Melville Corporate Finance, Inc

ASIAN CASE RESEARCH JOURNAL, VOL. 18, ISSUE 2, 221–249 (2014)

© 2014 by the authors DOI: 10.1142/S0218927514500096

ACRJ

This case was prepared by

Andrew Ray Lanney of the

Canadian International De-

velopment Agency, Gatineau,

Québec, Angeline Pacione of

Export Development Canada,

Santiago, Chile, and Prescott

C. Ensign of the Schlegel

Centre for Entrepreneurship,

Wilfrid Laurier University

for use as instructional mate-

rial for course assignments

and class discussion. It is not

the purpose of this material

to serve as an illustration of

how to effectively or ineffec-

tively address a managerial

situation. Some information

may be altered to protect con-

fidentiality. The development of this case was sponsored by

Export Development Canada.

Please address all corre spond-

ence to Professor Prescott

C. Ensign, School of Busi-

ness and Economics, Wilfrid

Laurier University, Waterloo,

Ontario, Canada. E-mail:

[email protected].

Melville Corporate Finance, Inc.

INTRODUCTION

12 September 2008, 3:58 pm, Melville Corporate Finance, Inc., Vancouver

Office

Just 72 hours after returning from a week’s holiday, Chris Haselbach was about to join a 4:00 pm progress briefing on the new financing deal in China. Chris was CEO and founder of Melville Corporate Finance, Inc. (Melville). The US$3.4 million deal had gotten off to a quick start two weeks earlier. A financing request had come in from an existing client, Kohen Manufacturing (KM) in Edmonton, Alberta. During the holiday with his family, Chris had used his BlackBerry to gather requirements from the KM sales lead, James Chui, and relay that information back to Nathaniel Shaw, Senior Vice President in Melville’s Vancouver, British Columbia office. Nathaniel’s coordination with the Vancouver office and the existing rapport between KM and Melville fast-tracked the preparations. Yet, Chris wondered if it was rea-sonable to expect the deal to materialize. He knew that he could not pursue this further without a full agreement from Export Development Canada (EDC). The deal could not proceed unless an EDC Account Manager in Ottawa, Ontario endorsed the deal. EDC would provide a loan guarantee for 85% of the loan value if they all came to the same conclusion. The EDC Account Manager had been great in the past and EDC’s knowledge and expertise complemented that of Mel-ville’s team. Together they were good at rapidly and properly evaluating risks.

This is an Open Access article published by World Scientific Publishing Co. It is distributed under the terms of the Creative Commons Attribution 3.0 (CC-BY) License. Further distribution of this work is permitted, provided the original work is properly cited.

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http://dx.doi.org/10.1142/S0218927514500096

222 ACRJ

Melville had financed previous KM deals and was accustomed to the time pressures of multi-million dollar, multi-year, international financing deals. Mr. Chui revealed that another manufacturer — one of KM’s competitors — would be sought if the financing could not be in place by

October 00 . Mr. Chui confided that a quarterly bonus hinged on this deal closing by 3 September 00 . Chris enjoyed a challenge.

ABOUT THE DEAL

On September 00 , KM finalized the technical specifica-tions for the sale of two large-scale preform production bot-tling systems. The machine created plastic soft drink bottles essentially taking a PET (polyethylene terephthalate) preform starter through an injection molding system to produce a beverage container. The preform looked like a rigid de ated balloon, where the open end already had the threads for the bottle cap. The purchaser was, Bottle King hongshan (BK), a bottler in hongshan, China (see igure ). BK had existing contracts with PepsiCo Inc. and The Coca-Cola Company for regional bottling operations. BK was facing an ongoing cash ow crunch as a result of rapid year-to-year growth

ig. . elationships among participants

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ME VI E CO PO ATE INANCE, INC. 3

(accounting reports estimated growth at 0 over the three previous years). As well, the contract renewal process with Pepsi was scheduled to begin in months renewal would be contingent on a satisfactory inspection of operations.

BK’s continued operations and growth depended on purchasing modern plastic preform production bottling tech-nology. Through improved automation, higher quality con-trols, and a greater operational capacity to meet demand, BK management was pleased the KM sales team was able to match their requirements with the right equipment. The new equipment from KM would increase production capacity by

. This was sufficient to meet growth projections for the next three years. nfortunately, the company’s on-hand cash supply could not cover this purchase cost. ntil now the natural second option to finance the purchase of the equip-ment would be mainland Chinese banks. However, BK was a family-owned business with 00 percent equity owned by Chinese citizens. egulations restricted Chinese bank par-ticipation in international financing deals for any company without partial foreign ownership. Even if financing were obtained it would not be S or Canadian dollars. It was nearly impossible for a private Chinese enterprise to obtain foreign currency. Other financing options in China were explored, but without success. An alternative financing option needed to be found quickly.

