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Difficulty: Advanced
1) Recap of Part 1
Link to PART 1 here! We screened for companies whose Market Cap was LESS than the sum of the company’s cash minus all liabilities. In Part 2, we will be taking a closer look at the stocks screened.
2) Our observations after looking into the stocks
- Most had poor share price performance historically, which explains why their valuations are so depressed.
- For most of these companies, the largest shareholder appears to have a strong financial incentive to take the company private.
- One had conducted share buybacks recently (Tsutsumi Jewelry)
- At least one warned of large capex on the horizon (China Rare Earth Holdings)
- At least two had a prior record of corporate governance issues (G-Resources, WeiQiao Textile)
- Two were in investments related businesses (G-Resources, Life Care Capital)
- Two had a lack of qualitative information in English (Tsutsumi Jewelry, Maruhachi Holdings)
- Two stocks have been suspended for years… (Hua Han Health Industry, China High Precision Automation)
3) We did a further screen to narrow down the list
We looked each company’s enterprise value through time, to see if it has just started trading at such depressed valuations or whether it’s always been depressed…
A negative enterprise value indicates that the company’s market cap is LESS than its cash minus total debt. Since Price-to-CMAL<1 stocks have a market cap that is LESS than its cash minus total liabilities (a stricter requirement), these stocks definitely have negative enterprise value currently. We just want to see how long it’s had negative enterprise value for.
4) Summary of our conclusions
Here are InvestQuest’s conclusions for companies we looked into fairly thoroughly. If you’re interested, all the details are in APPENDIX 1.
- Emperor Entertainment Hotel: IQ is keeping it on our watchlist.
- Tsutsumi Jewelry: IQ would invest!
- Tai Cheung Holdings: IQ is keeping it on our watchlist.
Here are InvestQuest’s conclusions for companies we only took a brief look at. If you’re interested, all the details are in APPENDIX 2.
- G-Resources: IQ wouldn’t invest right now.
- WeiQiao Textile: IQ wouldn’t invest right now.
- Cosco Shipping International: IQ wouldn’t invest right now.
- Maruhachi Holdings: IQ wouldn’t invest right now.
- China Rare Earth Holdings: IQ wouldn’t invest right now.
- Life Care Capital: IQ wouldn’t invest right now.
- ChangShouHua Food: IQ wouldn’t invest right now.
1) Recap of Part 1
We screened for companies whose Market Cap was LESS than the sum of the company’s cash minus all liabilities. We imagine that companies meeting such a criteria would not only offer some safety on the downside but also be a good candidate for privatization or buyout.
Here were the stocks screened.
In Part 2, we will be taking a closer look at these stocks.
2) Our observations after looking into the stocks
2a) Most have a poor share price performance historically
You can see their share price performance below in the Appendix 1 and 2, but the performance for these companies ranged from -18% to -78% over a 5.5 year period (from start of 2015 to now).
2b) For most of these companies, the largest shareholder appears to have a strong financial incentive to take the company private
Most of the firms look wildly attractive when we compare the potential cost to acquire the company VERSUS the excess cash (after paying all liabilities) that could be freed up after a privatization. In the chart below, we show the cash needed to take over the company assuming a 20-40% premium to current price (see the columns in orange) versus the cash minus all liabilities.
Of course, do note that shareholders of the company already “own” some of this excess cash vis-a-vis their share ownership. But the point remains that the cash remains trapped in the company (especially if the company does not pay out generous dividends). By privatizing the company, this cash would be “freed” and the owner could use the cash however he/she/it sees fit.
In most cases, the largest shareholders are insiders (typically the founder, his family, company management etc.) while in some cases, the largest shareholders are actually investment funds.
Privatization potential is of interest to potential investors, because privatizations are the main way in which IQ sees these companies unlocking their value. Privatizations typically happen at a premium to the last traded share price. Of course, investors would want the privatization to happen sooner rather than later, and for the share price not to decline in the meantime.
The main caveats:
- Potential acquirers would like the share price to stay as low as possible and to drift lower
- Potential acquirers may be very patient (and wait years before launching a General Offer…)
- Private Equity firms that may be keen on taking over the company may face bidding competition or may be blocked by the current shareholders who want greater compensation.
- If corporate governance is an issue, management may try to take out cash in unethical ways. E.g. by buying over assets that they secretly own at inflated prices, by making loans to shell companies and then writing down the debt, etc.
