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Value Investor Conference May 2010: Adapting the Investment Style of Buffett-Munger to Asia (Part 2), The Mungerian I-O Framework
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Value Investor Conference May 2010: Adapting the Investment Style of Buffett-Munger to Asia (Part 2), The Mungerian I-O Framework

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Value Investor Conference May 2010: Adapting the Investment Style of Buffett-Munger to Asia (Part 2), The Mungerian I-O Framework Value Investor Conference May 2010: Adapting the Investment Style of Buffett-Munger to Asia (Part 2), The Mungerian I-O Framework Presentation Transcript

  • Adapting the Investment Style of Buffett-Munger to Asia (Part II):(A) The Mungerian I-O Framework +(B) Reminders from the Global Financial Crisis Asia! 5th Annual LA Value Investor Conference May 3-5, 2010 Slide 1
  • Snippets From 2006 LA Value Investor Conf. Presentation: “Value”?: Buffett on “Growth”/Business The Security I Like Best (Dec 1951): GEICO“Charlie showed me in the direction of notjust paying for bargains, as Ben Graham had Premiums Policy Yeartaught me. This was the real impact he had Written Holderson me. It took a powerful force to move me 1936 $103,696.31 3,754on from Grahams limiting view. It was the 1950: Strong growth in the 1940 768,057.86 25,514power of Charlies mind. He expanded myhorizon; Boy, if I had listened only to Ben, past = Sell into 1945 1,638,562.09 51,697 strength?would I ever be a lot poorer; I became very 1950 8,016,975.79 143,944interested in buying a wonderful business at 2008 12.7 billion! 9 million!a moderate price.” “…would have turned- Warren Buffett down if the asking price [for See’s Candies] is a “Of course the investor of today dime more [than $25 does not profit from yesterday’s 1988 million]… that is how silly we were..” growth. In GEICO’s case, there is every Price-Book: 5x reason to believe the major portion PE: >15x of growth lies ahead.” “… the first time we - Buffett, Dec 1951 1972 paid for quality” Price-Book: 3x - Charlie Munger Slide 2
  • 0 200 400 600 800 1,000 1,200 1,400 1,600 30/03/1992 30/05/1992 30/07/1992 30/09/1992 30/11/1992 30/01/1993 30/03/1993 30/05/1993 30/07/1993 30/09/1993 30/11/1993 30/01/1994 30/03/1994 30/05/1994 30/07/1994 30/09/1994 30/11/1994 Bay 30/01/1995 30/03/1995 30/05/1995 NZSE 30/07/1995 30/09/1995 30/11/1995 30/01/1996 30/03/1996 30/05/1996 30/07/1996 30/09/1996 Baycorp: Innovation in traditional industry; 16-bagger 30/11/1996 30/01/1997 30/03/1997 The Key Idea: Long-Term & All Seasons 30/05/1997 30/07/1997 30/09/1997 30/11/1997Slide 3
  • Price (S$) 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 01/01/1991 26/03/1991 18/06/1991 10/09/1991 03/12/1991 25/02/1992 19/05/1992 11/08/1992 03/11/1992 26/01/1993 20/04/1993 13/07/1993 05/10/1993 28/12/1993 22/03/1994 14/06/1994 Price 06/09/1994 PE 29/11/1994 21/02/1995 16/05/1995 08/08/1995 31/10/1995 23/01/1996 16/04/1996 09/07/1996 Baycorp’s PE Jumped from 5x to 27x 01/10/1996 24/12/1996 18/03/1997 10/06/1997 02/09/1997 Quality Profit Growth x PE Jump! = Multibagger Returns 25/11/1997 0 5 10 15 20 25 30Slide 4 PE
  • Give Me a Place to Stand and I Will Move the World! Multibagger returns Knowledge accumulation Steal money from firm to in core biz invest in easy money, property and stocksFocus in investment “technology” to search diligently for multi-baggers, entrepreneurs who accumulate Archimedes: “Give me a knowledge in core biz DESPITE distorted incentive place to stand, and Ienvironment and avoid those who steal; buy enough will move the world” of these stocks and hold them long enough Slide 5
  • Adapting the Investment Style of Buffett-Munger to Asia (Part II):(A) The Mungerian I-O Framework Slide 6
  • In Asia, Invest in the Horse (Business Model) or the Jockey (Entrepreneur)? But Consider the (Booby) Track First! Track: The Asian Environment Jockey: Entrepreneur China is a big track: Shanghai has the world’s third largest stock market by market capitalization at around $3 trillion in its $3.2 trillion economy, a tremendous growth from $380 billion since the Non- Tradable Share Reform announced in April 2005. Shares worth $5.01 Horse: Business Model trillion changed hands on the Shanghai Stock Exchange in 2009, compared with $4.07 trillion on the Tokyo Stock Exchange Slide 7
