Published November 3, 2008

British 'toxic' notes fund out in the cold

S'poreans said to be behind fund blamed for small caps' share price tumbling

By CHEW XIANG

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A UK-based fund that over the past two years peddled hundreds of millions of dollars' worth of 'toxic' convertible notes to local small caps is now targeting Hong Kong and Australia-listed companies in need of cash.

PCIM was raising money from the public using the borrowed shares, and profiting from the capital appreciation.

Even though small companies here are finding it ever more difficult to raise cash, sources say the flow of deals for such instruments is drying up. 'Victims' blame such convertible notes schemes for sending their companies' share prices into a death spiral, and awareness is growing within the community.

A number of previous agreements have been terminated, while the depressed equity market has also dampened new demand.

The fund, Pacific Capital Investment Management (PCIM), has in the past six months signed just two agreements in Singapore - with Chasen Holdings and Stratech Systems - to pump in up to $90 million in return for convertible notes issues. How much is eventually disbursed will depend on the companies' share price staying buoyant. In contrast, PCIM signed at least 15 agreements with small caps in Singapore in the 18 months to January this year to subscribe for over $400 million in convertible notes.

A BT report in June highlighted the prevalence of such instruments in Singapore over the past year, and noted that PCIM was by far the most active in the market.

With Singapore deals now slow to come by, PCIM appears to be looking further afield. It sealed a A$10 million (S$9.93 million) deal with Australian-listed Greater Bendigo Gold Mines in March, while in February, a convertible notes issue worth up to HK$200 million (S$38.3 million) was signed with Grandtop International Holdings, a clothing and sportswear company.

A second Australian-listed company, Environmental Clean Technologies, in August inked a deal to issue up to A$10 million in convertible notes to PCIM.

However, many of the Singapore deals have already been terminated, in some cases costing the companies many thousands of dollars in penalty fees. Those that have backed out or declined to take up optional tranches include China Fashion, Guangzhao IFB Group, EMS Energy, Equation Corp, HLH Group, Anwell, Centillion Environment & Recycling, E3 Holdings, Dayen, and most recently Multistar Holdings, which paid $190,000 in cash in August to terminate its agreement.

Multistar said it had to take an interest-free loan from its chairman, after its share price fell following the issue of over 9 million shares to PCIM.

One of PCIM's more controversial practices was to stipulate a share lending agreement with a substantial shareholder to borrow about 20 million or 30 million shares upfront, ostensibly to facilitate conversion of subscribed notes when it happens. This is often done in places where the issue of new shares is more cumbersome, which is not the case in Singapore.

Sources familiar with PCIM's workings say the borrowed shares are instead quietly sold on the market; the funds raised are then paid back to the company as subscription for subsequent tranches of notes. The new notes are converted into shares and used to replace the borrowed ones.

Effectively, PCIM was raising money from the public using the borrowed shares. It would profit from any capital appreciation - especially since the conversion rates were often at 10 per cent discount to the market price - as well as a structuring fee, ranging from 3.5 per cent to over 5 per cent of the principal amount.

While the company gained ready cash, this was at the cost of often severe dilution. Because of the floating conversion price, the number of shares converted with each note increases as the share price falls. As the deals were usually for multiple tranches of notes, this created a recurring cycle of conversion and sale, each turn causing the share price to plunge even further.

Sources speculate that the fund initially focused on Singapore because its two early directors are both Singaporeans. According to UK regulatory filings obtained by BT, the directors when the fund was incorporated in June 2006 are listed as Kenneth Tan Jushin, a 40-year-old businessman said to be a former banker, and Karen Onsoyen, 42, a Singaporean residing in Norway.

Mr Tan subsequently resigned as director, but is understood to be still involved in PCIM. According to published accounts for the period ending Nov 30, 2007, PCIM had net assets of just &pound8,231, and only in April this year increased its nominal capital from just &pound1,000 to &pound250,000. It is said to be in the business of managing funds on behalf of pension funds and other large investors.

BT was unable to contact Mr Tan or Ms Onsoyen for this story. Audrey Lee, said to be an assistant vice-president and a local representative of PCIM, declined to comment when BT visited her Duxton Hill office last month.