ARC Capital Holdings has published results for the year ended 31 December 2014. These are obviously well out of date but they bring investors more up to speed with developments in the business. Normally we summarise large chunks of results statements to make your life easier but In ARC Capital’s case there is so much litigation going on that it is more straightforward to reproduce the Chairman’s statement.
” The composition of ARCH’s Board and Management has undergone a significant number of changes since the beginning of 2014. On 9 January 2014, Mr Christopher Gradel left the Board of ARCH as the other directors at that time wished the Board to be wholly independent from ARCH’s then investment manager, ARC Capital Partners Limited (the “Investment Manager”). Mr Gradel could not be considered an independent director due to his role with the Investment Manager and its parent, PAG Holdings Ltd (“PAG”), the latter company being one in which he also held an equity interest.
On 7 February 2014, the Investment Manager provided written notice of its resignation, and its investment management agreement ended on 7 August 2014, following the conclusion of its 6 month notice period.
Subsequently, on 20 March 2014, Borrelli Walsh Limited (“Borrelli Walsh”) was appointed as a consultant to the Board, with a mandate of providing independent oversight of the Fund’s portfolio and guidance to ARCH’s directors.
On 8 April 2014, Mr Timothy Rucquoi-Berger left the Board. The Board at that time announced that this was the outcome of its efforts to rationalise operating costs and streamline reporting and decision making processes.
In December 2014, entities related to PAG, which controls ARCH’s former investment manager, increased their shareholding in ARCH to over 50% and requisitioned an extraordinary general meeting to remove the then existing directors and replace them with a new board of directors. As a consequence, the Board composition changed in February 2015, with Messrs Steven Feniger and Tian Cho Chu, and MsHelen Wong leaving the Board, and Messrs Alpay Ece, Cosimo Borrelli and Sean Hurst being appointed as the new Board of ARCH.
Mr Cosimo Borrelli was removed from the Board on 30 March 2015. Subsequent to this, Borrelli Walsh tendered its resignation as a consultant to the Board, effective 15 April 2015. The Board has decided not to appoint a replacement for the Investment Manager or Borrelli Walsh at this time but to retain specialist consultants in relation to individual assets when appropriate.
Investments
Xiajin Dairy
On 20 January 2014, ARCH completed the sale of its entire stake in Ningxia Xiajin Dairy Co. Ltd. for a total consideration of US$30.0 million, which was approximately 1.7 times ARCH’s initial investment cost of US$18.1 million.
Buchang Pharmaceutical
On 30 April 2014, ARCH entered into a definitive agreement to sell its entire stake in Buchang Pharmaceutical for a total consideration of US$14.9 million. The transaction completed on 27 May 2014, at which point ARCH received the full consideration.
Jiadeli Holdback
Following the year end, on 15 June 2015, ARCH announced that an agreement had been reached with HNA Group for the settlement of the sum due from HNA Group in respect of the Jiadeli Holdback. This settlement was for the HNA Group to pay the full amount outstanding and this was achieved after a lengthy process of litigation in China. The full amount due of RMB90 million plus RMB3 million of costs was received by Shanghai Xinmeng Investment Co., Limited (a subsidiary of ARCH) on 12 June 2015. In return, ARCH has waived the interest due under the original China International Economic and Trade Arbitration Commission (“CIETAC”) award of 3 June 2014.
The net value of this settlement has been reflected in the December 2014 NAV as the carrying value of the Jiadeli Holdback was previously nil. The carrying value in the financial statements as at 31 December 2014 has also been adjusted. The net adjustment to NAV was approximately US$8.1 million compared to the NAV as at 30 September 2014, being RMB93 million (equivalent to approximately US$15.2 million) less fees and expenses incurred in China together with a provision of US$5.3 million in respect of any taxes that may be required to be paid. The fees and expenses included the success fee of approximately RMB11 million (equivalent to approximately US$1.8 million) payable to ARCH’s Chinese legal counsel. It should be noted that the success fee agreement with ARCH’s Chinese legal counsel was entered into on 10 December 2013, prior to the appointment of the current directors in February 2015. ARCH received a net amount of approximately RMB81.8 million (equivalent to approximately US$13.4 million), before any provision for taxes payable in China.
