1. 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

2. 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 not
just paying for bargains, as Ben Graham had Premiums Policy
Year
taught me. This was the real impact he had Written Holders
on me. It took a powerful force to move me 1936 $103,696.31 3,754
on from Graham's limiting view. It was the 1950: Strong
growth in the 1940 768,057.86 25,514
power of Charlie's mind. He expanded my
horizon; 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 8,016,975.79 143,944
interested 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

3. 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
30/11/1997
Slide 3

4. 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
30
Slide 4
PE

5. 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 stocks
Focus 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 I
environment and avoid those who steal; buy enough will move the world”
of these stocks and hold them long enough
Slide 5

6. Adapting the Investment Style of Buffett-Munger to Asia (Part II):
(A) The Mungerian I-O Framework
Slide 6

7. 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

8. (Distorted!) Incentive Structure in Asia:
Neglect of Knowledge Accumulation In Core Business
Neglect of knowledge
accumulation in core business
Easy money,
property and stocks
Slide 8

9. 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

10. Mungerian IO: Incentives (Why?)
1. Easy
Money
Easy to
expropriate
and don’t Incentives
2. Wedge (Why?)
have to be
held
accountable
3. “Easy”
Secondary
Issues
Slide 10

11. 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 not
Announcement of headline- their own rights because they
undertaking the projects
grabbing profitable growth know it is a bad deal, for the
mentioned in the original
projects 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

12. Earnings Management Incentives
?!
Slide 12

13. 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 three
consecutive 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’ (special
treatment) 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% in
each of the 3 years before the offering. Further modified in March 2001 to an average net ROE of at
least 6% in the 3 years before the offering
Slide 13

14. The Wedge & The Missing US$1 Billion Cash in Satyam
India’s Satyam
• Low cashflow rights (Ramalinga
Raju and family have 8-9% equity
stake in listed IT firm Satyam. Why
work so hard? Get only 8-9% of
cashflow
• High control rights as Founder
and CEO of Satyam
• Wedge! Expropriate at least $1
billion in cash and assets out of
Satyam to 100% stake in unlisted
property firm Maytas (where they
can get 100% of any cashflow
generated)
Slide 14

15. Secondary Issues? Growth from New (Hot?) Money,
Not Internal Sustainable Growth
• “…84% of the market growth in the U.S. was the result of internal
growth 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%) came
from the issue of new stocks (23.8% from IPOs and 40.6% from
seasoned equity offerings or SEOs)... ”
Slide 15

16. 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

17. 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 interest
China were previously
rates reported in the
production units that had
footnotes of firms’
been carved out from
financial statements
their parent SOEs, which Parent or Listed show that only 16.3% of
serve as the controlling controlling the related loans earned
owners after the listing. shareholder Subsidiaries interest revenue, of
After the carve-out and
which the average
IPO, the listed
interest rate was 0.55%,
subsidiaries continue to
significantly lower than
engage in frequent RPT
the typical bank rates of
with 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

18. 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 million
HK$1 billion are promissory notes due net cash; HK$330 were “deposits”
from related investment companies placed with related parties
Slide 18

19. 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 investors
On at least one occasion, Egana has acquired a distributor in exchange for cancelling
accounts receivable, and booking the set-off as goodwill.
Egana acquired a German distribution business which had net assets of $19.3m for $22.4m in
cash. 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

20. 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 the
year to 31-Mar-07 as "long term deposits to $191.9m of this “deposit” was “placed with
business associates for joint business business associates for the development of
development purpose. The business a retail chain network in Asia...the Directors
development of this project is under expected that the deposits will not be
progress and the Directors expected that realized within 24 months from the balance
this 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