On September 00 , KM’s sales team took the lead to identify financing in Canada and sought help from Mel-ville, their proven partner for export financing. sing Mel-ville provided several advantages. irst and foremost was Melville’s ability to quickly step in, assess merit and close the deal. If EDC’s and Melville’s requirements were met, financing would be made available immediately and the equipment would be shipped to hongshan within two weeks of approval. This deal, however, had a number of unusual characteristics that needed to be explored. This pro-posed deal did not look like previous deals.

Melville provided another advantage for KM in that their approval would simplify the deal. If approved, KM would be paid in full and have no further transactions with BK on this sale. Melville would assume full responsibility to

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224 ACRJ

recover the loan from BK directly. In other words, Mr. Chui and the KM sales team would earn their quarterly bonus without any strings attached and could move their energies onto the next sale. KM did not know or appreciate EDC’s role in the outcome. All KM knew was that Melville somehow made things happen. The truth was that EDC did a lot of the work to pull the deal together. As usual, the EDC Account Manager and EDC team would have to be convinced of the merits of this particular transaction before providing a guar-antee. Critical analysis of risks and mitigants would be per-formed by EDC and Melville.

It was up to EDC and Melville to assess the viability and decide. On the surface the hongshan deal needed to be considered carefully due to the rapidly changing global economy. Apart from the financials — which required the usual scrutiny — this deal was directly with a Chinese private company. There would be no guarantee by the ov-ernment of China or reputable Chinese bank as the inter-mediary. The rewards from this deal would be significant for Melville and would include: a strengthened relationship with KM, an opportunity to gain expertise inside a rapidly growing market, and financial yield. While Melville’s reputa-tion was built on its agility and speed to close the deal, this has never equated with hasty decisions. EDC also knew that no reward was completely divorced from risk.

Melville had plenty of ongoing projects in atin America and there were numerous financing arrangements to be explored. There were even those at EDC that thought prospecting in atin America was easier. Spanish was the most common language to be overheard at Melville offices and despite Chris Haselbach’s affinity for China, just one-fifth of their deals were linked to mainland China. Turning down a deal that might have been lucrative was not nearly as det-rimental as approving a deal that should have been turned down. Knowing when to pass up a deal was an important part of the business. Something else would always come along if EDC and Melville chose to pass on this one. Neither Chris nor the EDC Account Manager wanted to be swayed by BK choosing not to go with KM if this deal could not be resolved in time.

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ME VI E CO PO ATE INANCE, INC.

BUILDING THE NECESSARY DECISION CRITERIA

Meeting with Nathaniel Shaw

12 September 2008, 4:00 pm, Melville’s Executive Boardroom, Vancouver

Chris walked into the boardroom to find Nathaniel ready and waiting. Nathaniel looked up to greet Chris, and indicated that this deal would be the first of its kind in China for Mel-ville and apparently, it would be the first EDC deal in this part of China in this industry. Without Chinese government authorities or a trusted local bank working with them, they were on their own dealing directly with a private Chinese company.

Nathaniel informed Chris that Melville had shared with EDC what his team had compiled so far. It had only been a week, but the file was not nearly complete. At this point the proposal was missing some fundamental information. Nathaniel pointed out that with what they had right now Melville would likely not approve a domestic company for this amount. And given EDC’s high standards for new situ-ations, the Account Manager would need some convincing as well.

This deal represented a significant use of capital by Melville and it was crucial to ascertain that this capital was being applied very cautiously and risks of losses would be minimized as much as possible. Melville had a uncov-ered risk on this deal. Documentation and information had to be complete.

Company documents from BK were quite revealing. BK was not nearly as large as Chris and Nathaniel had expected, particularly considering the size of the loan for which ames was lobbying. Based on this financial snapshot document that arrived from hongshan, China through ames Chui, BK was requesting a loan that was close to one-third of their annual revenues. Nathaniel knew that if this did not stop the process it should at least merit serious consideration of the financing terms. Nathaniel paused and passed the annual revenues snapshot to Chris (see Table ).

Chris scanned over the report. Chris reviewed the document again. He questioned ames Chui’s judgment and

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AC

Table . Bottle King hongshan Annual evenues

Source: Company financial statements as at September 00 .

wondered if he was misinterpreting what he was seeing. Mel-ville would not normally follow through on such a dispropor-tionate financial request.

Nathaniel also recognized that something was missing. ames called that morning and pointed out that this could be

the first of many sales to BK. ames highlighted BK’s rate of growth and the stability of their multi-year bottling contracts with Pepsi and Coca-Cola.

KM’s position was understood but neither Chris nor Nathaniel could envision approving a deal based on the facts at hand. On paper the numbers looked strange consid-ering the size of the financing BK was requesting. Also, Bottle King hongshan’s income statement indicated that they were running a high debt to equity ratio. Melville would need to be able to have in uence over how BK managed future cash

ow. At a minimum, if Melville were to proceed, it would need BK to maintain a specific debt to equity ratio. urther, EDC had discovered that placing an enforceable lien on the equipment might be possible.