Given all these caveats, IQ is more focused on choosing a company (if there are any) that we find most reassuring in terms of history of enterprise value (to be explained later), cash flow through the years, indications of confidence by the management (e.g. through share buybacks), and a lack of glaring corporate governance issues.
We are less focused on choosing a company simply because it has a large disparity between the cash needed to take over the company and the excess cash after paying off liabilities.
2c) Out of those with majority shareholders, one had conducted share buybacks recently
That’s Tsutsumi Jewelry. It has repurchased JPY1.0bn worth of shares in the past year.
2d) At least one warned of large capex on the horizon
China Rare Earth Holdings: “The Guangzhou refining and packing plants are in final construction stage which requires large part of investment. There will be another squeezing plant for our production in Qiqihar and the Group just started its construction. These two productions expansion requires large capital expenditure. Finally, the Group kicked off the campaign of healthy kitchen and therefore a large amount of capital is required for the enhancement and expansion of the sales network. Thus, the Board does not recommend any final dividend for the year ended 31 December 2019.” (From FY19 Annual Report)
2e) At least two have a prior track record of corporate governance issues
As it turns out, the two companies with unfavourable track records also have lowest Price-to-CMAL. I would like to use this to belabor the point that investing decisions shouldn’t never be made solely on the basis on ratios (whether it be P/E, P/B, dividend yield, etc.).
- G-Resources: Sale of major asset to a fund partly owned by Vice-Chairman in 2016. In 2016, BlackRock (then a 8% shareholder of G-Resources) failed in its campaign to stop G-Resources from selling its crown-jewel gold mine in Indonesia at near book value to a consortium led by a fund partly owned by G-Resources vice-chairman Owen Hegarty. (From South China Morning Post)
- WeiQiao Textile: Loans and Funds Transfer in 2016. In May 2019, the company was censured by the Hong Kong Stock Exchange for failing to inform investors in a timely manner about transactions it made with its parent company. In 2016, Weiqiao conducted transactions to fulfill Weiqiao Chuangye’s funding needs, providing the parent company with loans and fund transfer channel service. The value of such transactions reached nearly 9.5 billion yuan ($1.4 billion) in 2015 and 2016… (From Caixin Global)
2f) Two have a core business model that primarily involves investments
IQ is usually not keen on investing in companies which make making investments the core part of their business. Cash flows may be particularly lumpy, the business set-up may lend itself more to undisclosed connected party transactions that do not benefit the shareholder, it’s tough to discern the quality of investment manager running this company, etc.. Of course, the ONLY exception to our aversion is Berkshire Hathaway which has a long and very enviable track record.
- G-Resources: After selling off its gold mine in 2016, it used the proceeds to make investments.
- Life Care Capital: The company is the first Italian thematic special purpose acquisition entity, with an exclusive investment focus on the Health & Life Care sector.
2g) Three have a lack of qualitative information in English
The annual reports of Tsutsumi Jewelry and Maruhachi Holdings are in Japanese, while that for Life Care Capital is in Italian. While we could get their quantitative data from Bloomberg, we still want to read comments from the management in prior annual reports.
2h) Two stocks have been suspended for years…Yikes!
Meaning you can’t actually trade these stocks now! We haven’t checked but stock suspensions are usually a result of regulatory issues. Sorry for not filtering them out earlier!
- Hua Han Health Industry
- China High Precision Automation
3) We did a further screen to narrow down the list
We looked each company’s enterprise value through time, to see if it has just started trading at such depressed valuations or whether it’s always been depressed…
A negative enterprise value indicates that the company’s market cap is LESS than its cash minus total debt. Since Price-to-CMAL<1 stocks have a market cap that is LESS than its cash minus total liabilities (a stricter requirement), these stocks definitely have negative enterprise value currently. We just want to see how long it’s had negative enterprise value for.
Here are the stocks we were more keen to research, given their enterprise value history
- Emperor Entertainment Hotel – Negative enterprise value only recently
- Tsutsumi Jewelry – Enterprise value appears to be growing less negative
- Tai Cheung Holdings – Negative enterprise value only recently
Their charts are as follows.
You can find the charts of the remaining stocks in the appendix.
4) Summary of our conclusions
Here are InvestQuest’s conclusions for companies we looked into fairly thoroughly. If you’re interested, all the details are in APPENDIX 1.
- Emperor Entertainment Hotel: IQ is keeping it on our watchlist.
- Tsutsumi Jewelry: IQ would invest!
- Tai Cheung Holdings: IQ is keeping it on our watchlist.
