Shanghai Century (SHA), a special acquisition company, reported six-month earnings for its intended target: Sichuan Kelun Pharmaceutical Co., Ltd. Sichuan Kelun is the largest producer of IV solution products in China.
Kelun reported revenues of 691 million RMB ($90.8 million) in the first half of 2007, an increase of 63% from the year earlier. About 39% of the increase was due to an acquisition that Kelun made in early 2007, while the rest came from increased sales and a move toward higher priced and higher margined members of its existing product line. Profits were 65 million RMB ($8.5 million).
The six-month profit number reflects writedowns for profits made before the acquisitions were completed and inventory. Without the writedowns, profits would be 80 million RMB ($10.5 million), for a net earnings margin of 11.6%.
Kelun Group, which consists of Kelun and 13 operating entities, is the largest manufacturer of intravenous solution products in the PRC. Kelun has introduced a first-to-market, patented upright-standing polypropylene [PP] soft bag for IV solution products in China. Kelun Group currently manufactures and sells more than 90 IV solution products, the largest IV solution product portfolio of any pharmaceutical company in the PRC market.
In addition to IV solution products, Kelun Group also manufactures and sells generic prescription injection products and over-the-counter drugs in China. Kelun Group has 126 new candidates in its product pipeline. Headquartered in Chengdu, Sichuan Province, Kelun owns or controls 13 operating entities, located in Sichuan, Hunan, Hubei, Jiangxi, Yunnan, Shandong, Heilongjiang and Jilin. As of December 31, 2006, Kelun Group had a total of approximately 6,800 employees.
Back Story for Shanghai Century
In April 2006, Shanghai Century, which is based in Hong Kong, raised $115 million in its American Stock Exchange IPO with the goal of buying a China-based business. Approximately $106 million remains in the company coffers.
The company sold 14,375,000 units at a price of $8 per unit. Each unit consisted of one share and a warrant that becomes exercisable to buy an additional share of Shanghai Century for $6, once the price of the stock trades at $11.50 or higher for 20 trading days during a 30-trading-day period. Management owned 3 million shares, bringing the total number of shares to 17.375 million, which has since risen to 17.5 million shares. Management effectively valued their expertise at $24 million (3 million shares at $8 each).
The underwriters paid $100 for 1,000,000 units, which differ from the public units in that the price paid to exercise the warrants will be $7.50 rather than $6.50.
The Kelun Acquisition
However, the vast majority of the Shanghai Acquisition’s IPO cash will continue to sit in interest-bearing accounts, because the deal for Kelun is structured as an all-stock transaction. Shanghai offered 20,000,000 shares for Kelun, with considerable additional payments (of stock) contingent upon the company’s profitability in 2007, 2008 and 2009.
After the acquisition, if the combined company (Shanghai Acquisition plus Kelun) makes a profit of 180 million RMB ($24.7 million), an additional 5 million shares will be issued to Kelun shareholders. A profit of 260 million RMB ($34.7 million) in 2008 triggers a 2 million share payment, as does a profit of 370 million RMB ($49.3 million). All in all, if Kelun hits all the marks, its shareholders would receive 29 million shares.
Also, if the stock price of Shanghai Acquisition reaches $11.50, the point at which the warrants (part of the original unit structure of the IPO) are made exercisable, the shareholders of Kelun will be recompensed to the tune of $11.5 million.
Shanghai Acquisition notes that it has 17.5 million shares outstanding before the transaction, with the public owning about 83% of them. The initial 20 million share payment to Kelun reduces SHA shareholders to a 47% net ownership position and, should all 9 million of the milestones be paid, existing SHA shareholders would own a 38% stake in the company.
Because of the importance of the acquisition, Shanghai Acquisition shareholders will have the opportunity to vote for or against the Kelun transaction. If they vote No, they have the right to demand that the company redeem their shares, which will be priced at a proportionate amount of the money held in trust from the IPO. Shanghai Acquisition will redeem up to 20% of the shares outstanding.
The charter for Shanghai Acquisition contained a clause binding the company to make a deal within 18 months from the IPO. If the Kelun transaction is not completed, Shanghai Acquisition will not have time to find another candidate and complete an agreement. It will have to be liquidated.