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Nathaniel would have Melville’s legal advisor include a reasonable debt-to-equity ratio into the letter of intent’ and explore the right to place a lien on the equipment as well. Chris would then send that draft letter over to BK to commu-nicate Melville’s expectations during the repayment period. BK’s response to this control might allow Melville to gauge BK’s intent to pay.

Nathaniel confirmed that he would push ames for confirmation on the revenue levels and ensure Melville’s legal advisor got updates and forwarded the revised letter of intent. BK would see it in a couple of days. BK seemed eager to get this resolved too.

Nathaniel knew that from a fundamental standpoint, BK’s size was at the lower end of the spectrum of deals Mel-ville would typically approve, but their growth over the past four years and their projections for the next four pro-vided merit for approval. Nathaniel considered those Cs of credit he had studied in finance. Those Cs’ now played such a prominent role in his daily work life. They were key in seeing creditworthiness and unlocking a borrower’s willing-ness and ability to repay a debt. There were both qualitative and quantitative measures to determine the chance of default (see Table ).

Bottle King hongshan’s year-to-year growth was impressive but hard to fathom (see Table 3). Chris reminded

Table . Cs of Credit

Character Borrower’s reputation. Are they responsible Past behaviour, expected future actions.

Capacity Borrower’s ability to repay based on a comparison of income and debts. Are they financially overextended

Capital Capital the borrower puts toward the investment the larger the contribution the less chance of default, ceteris paribus. How much cash is on hand

Collateral Property or large assets used to secure the loan. What do they own Can we get our hands on it

Conditions Interest rate, amount of principal, and payment schedule. Are things (revenue stream, customers, market, etc.) stable

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228 ACRJ

Nathaniel that Melville’s high growth domestic market clients were not even close to this. It was hard to gain proper perspective. Nathaniel wished they had performance data for this company or even others from a similar sector in China — EDC was unable to turn up anything concrete for comparison. The EDC Account Manager and his team had checked EDC databases and found almost nothing at all on BK and very little on this manufacturing segment in China. Typically both EDC and Melville relied on industry and company historical information to feed into their interpreta-tions. EDC and Melville were both tentative about proceeding without a good fundamental analysis.

EDC was able to determine that the accounting prac-tices were unique compared to those in North America. The Chinese government required each company to complete a standard form and this form established the basis for annual corporate taxation. It was a very rough financial picture, full of gaps by Western standards. Both Nathaniel and the EDC Account Manager were skeptical about the form’s veracity. They wondered if any penalty existed in China for non- compliance or submitting a misleading report.

Table 3. Bottle King hongshan Projected Annual evenues

Source: Company financial statements as of September 00 .

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Nathaniel and Chris had the suspicion, that no respect-able accounting firm in Canada or the S would let this go — there were just too many gaps. And there was no way to validate it without actually going to China. While Melville had approved deals with unique risk variables in the past, this one would be challenging.

Chris received a call from the EDC Account Manager in Ottawa. The EDC Account Manager wondered if Chris could meet to review the BK dossier via conference call. Chris looked to Nathaniel. Nathaniel nodded indicating the documentation could be ready next week. Nathaniel and he agreed to join EDC via conference call from Vancouver.

Chris and Nathaniel resolved to maintain momentum until a decision could be resolved on BK. Working closely with the EDC Account Manager was expected to help identify and qualify the risks.

Nathaniel conveyed to Chris that if Melville continued to proceed with assessing ability to pay (viability), Melville would need to be certain that Melville’s legal advisor was satisfied with the legal recourse to place a lien on the equip-ment. If BK could not pay, Melville would need the legal framework in place to quickly seize ownership of the equip-ment. Nathaniel concluded that they would be awaiting BK’s response to the revised letter of intent.

Chris too felt it was essential to get a reaction to the letter of intent — Melville might thus learn how serious BK was about making the deal happen.

DOCUMENT REVIEW WITH EDC

19 September 2008, 8:45 am, Export Development Canada, Ottawa,

Ontario

Meeting Attendees:

• EDC Account Manager• Several EDC small and medium-sized enterprises relations

Team eads• Chris Haselbach, CEO, Melville (via teleconference)

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30 AC

• Nathaniel Shaw, Senior Vice President, Melville (via tele-conference)

The EDC Account Manager welcomed Chris and Nathaniel to the conference call and explained that several members of the EDC team were in the room. The EDC Account Manager indicated that Melville’s documents were being projected onto a screen and asked them to walk through BK’s company profile, financials, and then the credit application and assessment.

Nathaniel informed those assembled in Ottawa that he had received a surprising update.

Nathaniel announced that ames Chui had sent Melville an email to correct a misinterpretation with BK’s financial statements. According to ames, the translators missed a key detail when they translated the Chinese government financial statements for each year. Melville now had in its possession confirmation that the financial statements were off by a factor of 0.