  • (Distorted!) Incentive Structure in Asia: Neglect of Knowledge Accumulation In Core Business Neglect of knowledgeaccumulation in core business Easy money, property and stocks Slide 8
  • Mungerian IO: Incentives (Why?). Opportunities/ Mechanism (How?). 1. Easy 1. RPTs Money Easy to 2. Asset expropriate Transfer/ How are Injection and don’t Incentives Opportunities 2. Wedge assets have to be (Why?) / Mechanism expropriated? held (How?) 3. accountable Laddering in IPO Expiration 3. “Easy” Secondary 4. Issues Delisting Slide 9
  • Mungerian IO: Incentives (Why?) 1. Easy Money Easy to expropriate and don’t Incentives2. Wedge (Why?) have to be held accountable 3. “Easy” Secondary Issues Slide 10
  • Set-Up Stage 1 Companies 1. Enticement and Earnings 2. Exercise Not! 3. Expropriate! Management! • Money is raised in the • Money is expropriated secondary market, but (through a mechanism which controlling shareholders we will explain later) and the• Earnings management + usually decline to exercise firm announces that it is notAnnouncement of headline- their own rights because they undertaking the projectsgrabbing profitable growth know it is a bad deal, for the mentioned in the originalprojects funds will be siphoned off. application to regulators to The more power controlling make a rights issue, or/and shareholders have, the more change the use of proceeds likely they are not to exercise to finish a money grab their rights Slide 11
  • Earnings Management Incentives ?! Slide 12
  • Earnings Management Incentives In China, reporting losses will lead to delisting or heavy government scrutiny - According to Article 157 of China’s Company Law, if a listed company sustains losses for threeconsecutive years, it will be temporarily delisted by the China Securities Regulatory Commission (CSRC)and subjected to ‘particular transfer’ (the stock can only be traded in the stock exchange on Fridays)and other transfer constraints. If it sustains losses for two consecutive years, it will have ‘ST’ (specialtreatment) prefixed to its name as a warning. Inability to make rights issue offerings (bright-line rules) - From 1996-98, mini 10% ROE (9% in protected industries) for 3 consecutive years before offering(CSRC Notice No. 17, 1996). In 1999, it was modified to an average ROE of at least 10% and a mini 6% ineach of the 3 years before the offering. Further modified in March 2001 to an average net ROE of atleast 6% in the 3 years before the offering Slide 13
  • The Wedge & The Missing US$1 Billion Cash in SatyamIndia’s Satyam• Low cashflow rights (RamalingaRaju and family have 8-9% equitystake in listed IT firm Satyam. Whywork so hard? Get only 8-9% ofcashflow• High control rights as Founderand CEO of Satyam• Wedge! Expropriate at least $1billion in cash and assets out ofSatyam to 100% stake in unlistedproperty firm Maytas (where theycan get 100% of any cashflowgenerated) Slide 14
  • Secondary Issues? Growth from New (Hot?) Money, Not Internal Sustainable Growth• “…84% of the market growth in the U.S. was the result of internalgrowth while only 16% was contributed by the issue of new stocks.China’s market presents an entirely different scenario... only 16.9%was the result of internal growth… almost two thirds (64.4%) camefrom the issue of new stocks (23.8% from IPOs and 40.6% fromseasoned equity offerings or SEOs)... ” Slide 15
  • Mungerian IO: Opportunities/ Mechanism (How?). 1. RPTs 2. Asset Transfer/ How are Injection Opportunities assets / Mechanism expropriated? (How?) 3. Laddering in IPO Expiration 4. Delisting Slide 16