Xian University (Shaanxi Da De Education)
On 23 November 2013, ARCH entered into a definitive agreement to sell its entire stake in Xian University for RMB165.2 million (approximately US$27.1 million).
On 1 December 2013, ARCH received an initial payment of RMB75.1 million (approximately US$12.3 million), and was expecting to receive a final payment of RMB90.1 million (US$14.8 million) no later than 10 December 2014 to complete the sale. The final payment has not been received and ARCH has commenced legal action in China to pursue recovery of the amount outstanding.
As at 31 December 2014, it was decided by the Board to recognise the initial deposit received as return of equity and the Board estimated the fair value of the investment at nil. The final payment had not been received by ARCH as at 31 December 2014 and has not been received since that date.
Bridge Loan to “DCSI” (Orient Home Retail Sale)
On 26 August 2013, ARCH agreed to extend the maturity date of the loan provided to a domestic Chinese strategic investor (“DCSI”), which related to the sale of Orient Home Retail, to 30 June 2014. In April 2014, ARCH’s valuation committee (the “Valuation Committee”) agreed to reduce the value of the loan by 10% and agreed to fully write off the remaining outstanding interests. The loan was not repaid on 30 June 2014. Following their appointment in February of this year, the new directors have initiated legal proceedings in China against the DCSI to seek recovery of the loan.
Orient Home Investment (RMB480 million)
In December 2010, the Fund’s then Investment Manager procured the transfer of RMB480 million (US$76.2 million) (the “Orient Home Payment”) under an equity purchase agreement (the “Equity Purchase Agreement”) for the purchase of a majority stake in Orient Home Property. The price paid represented the full purchase price. Subsequent to this transfer Orient Home failed to comply with the conditions precedent set out in the Equity Purchase Agreement. Accordingly, repayment of the Orient Home Payment fell due, but no repayment has been forthcoming and, in May 2013, a request for arbitration was filed with CIETAC.
On 17 June 2015, ARCH announced that CIETAC had unanimously ruled that Orient Home Co., Ltd be required to refund Shanghai C.P. Jing Cheng Enterprise Development Co. Ltd. (“Shanghai CP JC”) (a subsidiary of ARCH) the entire RMB480 million of the Orient Home Payment.
CIETAC also ruled that Orient Home Co., Ltd be required to pay Shanghai CP JC late payment interest calculated from 5 March 2011 to the actual payment date, applying the lending interest over the same period as published by the People’s Bank of China, as well as the arbitration fee of approximately RMB4.4 million (equivalent to approximately US$0.7 million).
Subsequently, on 8 July 2015, Orient Home Co. Ltd applied to the Beijing Second Intermediate Court to have this award set aside. However, on 20 August 2015 the Beijing Second Intermediate Court dismissed this application.
The Board of ARCH is consulting with its advisers on the means of enforcing the award. The carrying value of the claim in ARCH’s NAV is currently RMB250 million (approximately US$41 million) and the Board has resolved to keep this unchanged.
The Beijing First Immediate People’s Court granted a property preservation order for RMB280 million against Orient Home in July 2013.
Claim against Investment Manager (Orient Home litigation in England)
On 6 February 2014, ARCH announced a possible claim against the Investment Manager. The then directors believed that the Investment Manager had been negligent and/or breached its investment management agreement (the “IMA”) with ARCH in respect of the Orient Home investment. The then directors came to this view on the basis that the full consideration of RMB480 million in respect of the Orient Home transaction was paid away, without security or any escrow arrangements, and for merely a contractual promise to transfer all of the consideration shares at a future date if certain pre-conditions were met and, if they were not met, to return the money.
On 15 August 2014, ARCH announced that, despite being engaged in pre-action correspondence with the Investment Manager since February 2014, this exchange of correspondence had not led to a resolution of the dispute. Having considered the position with its legal advisers, the then directors announced that ARCH had issued legal proceedings in the English High Court against the Investment Manager for negligence and/or breach of the IMA. It claimed damages in the sum of RMB480 million for the loss of the Orient Home Payment and other losses, including the professional fees and other costs ARCH had incurred in attempting to secure repayment from Orient Home.