Nathaniel explained that the accounting practices in China, and that province in particular, removed a zero at the end of financial statements. It was a Chinese accounting method that the Canadian translators had missed. Bottle King

hongshan was not a S .3 million company, but a S 3. million company. ames had verified this accounting practice with the existing BK accountant who had sent over docu-ments used in negotiating with Coca-Cola three years prior (see Tables 4, , and ).

Nathaniel then relayed that EDC’s legal counsel made them aware that a new law in China would allow for liens to be taken. Melville’s lawyer called to confirm the enforce-ability of a lien on the equipment under Chinese law in case of a default on the loan. It was not a certainty, but they were confident the Chinese government could step in. However, Melville’s lawyer did confirm that there was no record of the successful application of a lien in hongshan. In summary, if BK did not pay, Melville would have little recourse but to seize the equipment and try to recoup some of its losses but through a very new and untried Chinese law.

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Table 4. Bottle King hongshan evenues


Table . Bottle King hongshan Annual evenues


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Nathaniel navigated through the key points of the deal and the EDC Account Manager used this time to under-score EDC’s reliance on formal financial analysis. orty-five minutes into the documentation review, all of the essential documents were covered. Nathaniel remained tentative on the potential of this deal. iven that BK had no previous relation-ship with KM, Melville or EDC, Chris would have preferred better quality information to guide their decisions. If only there was another way to gauge BK’s intentions and capabili-ties to handle this debt load.

Chris divided the arguments into points for and against providing financing to BK. In his mind he weighed the impact of a defaulted loan. What would it mean for Melville How would it affect his team and his relationship with EDC and KM

Continuing now, the EDC Account Manager shared that EDC had held off on making comments so that Nathaniel could maintain his objectivity through this process. EDC would like to help support KM and Melville in making this happen, but it must be understood that although this was a

Table . Bottle King hongshan Projected Annual evenues


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strategic opportunity, the EDC Account Manager was not yet comfortable forwarding this for approval.

Chris revealed that he too saw this as a tough decision. He appreciated the EDC Account Manager and EDC team’s frankness and noted that for Melville and him there too was no clear pathway on this deal and that time pressures only further complicated it.

Nathaniel shared that BK had approved the letter of intent without requesting further revisions. A signed copy was due to arrive tomorrow at the Vancouver office via air-courier.

Chris sat quietly for a few seconds assessing these new pieces of information carefully. Breaking the silence he asked their EDC Account Manager if he wanted to visit hongshan early next week with Nathaniel.

Chris Haselbach, CEO of Melville, would need a recom-mended course of action on their return from China. Chris would need a justification of how they should continue and whether or not they should approve or deny BK’s request for funding

Both the EDC Account Manager and Nathaniel needed to prepare if they were going to get at Bottle King hong-shan’s ability and intent to repay a loan from Melville Corpo-rate inance: Who should they visit What questions would need to be asked

APPENDIX ABOUT THE PLAYERS

Melville Corporate Finance, Inc.

Chief Executive Officer: Chris Haselbach — founder and major shareholder. He was a former employee of the Depart-ment of oreign Affairs and International Trade, Business Development Bank of Canada, and Export Development Canada. nder Haselbach’s leadership Melville had main-tained strong partnerships with Canadian exporters and EDC.

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Senior Vice President: Nathaniel Shaw — in charge of overall management and operations for Melville’s team of employees, with offices in Vancouver, Toronto, Montreal, and Calgary. He worked on analyzing risk and creditworthiness. He had the ability to gain insight quickly to support decision-making. He was trusted for new and high value proposals — his industry experience was an asset.

Background

Melville was a private firm created to support Canadian exporters by offering financing to creditworthy buyers of eli-gible Canadian goods and services. Melville’s acted as a uni-fying partner between the private sector and Canadian public sector actors (federal and provincial bodies). Melville worked with the support of various provincial and federal export-related institutions such as EDC, Western Economic Diver-sification, Business Development Bank of Canada (BDC), Canadian Commercial Corporation (CCC) and oreign Affairs and International Trade Canada (D AIT). Melville was prof-itable because they operated in the niche market of export financing for small and medium-sized transactions. They were able to dedicate more time and attention to smaller and more complicated foreign loans that the large Cana-dian banks did not have the expertise and risk appetite to support directly.

Melville’s target market in Canada was small and medium-sized enterprises (SMEs). SMEs were a major eco-nomic engine of growth for the Canadian economy and an area of strategic importance to EDC. Melville relied on EDC to provide insurance against nonpayment by the foreign com-panies. In order to be eligible for financing, exported goods and services had to satisfy Canadian benefits requirements of EDC.

Through Melville’s agile assessment, approval, and financing mechanisms Canadian exporters could expand into the global market with minimal risk. A Melville financed transaction allowed the Canadian exporter to be paid imme-diately while the buyer paid Melville over time at the agreed

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upon terms. Most of the risk of nonpayment was absorbed by EDC through insurance coverage provided to Melville.