  • Opportunity/ Mechanism (How?): Propping & Tunneling via Related Party Transactions (RPT) Propping via cash sales (vs accrual sales that may draw an auditor’s attention) - Similar to pre-IPO earnings mgmt Accounting 101 check:80% of listed firms in Related lending interestChina were previously rates reported in theproduction units that had footnotes of firms’been carved out from financial statementstheir parent SOEs, which Parent or Listed show that only 16.3% ofserve as the controlling controlling the related loans earnedowners after the listing. shareholder Subsidiaries interest revenue, ofAfter the carve-out and which the averageIPO, the listed interest rate was 0.55%,subsidiaries continue to significantly lower thanengage in frequent RPT the typical bank rates ofwith their parent SOEs Artificial sales! Parent can always tunnel 5-10% per year back the sales by getting loans from the subsidiaries. Related loans are usually NOT paid back by the parent! - Similar to post-IPO tunneling of assets out Slide 17
  • Egana (48 HK) and Peacemark (304 HK): Steady Consumer Companies & Value Stocks With Lotsa Cash in B/S?Egana (48 HK): HK$1.4 billion net cash; Peacemark (304 HK): HK$600 millionHK$1 billion are promissory notes due net cash; HK$330 were “deposits” from related investment companies placed with related parties Slide 18
  • Egana (48 HK): Converting Receivables to Goodwill Egana Acquisition Distributor Convert receivables that is due from Egana to distributor to goodwill via acquisition from funds raised from investorsOn at least one occasion, Egana has acquired a distributor in exchange for cancellingaccounts receivable, and booking the set-off as goodwill.Egana acquired a German distribution business which had net assets of $19.3m for $22.4m incash. It also set off $125.2m against accounts receivable and other receivable, booking$128.2m of goodwill while reducing receivables by $125.2m.- David Webb, “Egana and Upbest”, 26th July 2007 Slide 19
  • Peacemark (304 HK): Net Cash and Tunneling via Loans to Biz Associates $599.5m net cash ($327.8m were “long-term deposits”)$136.9m of this "deposit" was made in theyear to 31-Mar-07 as "long term deposits to $191.9m of this “deposit” was “placed withbusiness associates for joint business business associates for the development ofdevelopment purpose. The business a retail chain network in Asia...the Directorsdevelopment of this project is under expected that the deposits will not beprogress and the Directors expected that realized within 24 months from the balancethis amount will be injected into a new joint sheet date.”venture next year.”“Deposit“ are just secured loans which may not be actually paid. Slide 20
  • Opportunity/ Mechanism (How?): Propping & Tunneling via Related Party Transactions (RPT) Among the listed companies that have recorded two consecutive years of losses, 70%suffer from misappropriation by controlling shareholders, which is also a major reason forthe operational failure of the 15 delisted companies. In a 2003 survey by China SecuritiesJournal, a total of RMB 57.5 billion was found to be misappropriated by controllingshareholders and other related parties.- In 2001, the largest shareholder of Sanjiu Pharmaceutical, one of the blue chips in China, extractedUS$309 million, 96% of the listed company’s total equity- In 2004, when an individual shareholder sued Lianhua MSG Ltd (the largest MSG brand in China) andits parent company, the court accepted the appeal but the defendant declined to appear in court onthe excuse that fund misappropriation is very common among Chinese listed companies.- In 2003, Zhu Kuan, a company controlled by the government of the city of Zhuhai, defaulted onUS$750 million loans. The Zhuhai government transferred land worth US$125 million from Zhu Kuan tothe city- In 2004, In 2004, China Shipping Development transferred US$45 million from the listed company toits wholly state-owned parent by signing a service agreement Slide 21
  • Delisting, Liquidation Are “Easy” Escape RoutesA HK investor, David Webb is campaigning for the SFC to intervene in provisionalliquidations that seem unnecessary. "Companies, led by their management, areabusing the liquidation process as a means to run away from minority shareholdersand creditors," he said. "Unless the Securities and Futures Commission intervenes tooppose the winding-up petition and the appointment of provisional liquidators, theyhave a clear run at it.“Webb owned shares in Norstar Founders, a mainland car-parts manufacturer, whichreported net cash of 1.28 billion yuan for the six months to September last year andnet assets of HK$3.12 per share. In February, Norstar chairman Lilly Huang convincedthe High Court to put the firm into provisional liquidation. Norstar had made awrong-way bet on accumulators and owed 39 million yuan on that contract. It hadalso been sued by a supplier for 326 million yuan. However, according to Webb, thecompany should have had 753 million yuan of spare cash after these liabilities. Slide 22