21. 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 for
the operational failure of the 15 delisted companies. In a 2003 survey by China Securities
Journal, a total of RMB 57.5 billion was found to be misappropriated by controlling
shareholders and other related parties.
- In 2001, the largest shareholder of Sanjiu Pharmaceutical, one of the blue chips in China, extracted
US$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) and
its parent company, the court accepted the appeal but the defendant declined to appear in court on
the 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 on
US$750 million loans. The Zhuhai government transferred land worth US$125 million from Zhu Kuan to
the city
- In 2004, In 2004, China Shipping Development transferred US$45 million from the listed company to
its wholly state-owned parent by signing a service agreement
Slide 21

22. Delisting, Liquidation Are “Easy” Escape Routes
A HK investor, David Webb is campaigning for the SFC to intervene in provisional
liquidations that seem unnecessary. "Companies, led by their management, are
abusing the liquidation process as a means to run away from minority shareholders
and creditors," he said. "Unless the Securities and Futures Commission intervenes to
oppose the winding-up petition and the appointment of provisional liquidators, they
have a clear run at it.“
Webb owned shares in Norstar Founders, a mainland car-parts manufacturer, which
reported net cash of 1.28 billion yuan for the six months to September last year and
net assets of HK$3.12 per share. In February, Norstar chairman Lilly Huang convinced
the High Court to put the firm into provisional liquidation. Norstar had made a
wrong-way bet on accumulators and owed 39 million yuan on that contract. It had
also been sued by a supplier for 326 million yuan. However, according to Webb, the
company should have had 753 million yuan of spare cash after these liabilities.
Slide 22

23. Other Common Connected Transactions
 Asset acquisitions and divestments
 Asset sales and purchases
 Equity sales and purchases
E.g. In year 2000, Changling (Group) Co Ltd purchased an equity investment from its parent company
for RMB10 million and then resold it to another unrelated company for RMB80 million within one
month. Without this transaction, Changling (Group) Co Ltd would have incurred a loss of about
RMB57 million instead of a reported profit of RMB13 million for the year. The transfer pricing
manipulation had a major impact on company earnings and cash flows. Furthermore, the avoidance
of a loss enabled the firm to keep its listing status. Changling (Group) Co Ltd had previously reported
two years of losses (firms that report three consecutive years of losses may have their shares
suspended from trading).
The tax revenue recovered by transfer pricing audits increased from RMB460 million in 2006 to
RMB987 million in 20073 (Shanghai Daily, February 4, 2008). The Chinese tax authority regards
transfer pricing as one of the main channels for companies to avoid paying tax.
Slide 23

24. 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 cost
investments instead! In 2002, Wei change the business model to a caterer with millions of
customers in the form of factory workers and students buying lunch boxes, as well as
catering for weddings and major events. High volume to utilize the fixed-cost investments
to breakeven faster and enormous profits flow to the bottom-line after breaking even from
the fixed-cost investments
 First in China to operate on such a big scale. List in Dec 04. Raise HK$3.5 billion in funds
from 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

25. Fu Ji (1175 HK): Wei Dong’s Restaurant to Olympic Caterer
Slide 25

26. Missing Cash In S-Chips: No Holds (Industries) Barred
Sino-Environment (SINE SP) Fiberchem (FBCM SP) Ferrochina (FRC SP)
Slide 26

27. 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 Injection
2. “Easy” (Why?) / Mechanism are
have to be
to Wedge (How?) expropriated?
held 3.
accountable Laddering
in IPO
Expiration
3. “Easy”
Secondary 4.
Issues Delisting
Slide 27

28. China: Any Buy-and-Hold Multibaggers?
Slide 28

29. Yunnan Baiyao – Treasure of China’s TCM + Option Value in the $20
Toothpaste that Grew to a $3 Billion (And Growing) Business
Slide 29

30. Kehua (Reagent), Hengrui (Cancer Drugs), Weigao (Device)
Slide 30

31. 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

32. Tencent (700 HK)
Slide 32

33. Tingyi (322 HK), Hengan (1044 HK)
Slide 33

34. Adapting the Investment Style of Buffett-Munger to Asia (Part II):
(B) Reminders from the Global Financial Crisis
Slide 34

