Dutech Holdings

[[DY]]

Dutech has contracted to buy German safe company - FORMAT - to be valued at approx. $4.7m (based on the agreed purchase consideration of 28.536m new Dutech shares amounting to 8% of Dutech's enlarged capital base; and the last done share price of $0.165).....
http://info.sgx.com/webcoranncatth.nsf/V...B00374581/$file/Ann_ProposedAcquisitionofFormat.pdf?openelement [10Jun11 announcement]
http://www.format-tresorbau.de/en/products.html [FORMAT's corporate website]

While FORMAT is now loss-making, Dutech is buying the business essentially for its technologies and customer base, and has articulated very well the rationale for the Proposed Acquisition as follows:

"(a) Over the years, Format has developed certain advanced technologies,
products and production expertise which will take the Group some years to
develop. Owing to its high costs structure and production capacity
constraints, Format was not able to fully utilize these advantages.
However, if the certificates, technologies and new products are coupled
with the Group’s low cost competitive edge, the acquisition will
significantly consolidate the Group’s market leadership by capturing more
market share and improve its profitability.
(b) The Board believes that the Proposed Acquisition will significantly increase
the Group’s sales. The enlarged economies of scale will greatly enhance
the Group’s competitiveness and improve its capability to withstand
adverse situations and risks.
© The Proposed Acquisition will enable the Group to take a firm step into
Europe. Further, by acquiring Format, the Group may also eliminate an
avenue open to the Group’s competitors to enter into the European market
and high end safe and security market.
(d) The Board believes that it is able to reduce the procurement costs and
improve the cash flow of Format.
(e) The Proposed Acquisition will enable the Group to tap on Format’s
customer base. This will create synergy in term of sales and marketing.
(f) The Proposed Acquisition will enable the Group to have a production base
in Europe and will thereby enable the Group to mitigate the impact of
trade disputes and frictions which may arise between the PRC and other
developed countries due to trade imbalances.
(g) Droege’s shareholding in the Company will enable Droege to become a
strategic partner with the Company. With Droege nominating two nonexecutive
members to the Board, the Company can draw on the experience of Droege for
the advantage of the Company."

Based on FORMAT's 31Dec10 NTA of EUR5.389m - equivalent to $9.217m - Dutech stands to book a gain from bargain purchase of approx. $4.5m on closing of this acquisition. As Dutech's current share price appears to be substantially lower than its intrinsic value, I suppose we can assume, on a value basis, the proposed deal between Dutech and (the seller) Droege International Group AG is a fair exchange between the 2 future partners.

I am quite impressed by the structure of the deal, bearing in mind Dutech and its management are based in PRC.

Hi Sir,

I notice we share some similar stock picks. Dutech and HrGlass.

Just wanted to share something - my understanding is that Dutech is the only manufacturer of UL-certified ATM safes in China. This UL certification, which stands for "Underwriters' Laboratory", is a big deal. Without this certification, banks will not be able to purchase insurance for their safes.

I was given to understand that getting this certification isn't something easy. In a way, this is a moat of Dutech.

(correct me if I'm wrong about them being the only manufacturer of UL-certified ATM safes in china. If there is a competitor, I would love to hear/read about them.)

And cheers with the HrGlass pick too.

[Drizzt]

this business seem to be very taxing on receivables and inventory. that drives down their quarterly cash flow. nature of the busienss?

[changwk]

hi,

on the UL certified manufacturers in China, I have found 1 more in China. Looks like Dutech is not the only UL certified in China.

Rouchtec
http://rouchtec.en.alibaba.com/productgr...l#products

[dydx]

From Rouchtec's website, it is quite clear that the company makes mostly small safes for hotel rooms and offices, but not ATM safes which quite obviously have to carry higher standards in technical specifications and security. I suspect the "UL" certification for ATM safes is different from that for other safes.

[changwk]

hi,

Dutech is a member of ECB•S (European Certification Board of Security Fire & Life safety.

The European Security Systems Association (ESSA) e.V. is a neutral certification body accredited to EN 45011. It certifies products providing protection against burglary and fire as well as high security locks. ECB•S is the "brand" of the ESSA.

Dutech is indeed listed on the ECB website.
http://www.ecb-s.com/_rubric/index.php?r...rke=&name=

[changwk]

hi dydx

I was reading thru Dutech AR for FY 2010.
they have a short term loan of 60mil.
do u know why they want to borrow when they have cash
in access of 182mil? take advantage of the lower interest rate?

[d.o.g.]

I was reading thru Dutech AR for FY 2010.
they have a short term loan of 60mil.
do u know why they want to borrow when they have cash
in access of 182mil? take advantage of the lower interest rate?

EDIT: I missed the fact that the loan is in SGD while the collateral is in RMB. It was mentioned in the Chairman's message but not disclosed in the actual Notes to the Financial Statements. There is an interest rate arbitrage going on. The company is taking on forex risk in exchange for a positive carry. Mystery solved.

The loan makes absolutely no sense at all since:

1. It is fully secured

The collateral is RMB 55,635,000 of pledged deposits, against a loan of RMB 55,657,000. Essentially the real loan quantum is only RMB 22,000 or less than 0.04% of the stated loan amount, since the balance of the cash is pledged and cannot be used. It is quite normal to pledge land, buildings and machinery as security for a cash loan. But pledging cash to get cash? This seems to come straight from the Department of Redundancy Department.