Every deal posed direct risk to Melville’s financial health. Depending on the terms of the financing, Melville could be exposed significantly. This made EDC’s role vital. If a deal failed, i.e., a borrower defaulted on their loan, this would considerably hurt Melville’s balance sheet. Other forces included waiting periods, interest, collection costs, etc. Despite the reality of these constant concerns, Melville had a consistent record of accomplishment in qualifying good deals. Without EDC’s insurance, Melville could not proceed with this or any financing. Melville, or for that matter any Cana-dian company venturing abroad, could expect to encounter all sorts of problems in collecting payment. Even if a party were willing to make payment, barriers might exist, such as restrictions on currency exchange and transfer.

Melville’s Performance in Recent Years

• Annual disbursements of S 0 million, stable and increasing revenue.

• Solid track record of backing growth companies and good deals.

Melville Offered

• Export financing for SMEs. • In most cases, payment within 0 days of shipment to the

foreign buyer (provided all obligations under the sales con-tract with the buyer had been met).

• uick application processing did not hold up the sales process.

• oan negotiations were handled by Melville.

enefit fo nte national ye hen in elville

• A quick turnaround of buyer applications for buyer financing (within 0 days).

• oans were available to the buyer in several approved currencies.

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• oan documentation was standardized for greater efficiency.• Competitive interest rates. • The interest rate was fixed and would not uctuate with

the movements of interest rates on international money markets. Alternatively, variable interest rates were available to suit client needs.

enefit fo Te m inance

ixed-rate, medium-term loans, from two to five years were available from Melville to foreign buyers, providing them with a regular repayment schedule. These loans were for amounts up to S million, and were secured by a regis-tered liena on the exported goods.

EDC’s Export Guarantee Program

To compensate EDC for taking on their spread of the loan’s risk ( ), EDC charged an annual fee of . of the total loan (paid each year for the life of the term and re-calculated annually based on the outstanding principle). or this loan, the terms were 3-year repayment term at a fixed rate of payable to Melville. EDC charged an additional . on top of this rate.

Export Development Canada

EDC Account Manager — had worked directly with Chris Haselbach and Nathaniel Shaw on several deals over the past three years and served as an essential partner in identifying and assessing risk management issues.

aA lien allowed the holder of it to take possession or control of property belonging to another until a debt owed by that party is discharged.

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Background

Supporting Canadian exports and foreign direct investment, EDC was Canada’s export credit agency. EDC offered inno-vative financing, insurance, and risk management solutions to help Canadian exporters and investors expand their inter-national business. Every year, EDC’s knowledge and partner-ships were used by over ,400 Canadian companies and their global customers in up to 00 markets worldwide. Approxi-mately 0 of EDC’s customers were SMEs. EDC was a crown corporation wholly owned by the overnment of Canada. The corporation was financially self-sustaining and operated on commercial principles.

Export Development Canada’s mandate was to grow and develop Canada’s trade, and the capacity of Canadian companies to participate in and respond to international busi-ness opportunities. EDC provided trade finance and risk miti-gation services to Canadian companies to help them compete internationally. Partnering with Melville Corporate inance, EDC had participated in approximately C . billion in deals.

EDC provided a number of risk mitigation solutions to Canadian exporters. EDC offered Canadian companies the creditworthiness ratings of potential foreign customers. This gave them an idea of the likelihood of repayment by that buyer. or Melville, such a credit check would give them an idea as to whether or not a foreign corporation could fulfill its payment obligations. EDC also provided other financing mechanisms for foreign and Canadian companies to gain access to working capital.

Bottle King Zhongshan

CEO and Chairman of the Board: Hong hen — company founder, who — despite his age, still maintained direct involvement in operations and decision making, thus lever-aging his more than three decades of experience in the industry. His political clout in the local region was also known to be strong. Hong hen was admired and respected for his contribution to the community.

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3 AC

Background

Bottle King hongshan was founded in its head office and principal manufacturing facilities were across from Macau, in a special economic development zone in hong-shan in the province of uangdong. When BK was estab-lished, its original activity was boat repair. rom those humble beginnings, the company quickly entered into two new areas: textiles and plastic packaging. In , BK pur-chased from apan its first injection molding equipment to manufacture the bottles locally to save cost, and it was able to secure contracts with Coca-Cola and Pepsi for their bottling needs.

Over this time period, BK’s business expanded rapidly. BK grew from one small local factory to 0 large modern industrial enterprises in hongshan, and approximately 00 subsidiaries located throughout the whole of China. BK

employed 4,000 workers and administrators, including 00 engineers and technicians. Every employee was a shareholder of the company.

or the past decade, Bottle King hongshan had been dedicating itself to the development of food and beverage packaging and non-woven cloth products. ollowing a regional development strategy, whereby the company was no further than 00 kilometers from its most important clients, BK had become a China-wide enterprise.

Additionally, there was a current drive at BK to increase exports, which only comprised of the company’s revenues. BK was placing a significant focus on Southeast Asia with its relatively new operation in Thailand (the market that would be served with this equipment from KM).