On 22 April 2015, the new directors announced that they had commissioned an independent review of ARCH’s litigation against the Investment Manager in respect of the Orient Home investment and had appointed leading international law firm Baker & McKenzie LLP (“Baker & McKenzie”) to undertake the review. Baker & McKenzie was tasked with undertaking an independent review of ARCH’s claim in the English High Court against ARC Capital Partners Limited concerning Orient Home and providing an opinion on the reasonableness of pursuing such claim.
Funtalk China Holdings (formerly Beijing Pypo)
On 31 March 2014 ARCH announced that ARCH Digital Holdings Limited (“ARCH Digital”), a wholly owned subsidiary of ARCH, had entered into certain definitive agreements to sell, subject to shareholder approval, its entire equity stake in Fortress Group Limited (“Fortress”) for a minimum cash consideration of US$137.3 million. Fortress was the 100% shareholder of Funtalk China Holdings Limited (“Funtalk”). The proposed buyer was Sanpower Group Co. Ltd. (“Sanpower”). The sale of Fortress was approved at the ARCH extraordinary general meeting, held on 16 May 2014, but did not progress to completion as the conditions precedent were not satisfied. Fortress subsequently entered into an agreement for the sale of its 100% equity interest in Funtalk (“Fortress Sale”).
On 27 August 2014, subsequent to the Fortress Sale, ARCH Digital received a letter from Fortress, which enclosed a notice addressed to Fortress dated 25 August 2014 (the “Put Option Notice”) issued by PAGAC Fortress Holding I Limited (“PAGAC”), a company affiliated with PAG, of the exercise by PAGAC of the put option (the “Put Option”) referred to in the shareholder agreement, dated 25 August 2011, that ARCH Digital had entered into at the time of the privatisation of Funtalk (the “Shareholder Agreement”). The background to the Put Option is as follows. If Fortress did not consummate an exit of Funtalk by 25 August 2014 then PAGAC would have the right to require Fortress to repurchase PAGAC’s holding in the preferred shares and convertible bonds issued by Fortress. If Fortress was unable to perform its obligation under the Put Option, the requirement to repurchase PAGAC’s preferred shares and convertible bonds fell to the shareholders of Fortress, other than PAGAC, pro-rata, including ARCH Digital.
On 2 September 2014, the Fortress Board resolved to repurchase all of the convertible bonds and 2,093 out of the 4,999 preferred shares at a cost of approximately US$250 million. Subsequently, on 3 September 2014, ARCH Digital received a notice from PAGAC notifying ARCH Digital that Fortress had failed to pay the entire put price with respect to the Put Option and that PAGAC was exercising its right pursuant to the Shareholder Agreement to require that ARCH Digital purchase its pro rata portion of the put securities that were not purchased by Fortress (the “ARCH Digital Put Option”). The notice relating to the ARCH Digital Put Option (the “ARCH Digital Put Option Notice”) further stated that the unpaid Put Option price attributable to ARCH Digital was US$52,322,284, and that ARCH Digital was required to pay this amount within 10 business days, i.e. no later than 17 September 2014.
ARCH Digital did not have the necessary cash or liquid assets to pay the unpaid Put Option price attributable to ARCH Digital as required in the ARCH Digital Put Option Notice. ARCH Digital had, by a share charge agreement dated 25 August 2011 (the “Share Charge Agreement”), conferred on PAGAC a security interest over ARCH Digital’s equity holding in Fortress (the “Charged Assets”) to secure, among other things, ARCH Digital’s performance of its obligations under the Shareholder Agreement. If ARCH Digital failed to perform its obligations under the Shareholder Agreement, including its obligation with respect to the ARCH Digital Put Option, PAGAC could enforce its security under the Share Charge Agreement, including, but not limited to, to receive and retain all dividends, interest, distributions or assets accruing in respect of the Charged Assets, and to sell, transfer, grant options over or otherwise dispose of the Charged Assets. All money received by PAGAC under the Share Charge Agreement was to be paid in accordance with that agreement, including towards satisfaction of any amounts in respect of ARCH Digital’s obligations under the Shareholder Agreement. Any surplus remaining following payment under the Share Charge Agreement was to be repaid to ARCH Digital.
