and profits?
The results generated by China Yuchai International, Ltd. prove that it works and that it is extremely profitable. The company is small and undiscovered by Wall Street and has no research coverage. With approximately $US2.50 per share in cash and the stakes in Thakral and HLG now worth approximately $US6.0, you are purchasing the largest independent Chinese diesel engine maker for approximately $US2.75. Given this extremely cheap valuation and as I stated in my shareholder activist letter, “I emphatically believe several global buyout firms would be very intrigued in owning a 76.4% interest in Guangxi Yuchai Machinery Co., a subsidiary of Yuchai Group, now a top 25 Industrial and Machinery brand in The People’s Republic of China.” Hello Carlyle or Warburg Pincus?
In the end, I would still like to see HLA and Yuchai management implement the Reorganization Agreement - abolishing the golden/special share, and assist the company in raising additional capital for expansion, and achieving a dual China/HK-NYSE listing, I envision the newly formed company (“Newco”) could continue to grow the business (top line 12% -16% per year), expand market share by completing a few strategic acquisitions to enhance Yuchai’s great brand name, and expand international sales in Asia and the Middle East. I strongly believe that Mr. Yan Ping has some strategic plans for the newly formed Chinese company, namely, making a strategic acquisition in northeast China (Hebei, Shandong, or Jiangsu provinces) where Yuchai Group would be better able to serve its northern customers and capture greater market share (looking at the Zacks news stories in the above link it appears I was correct – May 15, 2007). I would like to remind all investors that the central government in Beijing is still ramping up spending for public works projects for the Olympic Games in 2008 and World’s Fair in 2010.
In conclusion, I hope “China opportunity” seeking investors find the above insightful and worthy of interest. I presently feel this investment opportunity in China Yuchai International is very compelling and merits an in-depth look. I would encourage all investors to review the public SEC filings on China Yuchai International, Limited and make their own investing decisions. I am aware that I do not have the fund size of the likes of Dan Loeb of Third Point, Carl Ichan of Icahn Management LP, or Warren Lichtenstein of Steel Partners who immediately grab headlines when they engage in their activist tactics, but as a Registered Investment Adviser, I have a fiduciary responsibility to my clients to do what I believe is right for the companies that they (and my firm) are invested in; and to date in my opinion, the Board and executive management of CYI are failing in their fiduciary obligations.
Disclosure: Peter A Delgado II is the Principal and owner of Threshold Capital Corp, a state Registered Investment Adviser in the State of New Jersey. Threshold Capital Corp and its clients currently hold a position in China Yuchai International, Limited and plan on holding that position through the Company’s Annual meeting.