Market & Competition

Based on performance statements from Coca-Cola and Pepsi the following summary had been compiled.

With regard to the soft drink industry in China, the market has experienced rapid development in the food industry. The key drivers were hot weather and increasing pros-perity. The Chinese market however has proven to be very

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diverse with great variations in the market demand for different products. Carbonated drinks have shown strong demand throughout. rowth in almost all types of drinks is expected to continue to see strong growth in the near term.

BK had been a manufacturer of PET bottles and a major vendor for Coke and Pepsi in China for over two decades. BK supplied 40 of Coca-Cola’s needs, of PepsiCo’s, and about the same for a leading Chinese beverage company. It was expected that the bottling industry would consolidate and BK was in a position to benefit as the total volume of soft drinks in China was expected to increase at three to five percent annually.

Regional Connections and Strategic Investments

apid growth rates in uangdong Province as a whole was mirrored by many companies. This presented a synergistic opportunity for BK to expand via stronger and more inte-grated business relationships with these growing enterprises.

Hong hen sought to leverage his family’s business network to establish shared ownership arrangements and strategic investments in Yingde City (population ,0 0,000) and Dongguan (population ,000,000). As it happened, two of his uncles were minority owners of a Chinese holding company, uangdong Corporation, whom was aggressively franchising convenience stores (franchising a well-known apanese convenience store brand). As uangdong Corpo-

ration worked to establish its supply chain locally, they also sought a local partner through whom they could integrate and balance supply risk variables. The president offered a minority ownership stake to Bottle King hongshan and additional shares to Hong hen and his two uncles in mid-004. As a sign of good faith and desire for partnership, Hong hen arranged for uangdong Corporation to own a small

mix of preferred and minority equity in BK. The growth of BK’s joint venture ownership portfolio

surged in 00 as uangdong Corporation opened 40 con-venience stores another were opened in 00 . The return on investment was modest, however it was the assurance of

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240 ACRJ

demand for BK’s products that pleased Hong hen. urther-more, the relationship ensured alternative suppliers would not be sought in the foreseeable future and BK would be best positioned to adapt if supply requirements changed for the convenience store chain. Strategically, the timing of the move made sense for all those involved and aligned key persons to a common set of business objectives and gain leverage within the supply chain. As an additional, unexpected, reward for his business acumen, uangdong Corporation, subtly informed Coca-Cola and Pepsi’s regional account managers of their deal with BK — in effect, this benefit of this relationship, was leverage over Coca-Cola and Pepsi for current and future contracts in the region.

BK’s financial statements (Balance Sheet and Income Statement) are found in Exhibits and .

Kohen Manufacturing

Asian Markets Sales ead: ames Chui was born in Hong Kong. He immigrated to Canada and graduated from the

niversity of Ottawa. He was recruited in 00 by KM’s VP Sales to lead a major expansion into non-domestic markets of China, Thailand, apan, South Korea, and Taiwan. Mr. Chui had worked in the industry since 0.

Background

ounded in in Edmonton, Alberta, KM was a diversified manufacturer and exporter of products ranging from standard plastics preform production equipment to large-scale custom mold design. KM plastic preform and molds equipment used industry leading engineering and design for the production of plastics found in everyday life (bottles, containers, bottle caps, and more).

Beginning in mid- 00 Kohen Manufacturing had decided to actively pursue sales growth in Asia. Soft drink consumption — the key diver of demand for KM’s tech-nology — was rapidly increasing in this region of the world. KM’s market share had continued to climb and in the past

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year, sales were sufficient in Asia to begin strategic planning to open a new production facility in South Korea. During the last three years, KM had completed transactions in over 3 countries and a substantial base of users was now in Asia. Being located in the Asia-Pacific region offered a number of benefits in serving these customers. irst, it showed commit-ment and a willingness to interact with Asian customers. This aided in understanding requirements and technical specifica-tions. inally, being located in Asia reduced costs associated with design, development, and transportation of bottling equipment. According to their website:

KM’s goal is manufacturing the best quality products while maintaining competitive pricing and prompt delivery time for our customers. uality control is a major competitive advantage within the industry and KM achieved ISO 00 ( 000 version) in the fall of 00 and are now a fully certi-fied manufacturer.

KM had established a worldwide reputation for quality products with a relatively favourable benefit-cost realiza-tion for purchasers. In addition, a major advantage over their competitors was a continuous focus on innovation in design. Over the past three years several PET preform equipment designs received awards for being economical and having short production start-up times.

Previous and Ongoing Deals with Melville

Since ames had arrived, KM had relied on Melville’s ex-ible and responsive services to streamline its rapid expansion into Asia. KM had established itself as a high quality exporter with good business values and trustworthy conduct during the exporting process. Total cumulative value of KM-EDCMelville deals reached S 00 million in 00 . Currently, Melville was working on financing for additional KM sales most of which were multi-year financing in Asia and Eastern Europe.