  • Other Common Connected Transactions Asset acquisitions and divestments Asset sales and purchases Equity sales and purchasesE.g. In year 2000, Changling (Group) Co Ltd purchased an equity investment from its parent companyfor RMB10 million and then resold it to another unrelated company for RMB80 million within onemonth. Without this transaction, Changling (Group) Co Ltd would have incurred a loss of aboutRMB57 million instead of a reported profit of RMB13 million for the year. The transfer pricingmanipulation had a major impact on company earnings and cash flows. Furthermore, the avoidanceof a loss enabled the firm to keep its listing status. Changling (Group) Co Ltd had previously reportedtwo years of losses (firms that report three consecutive years of losses may have their sharessuspended from trading).The tax revenue recovered by transfer pricing audits increased from RMB460 million in 2006 toRMB987 million in 20073 (Shanghai Daily, February 4, 2008). The Chinese tax authority regardstransfer pricing as one of the main channels for companies to avoid paying tax. Slide 23
  • Fu Ji (1175 HK): Wei Dong’s Restaurant to Olympic Caterer Restaurant Caterer Restaurants are “slow”. Franchise to lighten up? Load up aggressively on the fixed costinvestments instead! In 2002, Wei change the business model to a caterer with millions ofcustomers in the form of factory workers and students buying lunch boxes, as well ascatering for weddings and major events. High volume to utilize the fixed-cost investmentsto breakeven faster and enormous profits flow to the bottom-line after breaking even fromthe fixed-cost investments First in China to operate on such a big scale. List in Dec 04. Raise HK$3.5 billion in fundsfrom investors in 4 years. Olympic 2008 caterer, >$2 billion market cap Apply for provisional liquidation, leaving behind HK$2.2 billion CB unpaid Slide 24
  • Fu Ji (1175 HK): Wei Dong’s Restaurant to Olympic Caterer Slide 25
  • Missing Cash In S-Chips: No Holds (Industries) Barred Sino-Environment (SINE SP) Fiberchem (FBCM SP) Ferrochina (FRC SP) Slide 26
  • Summary: Running The Asian (Booby) Track with the Mungerian IO Framework 1. “Easy” 1. RPTs Money Easy to 2. Asset expropriate Transfer/ and don’t Incentives Opportunities How assets Injection2. “Easy” (Why?) / Mechanism are have to beto Wedge (How?) expropriated? held 3. accountable Laddering in IPO Expiration 3. “Easy” Secondary 4. Issues Delisting Slide 27
  • China: Any Buy-and-Hold Multibaggers? Slide 28
  • Yunnan Baiyao – Treasure of China’s TCM + Option Value in the $20 Toothpaste that Grew to a $3 Billion (And Growing) Business Slide 29
  • Kehua (Reagent), Hengrui (Cancer Drugs), Weigao (Device) Slide 30
  • Kweichow Moutai, Swellfun Jap try to copy but failed miserably. Hired the very top engineers and managers, brought back the soil to Japan, etc Germs in the soil that give the Maotai the unique smell and taste can only grow in Guizhou province in China Slide 31
  • Tencent (700 HK) Slide 32
  • Tingyi (322 HK), Hengan (1044 HK) Slide 33
  • Adapting the Investment Style of Buffett-Munger to Asia (Part II):(B) Reminders from the Global Financial Crisis Slide 34
  • Clawing Back from Losses After Shocks… “Averaging Down”? Slide 35
  • Clawing Back from Losses After Shocks… “Averaging down” begs the question of timing (mechanical rules?) and “catching a fallingknife”. They usually do not work unless:(1) If we know our stock well (Right Stock) we could add to good effect (Right Amount) totake use the beneficial intrinsic value of “time” (Right Time) in investing in stocks.(2) Having accumulated over the last 3-5 years, the last 1-2 years would have given usopportunities to achieve “good average holding cost” in a stock. This is instead of panickingto exit after 3-5 years of accumulating a Right stock. It is this second chance of accumulatingstocks at low levels, often during a crisis, that gives us good average stock cost to last thedistance, to achieve Right Time. It is not right “timing” per se.(3) This buy-and-hold works if we have the first Right, which is Right Stock. We have theconviction to hold. And buy if possible if we have the Right Client. Slide 36