35. Clawing Back from Losses After Shocks… “Averaging Down”?
Slide 35

36. Clawing Back from Losses After Shocks…
 “Averaging down” begs the question of timing (mechanical rules?) and “catching a falling
knife”. They usually do not work unless:
(1) If we know our stock well (Right Stock) we could add to good effect (Right Amount) to
take 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 us
opportunities to achieve “good average holding cost” in a stock. This is instead of panicking
to exit after 3-5 years of accumulating a Right stock. It is this second chance of accumulating
stocks at low levels, often during a crisis, that gives us good average stock cost to last the
distance, 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 the
conviction to hold. And buy if possible if we have the Right Client.
Slide 36

37. To Protect, To Preserve, To Guard Slide 37

38. Clawing Back from Losses After Shocks…
 Often in investing we have to enter investing “tunnels”. We could tell how the
only way to manage our fright of the darkness in investing tunnel by knowing that
the same trolley we use to enter the tunnel is also the same trolley that will take us
out. How the stock’s price drops will be followed by its bounce back up. We should
not jump out of the trolley midway during the descent. We should not switch to
another vehicle we don not know to recover and get out back into the light. The
first principle is paramount in investing: get the Right Stock for us to have
conviction to win as we fly into the numerous turbulences in the markets over
time. It is the volatility that kills when it should be our friend.
Slide 38

39. 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

40. 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

41. 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

42. 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

43. 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

44. Epilogue
Slide 44

45. Gaining Control Rights Through Complex Ownership Structure
Lower cashflow equity rights
Higher control or voting rights
Bigger WEDGE
Epilogue 1
Slide 45

46. Opportunity/ Mechanism (How?):
Propping & Tunneling via Related-Party Transactions (RPT)
Epilogue 2
Slide 46

47. 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

48. Propping via (Artificial) Cash Sales and
Tunneling Out via Related Lending
Epilogue 2
Slide 48

49. Pre-IPO Propping & Post-IPO Tunneling
Epilogue 2
Slide 49

50. 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

51. 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 different
types of connected transactions earn significant market-adjusted negative abnormal
returns 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, on
average.
 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 assets
earn negative returns of 27% during the post-event period, firms selling equity to
connected parties earn negative 20.3%, firms initiating a trading relationship with their
parents 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 the
tunneling actually occurs
Epilogue 2
Slide 51

52. How Does the Market React to Announcements of HK-Listed
Connected Transactions?
Epilogue 2
Slide 52

53. Other Cases of Tunneling/Expropriation During the Asian Financial Crisis
Epilogue 2
Slide 53

54. 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 (usually
6 months) to allow the insiders and blockholders to exit in stages. They will work with the information
intermediaries such as the IPO manager, the underwriter and the sell-side analysts to hype up the stock to
lure 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

55. 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 of
the National Congresses of the Chinese Communist Party and in advance of political promotion
decisions
• Moreover, HK-listed Chinese firms, arguably the most visible Chinese firms and bell-weather
indicators about the Chinese economy, experience a greater reduction in stock price crashes around
National Congress events, consistent with release of negative information by these high profile firms
during a National Congress being very costly for both regional and national politicians.
Slide 55

56. 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 shares
traded 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 in
an escrow account until a potential suitor for a RM can be found. A SPAC has 18 months to
find a target, or the fund is liquidated and the cash, less administrative expenses, is
returned to the shareholders. After an intended target is announced, the shareholders get
to 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 of
time SPACs have raised more than $25 billion in 173 IPOs, comprising 16% of total new
issues
Epilogue 5
Slide 56

57. The Growing Influence of Reverse Mergers in U.S.
Epilogue 5
Slide 57

58. 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

59. 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

60. 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 Ji's 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 CPA's staff refused to comment.
Epilogue 6
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61. China Is A Manipulative, Liquidity/Sentiments-Driven &
Irrational Market? The Chinese Warrants Bubble
Epilogue 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 exchange's 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