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Relationship with Export Development Canada

Kohen Manufacturing had maintained an excellent record of performance and repayment when directly using EDC ser-vices. However, since the arrival of ames Chui at KM, the sales team had preferred the immediate financing advantage provided by Melville over managing a loan within KM’s finance department.

Direct Competitors

Sidel, Inc was located in eorgia — the home of Coca-Cola. Sidel was part of the Tetra aval roup, a global leader in food packaging and equipment. There was every likelihood that Sidel had been considered by BK. Sidel was pushing an alternative technology — stretch blow molding. KM believed that their own equipment could generate greater throughput (volume of PET bottles formed per minute) than any current Sidel models.

Hovert Impex was based in Ahmedabad, India. While Kohen could argue that Hovert Impex’s technology was much less modern, it had been proven to be cost-effective in developing countries. Maintenance costs were low for Hovert Impex customers, even if the equipment were not nearly as state-of-the-art as KM’s fully automated machines.

Nissei and Aoki were two prominent players in the PET bottle production equipment industry. These compa-nies from apan were well established in the region and it was likely that BK had a number of their bottle production lines currently in use. While Nissei and Aoki already had market penetration in China, they did not have unblemished reputations in day-to-day operations. Nissei and Aoki equip-ment had reliability issues and were known to be over-engi-neered, requiring knowledgeable operators to keep the finicky machines running.

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RISKS AND MITIGATING FACTORS

China was a massive country with the highest of expecta-tions for growth and prosperity (see Exhibit 3). But with very little comparable data available broken down on regional and sectoral performance, both EDC and Melville were nervous. EDC’s office in Beijing had existed for quite some time, but the office in Shanghai had just opened in late 00 . This office covered the booming Yangtze iver Delta region and was getting to know that part of China. EDC’s Shanghai office boasted being in the business capital of China and focused on the provinces of iangsu, hejian, and Anhui. Despite being an economically well-off province (its DP was S billion), uangdong was politically distant from Beijing.

uangdong was relegated to a lower status when it came to most matters. Other regions with more political clout received greater attention from national authorities.

The stability of the central federal government authority was striking and local leaders had to stay in line. But still there were wide discrepancies from region to region. The EDC Account Manager had firsthand observations and stories relayed by EDC colleagues confirming that a local mayor or business family could take his or herb town in a direction that could shake things up for outside interests. While political risk was not great, it was real. EDC’s political risk insurance covered the following scenarios (Exhibit 4):

Zhongshan, China

hongshan was a prefecture-level city situated in the centre of the Pearl iver Delta of uangdong Province (see Map of egion). It faced Hong Kong on the east across the ing-ding Ocean, inhui and Taishan on the west, with Macau and huhai to the south. It was 00 kilometers away from

bThe People’s Daily newspaper reported on uly 00 that about 0 percent of China’s ,000 major cities had a female mayor or vice-mayor. The Chinese govern-ment affirmed in its Program for the Development of Chinese Women ( 00 –2010) that more efforts should be made to improve women’s capacity in management and decision-making in state and social affair, and increase the proportion of women leaders.

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uangdong, China

Map of egion: hongshan, uangdong

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uangzhou and a high-speed ferry serviced Hong Kong. hongshan held historic and political significance as it was

renamed for Dr. Sun honghsan (a.k.a. Sun Yat-sen), the father of modern China who overthrew the feudal ing

Dynasty. The city authorities had attempted to balance a pleasant living environment with industrial growth. Most vis-itors found it warm and charming and less frenetic than other high-growth areas of China. The city boasted having opera-tions for 0 of the ortune lobal 00 and a thriving high-tech sector.

nusual by Chinese standards it was missing an administrative layer — hongshan had no county-level divi-sion. hongshan held townships under its control and itself fell under the guidance of uangdong authorities. In additional to the towns, hongshan city government directly oversaw four district offices and the hongshan Torch Park (high-tech industrial development zone). While holding on to its lineage as the ragrant Mountain town,

hongshan welcomed the move to diversify from its tradi-tional agricultural base, including rice, lychee, banana, sugar cane, and its famous owers — particularly chrysanthemum.

hongshan was one of the our ittle Tigers in uang-dong, the others being: Dongguan, Nanhai, and Shunde. These four economically virile centres served as exemplars for others to emulate. hongshan’s thriving state-owned enterprises in the 0s gave way to township and village enterprises and more recently to foreign multinationals.

hongshan was known by the credo One industry in one town. Pillar industries included: mahogany furniture from Dachong ( 00 local enterprises accounted for 0 of China’s output), electric household appliances manufactured in Dongfeng, lighting fittings manufactured in uzhen (over 3,000 lighting enterprises of uzhen’s DP came from lighting), food from Huanpu, casual wear (blue jeans and shirts) made in Shaxi, and locks, hardware, and electronic acoustics from iaolan.