  • To Protect, To Preserve, To Guard Slide 37
  • Clawing Back from Losses After Shocks… Often in investing we have to enter investing “tunnels”. We could tell how theonly way to manage our fright of the darkness in investing tunnel by knowing thatthe same trolley we use to enter the tunnel is also the same trolley that will take usout. How the stock’s price drops will be followed by its bounce back up. We shouldnot jump out of the trolley midway during the descent. We should not switch toanother vehicle we don not know to recover and get out back into the light. Thefirst principle is paramount in investing: get the Right Stock for us to haveconviction to win as we fly into the numerous turbulences in the markets overtime. It is the volatility that kills when it should be our friend. Slide 38
  • No Alternative to Knowing the Company …(1)We must know the company and management for a long time(2) If so, we can only buy slowly over a long time(3) And we have to wait for results for a long time. However, time is a good friend to allow opportunities to appear for the value investor to benefit.This buy-and-hold works if we have the first Right, which is the Right Stock. (Following this we will have the conviction to hold, Right Time. And buy more if possible, hence achieving the Right Amount.) Slide 39
  • Qualitative Analysis Must Complement Numbers…(1) We must not only rely on quantitative numbers in Asia(2) We must have a huge database of knowledge in other “business models”(3) We cannot invest from afar. We have to understand the “jockey” and “horse”. In Asia, knowing the “track” is extremely critical. Slide 40
  • Asia Looking Exciting …Asia is entering its Stage 2 in economic/market development, Asia will require business models scaling abilities, intellectual properties, team work. This is to capitalise what has been built over the last 20-30 years. The US on the other hand will require an overhaul, re-engineering of economies and markets. The gift of entrepreneurism in individuals will be more important.Hence, whilst US/Western markets will once again present huge opportunity for a “Peter Lynch”, less so a “Warren Buffett”, Asia will present huge opportunity for a “Warren Buffett”. Slide 41
  • Investing In Lions vs Hyenas The Lion The Hyena Commitment to - Ethical & Moral Values  Little interest in Ethics & Morals - Winning the Game Honorably  Just wants to win the Game - Excellence  Little interest in knowledge & learning Strong intellect, thirsty for knowledge & learning  Not worked in a “world-class” institution Worked in a “world-class” institution  Has entrepreneurial values, is a “survivor” Has entrepreneurial values, is a “leader” - Short-term focus, Opportunist - Visionary - Works mostly alone - Long-term focus - Treats employees as expenses - Supports partners and alliances - Admire “tactics – resourcefulness – guile” - Treats employees as partners - Admire “strategy – planning – perseverance” Slide 42
  • A Simple Test! Are You A Lion or Hyena Investor?If you observe people manipulating stock prices or investing in dubious stocks, and they are making huge money out of these activities, Do you admire or envy that sort of easy money that these people make? Or do you stick to your game plan? Slide 43
  • Epilogue Slide 44
  • Gaining Control Rights Through Complex Ownership Structure Lower cashflow equity rights Higher control or voting rights Bigger WEDGE Epilogue 1 Slide 45
  • Opportunity/ Mechanism (How?):Propping & Tunneling via Related-Party Transactions (RPT) Epilogue 2 Slide 46
  • Opportunity/ Mechanism (How?):Propping and Tunneling via Related-Party Transactions (RPT) Accounting 101: Don’t be lazy, at least check the ORECTA (net other receivables as % of total assets) Higher ORECTA, higher probability of expropriation of assets from listed firm by parent or controlling shareholder Epilogue 2 Slide 47