2. The actual interest rate is very high

Interest is being charged on RMB 56m of loans even though only RMB 22k is actually usable. The RMB 56m collateral does earn interest so we need to compute the spread.

The company earned RMB 1.6m of interest income in 2010. Assuming an average cash balance of RMB 145m (average of starting and closing cash balances), that's an interest rate of 1.1%. So there is a negative spread of 0.1% on the RMB 56m (it earns 1.1% of interest but attracts a borrow fee of 1.2%). This means the net interest cost is 0.1% or RMB 56k. But since the real loan amount is only RMB 22k we have an effective interest rate of 250%. Nice deal for the bank, horrible deal for the company. What if deposit rates rise? Would the company benefit since the loan interest rate is low? Well, then the bank could just cancel the loan... see below.

3. It is repayable on demand

The bank can call the loan at any time, regardless of whether there has been a default. So even though the loan is due in 2012, in reality it could come due tomorrow. This type of loan is completely useless since the bank can ask for its money back just when you need to use it, or worse, just after you have used it.

Putting all 3 factors together, we have a loan that is only 0.04% of the amount claimed, an effective interest rate of 250%, and that can be canceled at any time.

Maybe China is indeed special and there are companies that can do business with this type of financing. Maybe banking is so complicated in China that it is normal to borrow money and then leave 99.96% of the cash in the bank as collateral. Or maybe there is more to the company than meets the eye. Maybe.

As usual, YMMV.

[freedom]

It explained in the note to the secured loan that the borrowing was borrowed in sgd from a Singapore bank to pay dividend and secured against yuan deposit in China. It is not easy to just transfer yuan out of China for small foreign owned enterprise.

---

As Chinese government relaxes the rule of capital flow, dutech can settle its loan using its oversea sales.

[dydx]

hi dydx

I was reading thru Dutech AR for FY 2010.
they have a short term loan of 60mil.
do u know why they want to borrow when they have cash
in access of 182mil? take advantage of the lower interest rate?

Dutech's FY10 (ended 31Dec10) AR.....
http://info.sgx.com/listprosp.nsf/07aed3...1002e7879/$FILE/_Dutech%20Holdings%20Annual%20Report%202010%20(SAR1009018).pdf

From the B/S and Note 22 (in p48/49), we know the RMB60.385m total Borrowings balance comprised 2 seperate loans:
(a) an unsecured interest-free 'soft' loan of RMB5.0m borrowed by a subsidiary from the local PRC government, repayble by 25Nov11 in a lump sum payment. This loan was first taken up in FY08.

(b) a secured bank loan of approx. RMB55.657m borrowed by a subsidiary, repayable in 2012, and bearing interest rates ranging from 1.199% to 1.201%p.a. in FY10. This loan was secured by pledged deposits of RMB55.635m in PRC and a corporate guarantee from Dutech. For accounting purposes, this loan was classified (likely at the request of the external auditors, Crowe Horwath First Trust LLP) in the AR as a current liability due to "an overriding repayment on demand clause at the bank's discretion, irrespective of whether a default event has occured" in the loan agreement. From the Chairman's Message (in p3), we know this loan is actually denominated in the SGD equivalent of the pledged RMB deposits, from a Singapore bank (an educated guess will point to OCBC), and was taken up for arbitrage purposes. From Note 19 (p48), we know that Dutech earned effective interest rates for fixed deposits ranging from 2.79% to 4.33%pa in FY10. Based on the positive rate differential derived from the above doposit and loan interest rates, it appears that Dutech stands to make some extra money from this match-funded, cross-currency, 'parallel' deposit-loan arangement with OCBC.

From Dutech's Q3-FY10 results announcement....
http://info.sgx.com/webcoranncatth.nsf/V...90032689D/$file/Dutech_3rdQ_30Sep10.pdf?openelement
we know that this 'parallel' deposit-loan arrangememnt with OCBC actually started in Q3-FY10, and the orginal loan amount drawn was for RMB16.359m as a 2-year loan, specifically to fund the $0.01/share Interim dividend (total amount in RMB equivalent: RMB16.492m) paid on 30Sep10....
http://info.sgx.com/webcorannc.nsf/Annou...endocument
The loan amount was subsequently raised to RMB55.657m as at 31Dec10, and by further a little more to RMB56.568m (likely due to accumulation of interest accrued) as at 31Mar11....
http://info.sgx.com/webcoranncatth.nsf/V...1003583C8/$file/Dutech_1stQ_31Mar11.pdf?openelement
It is of interest to note that in Q1-FY11, Dutech recorded a much higher net financial income of RMB1.221m (vs. only RMB0.213m in Q1-FY10).

A relevant question: As such a cross-currency interest-rate arbitrage operation will likely involve currency exposure - in this case, SGD for Dutech - would Dutech, with the help of OCBC, be able to effectively collapse this seemingly profitable (for both sides) 'parallel' deposit-loan arrangement in a timely manner, if and when changes in SGD/RMB interest and exchange rates make the arrangement too risky or unprofitable?

[dydx]

Dutech's Circular to Shareholders dated 7Sep11 on the proposed acquisition of German safe company FORMAT makes interesting reading.....
http://info.sgx.com/listprosp.nsf/bc9c2d...50011df9f/$FILE/Dutech%20Holdings%20Limited%20-%20Circular%20dated%207%20Sept%202011.pdf

More info on FORMAT....
http://www.format-tresorbau.de/en/home.html
http://www.altera-the-corporate-safe.de/...seite.html [website for FORMAT's "ALTERA" brand corporate safes]