Subcontractor to finance funding needs

money-glitz | Avery Chen 3 Aug 2020

Chi Kan, the second-largest local formwork contractor with a market share of about 11 percent by revenue, has launched the Hong Kong initial public offering to raise up to HK$160 million.

However, some mainland brokers including Futu Securities have stopped accepting retail orders for Chi Kan's public sale. Some mainland netizens are calling for boycott Chi Kan as it says the recent occurrence of Covid-19 "was originated from Wuhan" in its prospectus, sparking patriots' anger. Chi Kan made an announcement on Friday night to clarify the definition and remove the sentence related to Wuhan.

Chi Kan mainly provides formwork services as a subcontractor to public or private construction projects in Hong Kong.

The local formwork services market has expanded at a compound annual growth rate of 10.2 percent from 2014 to 2019, with market size rising to HK$6.26 billion last year, mainly due to the 10 major infrastructure projects as well as the government's determination to stabilize the residential property market by building more public rental housing, says Frost & Sullivan.

However, the expansion is expected to slow due to the gradual completion of the 10 projects. The formwork services market is projected to grow at a CAGR of around only 3.5 percent to HK$7.42 billion in 2024.

The company's five largest customers accounted for over 91 percent of total revenue in the past three years. Hip Hing Group, a subsidiary of NWS Holdings (0659), is Chi Kan's largest customer, which contributed around 60 percent of revenue.

Hip Hing has 22 projects with a contract value ranging from around HK$14.8 million to HK$305.9 million with the contractor. Among them, Chi Kan completed 15 projects, and the remaining seven projects have an contract value of about HK$1.37 billion.

As Chi Kan generated a significant portion of revenue from the top five customers, particularly Hip Hing, any decrease or failure to maintain a business relationship will bring material adverse effect to its operations and financial performance, it warns in the prospectus.

Chi Kan's revenue slumped by 48.2 percent to HK$525.2 million for the year ended March 2019, mainly dragged down by revenue decline in projects with Hip Hing, Paul Y. Group and other developers, as well as delays in some large projects with Hip Hing.

Its revenue grew by about 30.6 percent to HK$685.9 million for the year ended March this year, as the delayed project with Hip Hing was completed and revenue derived from the public sector increased.

Chi Kan's net profit also dropped by 32.6 percent to HK$41.6 million for the financial year 2019, and further slid by 4.7 percent to HK$39.6 million for the FY2020, affected by listing expenses. Meanwhile, Chi Kan warns that there is material uncertainty relating to South Shore (0577), the parent of the company's major client, Paul Y. Group, which accounted for 19.6 percent of revenue for the year ended March.

South Shore has incurred net losses for seven years, with a loss of HK$1.02 billion for the year ended March as the coronavirus takes a toll on its already-embattled hotel business in Macau. Its net liabilities reached HK$1.6 billion last financial year and failed to repay a bank debt of around HK$470 million in April.

Chi Kan says it has four ongoing projects with Paul Y. Group with the outstanding revenue to be recognized of around HK$82.8 million as of end-May.

Chi Kan says it will continue to provide formwork services to Paul Y. Group. But in the worst-case scenario, if all of its business relationship with Paul Y. Group is halted due to defaults of South Shore, the company believes it could capture new revenue sources from newly-acquainted customers.

Chi Kan plans to use 85 percent of the net proceeds from the IPO to finance the upfront funding needs for its projects and 5 percent to expand the workforce. The remaining 10 percent will be for general working capital.

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