  • Propping via (Artificial) Cash Sales and Tunneling Out via Related Lending Epilogue 2 Slide 48
  • Pre-IPO Propping & Post-IPO Tunneling Epilogue 2 Slide 49
  • Are Market & Investors Dumb and Cannot Predict These Events?  If markets and investors can predict tunneling episodes beforehand, we would have negative share price reaction BEFORE the event Epilogue 2 Slide 50
  • Opportunity/ Mechanism (How?): How Does the Market React to Announcements of HK-Listed Connected Transactions? During the 10-day window following the announcement, firms announcing differenttypes of connected transactions earn significant market-adjusted negative abnormalreturns of 7.1% for acquisitions of assets to connected parties, 6.7% for asset sales, 10.1%for sales of equity stakes, and 7.5% for trading relationships with the parent firm, onaverage. Firms undertaking connected transactions also under-perform during the post-event 12–month period following the announcement month, earning significant size and market-to-book bias-adjusted negative abnormal returns of 12.6%, on average. Firms selling assetsearn negative returns of 27% during the post-event period, firms selling equity toconnected parties earn negative 20.3%, firms initiating a trading relationship with theirparents earn negative 21.6%, and firms making cash payouts earn negative 18.7%. Investors cannot predict tunneling episodes, and so they revalue the firms when thetunneling actually occurs Epilogue 2 Slide 51
  • How Does the Market React to Announcements of HK-Listed Connected Transactions? Epilogue 2 Slide 52
  • Other Cases of Tunneling/Expropriation During the Asian Financial Crisis Epilogue 2 Slide 53
  • Opportunities/Mechanism (How?): “Laddering” in IPO/SEO Lock-Up Period Expiration - West Vs East Epilogue 3 Prices decline after IPO expiration period in the West. Opposite reaction in the East! Field (2001), The Expiration of IPO Share Lockups, Journal of Finance 56 (2): 471-500 Post IPO expiration, share prices decline in the short-term for US companies on average. Not in the East! Often, share price continue to rise in the short-term after the IPO expiration date (usually6 months) to allow the insiders and blockholders to exit in stages. They will work with the informationintermediaries such as the IPO manager, the underwriter and the sell-side analysts to hype up the stock tolure greedy and overconfident investors. However, if the “shells” are able to utilize the IPO funds raised to find viable customers, the game is reset Slide 54
  • Opportunity/ Mechanism (How?): No News Is Good News In Asia? Companies Suppress Negative News! Epilogue 4 Calmness in Spikes in stock stock prices price crashes before Event at after Event at time date = 0 time date = 0• State-controlled firms in China temporarily suppress the release of negative news around the years ofthe National Congresses of the Chinese Communist Party and in advance of political promotiondecisions• Moreover, HK-listed Chinese firms, arguably the most visible Chinese firms and bell-weatherindicators about the Chinese economy, experience a greater reduction in stock price crashes aroundNational Congress events, consistent with release of negative information by these high profile firmsduring a National Congress being very costly for both regional and national politicians. Slide 55
  • So You Think You Are Safe If You Invest in Asian Stocks Listed on Western Exchanges? Peril may lurk in U.S.-listed Chinese firms – total value of small Chinese firms with sharestraded in U.S. born as Reverse Mergers (RMs) or Special Purpose Acquisition Companies(SPAC) reached $25 billion (Barron’s, 8 Feb 2010) SPACs are shell companies that issue shares in an IPO and then hold the cash collected inan escrow account until a potential suitor for a RM can be found. A SPAC has 18 months tofind a target, or the fund is liquidated and the cash, less administrative expenses, isreturned to the shareholders. After an intended target is announced, the shareholders getto vote to either approve or reject the takeover. SPACs have grown in number from only one in 2003 to 87 in 2007-08. Over this period oftime SPACs have raised more than $25 billion in 173 IPOs, comprising 16% of total newissues Epilogue 5 Slide 56