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4 AC

Exhibit

Bottle King hongshan Balance Sheet

In Millions of USD Year Ending 2007-12-31

Year Ending 2006-12-31



Cash on Hand 0.90 0. 0 1.90 0.08

HK overnment Certificates of Deposit Held . 0 . 0.80 0.01

Investments in Subsidiaries and oint Ventures 12.00 . 0 .00 4.00

oans and Advances to Customers 4. .30 19.81 .30

Current Assets (including land value) 33. 0 21.80 . 4. 0

Inventory .03 . 0 2.92 2.80

Total Assets 80.75 73.95 55.98 23.69

Short Term Debt .3 3. 0 . 0 3.

ong Term Debt 3 . 0 3 .4 4. 9.88

Chinese overnment Currency Notes in Circulation . 0 . 4. 0. 3

Other iabilities 3. 0 . . 3 3.44

Owner’s Equity .30 12.94 .30 .

Minority Interests Equity 0. 0 0.40 0.00 0.00

Preferred Share Equity . 0 . 0 0.00 0.00

Total Liabilities 80.75 73.95 55.98 23.69

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Exhibit

Bottle King hongshan Income Statement

In Millions of USD Year Ending 2007-12-31




Revenue 93.15 72.04 38.80 14.54

Operating Income .3 . 3 .00 4. 0

Other Operating Income (joint ventures’ operations) 0.90 .0 1.80 1.14

Interest Income 4. 4. . .

Interest Expense -3.35 -2.15 -1.25 -2.35

Total Operating Expenses (including depreciation) 88.90 68.14 24.55 6.28

Gross Profit (before taxation) 4.25 3.90 14.25 8.26

Taxation ate ( ) 3. 3. .4 . 0

Taxation 0. 0. 4 2.20 .3

Profit/(loss) after taxation 3.66 3.36 12.05 6.95

Minority Interest Payments 0.0 0.04 0.00 0.00

Preferred Share Payments 0.08 1.20 0.00 0.00

Net Profit 3.53 2.12 12.05 6.95

Revenue Growth (%) 29.30% 85.67% 166.85% …

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CHINAChina consistently ranks as one of Canada’s top five export destinations. The country’s strong economic growth continues to offer extensive opportunities for Canadian export businesses and investors. China is the base of manufacturing operations for many Canadian companies that have incorporated the advantages of China’s low cost of production into their global supply chains. However, in a market experiencing rapid evolution, there are potential credit, regulatory and Corporate Social esponsibility risks that must be mitigated wherever possible.

Country Risk: Medium

EDC’s Position Actively seeking new business Open under all programs, subject to EDC’s regular approval criteria

Canada’s strengths in natural resources, agricultural, information and communication technologies, educational services, automotive and environmental technologies make China a natural business partner to explore. In addition to these sectors, EDC will look at transactions in any sector in which Canadian companies have found opportunities.

With representations in Beijing and Shanghai covering reater China, EDC provides on-the-ground support to Canadian companies doing business in China. EDC’s regional representatives have developed strong relationships with major local clients and have created an extensive network of local contacts. EDC is well positioned to help Canadian companies finance and manage credit risk associated with sales to Chinese buyers, and to support Canadian Direct Investment Abroad and Canadian affiliate operations in China.

What is China Buying from Canada?

Canadian Export to China, 00

anking Sector C

1 Industrial Chemicals ,4 , ,03

2 Paper Products ,4 4,33 ,

3 Non- errous Metals , 3,0

4 Metals, Ores, Non-metallic Minerals , 0 ,4

Agriculture, Hunting, orestry, ishing , , China’s Fastest Growing Sectors

orecast of Domestic Market rowth, 00

anking Sector

1 Non- errous Metals 3 .4

2 Pottery China .

3 Motorcycles Bicycles 3.3

4 Textiles 22.8

Agriculture, Hunting, orestry, ishing .

Source: EDC website, September 00 .

Exhibit 3

EDC’s Position on China

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Exhibit 4

Political isk Scenarios

Breach of contract risk: The breach of a contractual obligation by a foreign government or state-owned entity and the ensuing refusal by the government or entity to honour an arbitral award in your favour.

Non-payment by a sovereign obligor: The refusal or inability of a foreign government to make scheduled loan payments or to make a payment under a guarantee.

Expropriation risk (including gradual or creeping expropriation): An act or a series of acts taken by a foreign government to seize, confiscate or otherwise expropriate your assets or investments, or foreign government acts that have had the effect of expropriation.

Political violence risk: Terrorism or other forms of political turmoil aimed at in uencing the policies of the host country government that damage assets or force you to shut down foreign operations.

Conversion risk: The inability to convert the local currency of a foreign country into hard currency.

Transfer risk: The inability to transfer hard currency outside a foreign country.

Repossession risk: Measures that a foreign government may take that prevent you from repossessing or re-exporting physical assets brought into the country (e.g. machinery, equipment, rolling stock, an aircraft, etc.).

Source: EDC Website, September 00 .

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Documents

Melville Corporate Finance, Inc