ARCH Digital did not pay the US$52,322,284 to PAGAC by 17 September 2014 and has not made any payments to PAGAC since the ARCH Digital Put Option Notice was received from PAGAC on 3 September 2014. Shareholders should note that, other than its interest in Fortress, ARCH Digital has no other assets. Further, ARCH has not guaranteed ARCH Digital’s obligations to PAGAC.
The current Board has commissioned an investigation into the acquisition of Funtalk by Fortress in 2011, ARCH’s investment in Fortress and the events concerning the Fortress investment from 2011 to date from the same legal adviser acting for ARCH on the Claim against the Investment Manager in respect of Orient Home in England. This investigation is ongoing.
Asset Valuation and Audit Opinion
ARCH’s auditor has qualified its opinion on the Fund’s consolidated financial statements because it has been unable to obtain sufficient evidence as to the carrying value on several financial assets – Shannxi Da De Education, DCSI Bridge loan, Orient Home and Fortress. The Board acknowledges the significant uncertainty surrounding these financial assets which are all the subject of litigation and the likelihood of achieving any recovery in the future and has based its valuation of these assets on the information available to it and the advice of its various legal counsel. The Board acknowledges that the outcome of such litigation is uncertain and can have a material impact on the value of such assets.
NAV
ARCH’s NAV has decreased by approximately 64.28% from US$0.3315 (as at 30 September 2014) to US$0.1184 (as at 31 December 2014). This decrease is primarily due to the accounting treatment of ARCH Digital when producing ARCH’s consolidated balance sheet. Under ARCH’s current accounting policies, even though the Fortress investment has been written down to nil, the exercise of the Put Option by PAGAC means that ARCH Digital’s liabilities exceed its assets by approximately US$57.76 million (as at 31 December 2014). On consolidation, this net liability has to be recognised in ARCH’s consolidated accounts, hence the reduction in NAV of US$57.76 million. However, shareholders should note that ARCH has not guaranteed ARCH Digital’s obligations under the Shareholder Agreement. The pro forma adjusted NAV represents an increase of approximately 12.10% compared to the last reported NAV per share at the close of business on 30 September 2014.
The Board has resolved that, as ARCH’s investment portfolio is predominantly comprised of claims against third parties rather than investments in businesses, it will no longer report quarterly NAVs. Updates to the market will be communicated at the time of the final and interim results and when there is any development in the Fund’s portfolio.
Return of Capital
Following the sale of its stake in Ningxia Xiajin Dairy Co. Ltd., ARCH distributed US$28.0 million by way of a mandatory share repurchase which was settled on 3 February 2014 at US$0.85 per ordinary share, equal to ARCH’s unaudited Net Asset Value per share as at 31 December 2013. ARCH has now distributed a total of US$113 million to shareholders in 2013 and 2014.
In addition to cash holdings, ARCH’s remaining portfolio consists of a number of litigation and arbitration claims. While there are further challenges ahead, the Board has acted and will continue to act diligently to realise value where possible and to protect shareholders’ interests.
The Board is currently reviewing the cash required for ARCH to continue its operations and plans to retain sufficient working capital to pursue the Fund’s various litigation claims to the fullest extent necessary. The Board has therefore resolved to await the outcome of the investigation into the Funtalk investment and also the repatriation of the surplus cash held within ARCH’s Chinese subsidiaries before considering making a further return of capital.
Trading on AIM (Suspension)
On 14 August 2015, ARCH announced that it had been notified by Grant Thornton UK LLP of its resignation as Nominated Adviser effective 15 September 2015. The Fund futher announced that, pursuant to AIM Rule 1, if a replacement Nominated Adviser is not appointed by 15 September 2015 then ARCH will continue to be suspended for a further month, at which time the admission of its ordinary shares to trading on AIM will be cancelled.
Discussions concerning the appointment of a replacement Nominated Adviser continue and a further announcement regarding a replacement will be made in due course.”
ARCH : ARC Capital’s final results make interesting reading