  • The Growing Influence of Reverse Mergers in U.S. Epilogue 5 Slide 57
  • Western Investors Should Be Familiar With Shell Games(Reverse Mergers): Returns Around Merger Consummation Short-Run is Good! Abnormal average return of 15.4% 30 days before Short-Run is merger date Good! Abnormal average return of Long-run is bad! 32.7% 30 days Abnormal average after merger date return of -35.7% 60-390 days after merger date Epilogue 5 Slide 58
  • Back to SPACs: Think You Have No Downside Risks? Bad Shells!  SPACs are subset of Revere Mergers (RM). Think you are safer with SPACs? No downside risk since escrowed cash is returned to investors (less administrative expenses) if no merger targets are found after 18 months?  They are bad shells on average, generating tepid returns prior to a merger agreement, and negative returns upon consummation of a deal Epilogue 5 Slide 59
  • Fu Ji (1175 HK): Seems to be a Value Stock from the Usual Quant Financial Analysis (“looked healthy and solvent”) An October 23 report for bondholders by accounting firm KPMG and reviewed by the South China Morning Post showed Fu Ji had lost almost 11,000 of its 13,823 staff in the past 12 months and lost catering contracts with major corporate clients including Intel Corp, Wal-Mart Stores and Taiwanese computer manufacturer Asus. Fu Jis shares were suspended at HK$7.20 in July because the company did not publish annual results. When it last updated the stock market on its financial position in December last year, it reported a 272 million yuan (HK$308.75 million) net profit and more than HK$3 billion worth of assets. But investors had no idea the caterer was heading for liquidation. When Fu Ji last released accounts, it looked healthy and solvent. "[There is] possible inflation of revenue figures for the past few years," wrote KPMG. Fu Ji issued bonds totalling HK$3.1 billion from 2005-07, saying it would use the cash to expand its food factories on the outskirts of Shanghai and build new facilities in Jiangsu province and Beijing. In December last year, Fu Ji said it had 2.1 billion yuan of assets in the form of "construction in progress" and a further 1.35 billion yuan of other land and property. These incomplete food factories, which are on industrial land on the outskirts of cities, could be hard to shift. Fu Ji auditor CCIF CPAs staff refused to comment. Epilogue 6 Slide 60
  • China Is A Manipulative, Liquidity/Sentiments-Driven & Irrational Market? The Chinese Warrants BubbleEpilogue 7  In 2005-08, over a dozen put warrants traded in China went so deep out of the money that they were certain to expire worthless. Nonetheless, each warrant was traded nearly three times each day at substantially inflated prices. This bubble is unique, because the underlying stock prices make the zero warrant fundamentals publicly observable. Investors overpay for a warrant hoping to resell it at an even higher price to a greater fool. Because of the restrictive legal ban on short-selling financial securities (including warrants) in China, smart investors cannot arbitrage the bubble and correct the price. Designated brokerages are allowed to issue new warrants and to short! The length of the zero-fundamental period varied across warrants from a minimum of 6 days to a maximum of 165 days, with an average of 54 days.  Half of the exchanges warrant trading volume involved the top 1% most active accounts (measured by trading volume) and that these accounts (likely sophisticated professionals) had managed to make a profit trading these overvalued warrants Example (Wuliangye – arguable China’s most popular wine): • While the put warrant was initially issued in the money, the big run up of WuLiang stock price soon pushed the put warrant out of money after two weeks, and it never came back in the money. Surprisingly, the figure also suggests a positive price comovement between the put warrant and its underlying stock: the warrant price moved up with the stock price from an initial price of 0.99 Yuan to as high as 8.15 Yuan in June 2007 and only gradually fell back to one penny at the last minute of the last trading day. Slide 61