Here are InvestQuest’s conclusions for companies we only took a brief look at. If you’re interested, all the details are in APPENDIX 2.
- G-Resources: IQ wouldn’t invest right now.
- WeiQiao Textile: IQ wouldn’t invest right now.
- Cosco Shipping International: IQ wouldn’t invest right now.
- Maruhachi Holdings: IQ wouldn’t invest right now.
- China Rare Earth Holdings: IQ wouldn’t invest right now.
- Life Care Capital: IQ wouldn’t invest right now.
- ChangShouHua Food: IQ wouldn’t invest right now.
APPENDIX 1 (shortlisted stocks)
Emperor Entertainment Hotel (296 HK)
The InvestQuest’s View: IQ is keeping it on our watchlist.
Background: Emperor Entertainment Hotel Ltd. operates a hotel and casino in Macau. The hotel offers restaurants and bars, a business center, spa, sauna, and nightclub, guest accomodations, and gambling services. (From Bloomberg)
In our opinion, here are the positive points
- History of positive operating cash flow. Hotels and casinos are generally very cash-flow generative businesses. Check out the orange bar in the 3rd chart below.
- Share price moves with other Macau entertainment companies. When we looked at Emperor’s enterprise value over the past few years, we thought that its trend could potentially be explained by cyclical sector movements. Indeed, over a two-year period, the correlation with the Macau casinos is an average of 0.55 based on weekly observation. Over a 5-year period, it has an average correlation of 0.44. We consider this a moderate correlation. This is reassuring as we’d rather pick a stock that is mistakenly undervalued after declining along with its peers, than one that is trading at low valuations for company-specific reasons.
In our opinion, here are the negative points
- That said, we are bearish on Macau gaming for now. Until a vaccine is found, IQ doesn’t see the gambling crowds coming back to Macau any time soon. Given that it may take 1-2 years before a vaccine is found, we are keeping the stock on our watchlist for now.
- The founder of the Emperor Group has a very interesting reputation according to news reports. Links to some articles: New Republic, SCMP, SCMP, Webb-site
- The stock has pretty low trading liquidity of less than US$100k per day.
Given the points above, IQ is keeping Emperor on our watchlist for now. We may buy the stock when our views on the Macau gaming sector change.
Tsutsumi Jewelry Co Ltd (7937 JP)
The InvestQuest’s View: IQ would BUY this stock! Please take this as a disclaimer that IQ intends to buy the stock after publishing this article. While not a screaming BUY, IQ believes that the positives outweigh the negatives for Tsutsumi and is planning to take on a small position in the stock.
Background: Designs, manufactures, and sells wholesale and retail jewelry. The Company sells mainly rings, necklaces, and bracelets. Tsutsumi Jewelry operates directly managed stores based in Saitama prefecture. (From Bloomberg)
In our opinion, here are the positive points
- Large shareholder, for whom it might make financial sense to privatize the stock (as explained above). Separately, note that Seiji Tsutsumi is NOT the one featured in this wiki page. They are two different people!
- Company has conducted a not-insignificant share buy back recently, and has a history of conducting share buybacks (JPY 4.4bn in FY16, JPY 1.7bn in FY17, JPY 1.0bn in FY19, JPY 2.0bn in FY20)
- Price chart is not far from the 2016 support of JPY 1,555, 16% below current share price of JPY 1,848
- Operating cash flow has been positive in the past several years. Negative net change in cash during some years is largely due to share buybacks
In our opinion, here are the negative points
- Lack of qualitative information in English. We couldn’t find a full annual report in English on Bloomberg or their website.
- With Covid, luxury spending should be weak in at least the coming two years.
Given the points above, IQ is keen to buy a small position in Tsutsumi. That said, we are eager to learn more about the stock – especially qualitative information! Let us know if you’re fluent in Japanese and can walk us through the annual report…
Separately, in case anyone was wondering
- We looked at the correlation of Tsutsumi with Gold Prices, across different time periods and frequency (daily, weekly, monthly). There isn’t a significant relationship.
Tai Cheung Holdings (88 HK)
The InvestQuest’s View: IQ is keeping it on our watchlist.
Background: Develops and manages properties. The Company also invests in securities. (From Bloomberg)
In our opinion, here are the positive points
- Appears to move with the other HK developers. The share price performance and enterprise value track record seem to suggest the fall in share price (and currently depressed valuation) might be in line with the industry’s share price movements. Indeed, over a two-year period, the correlation with the HK developers (Sun Hung Kai, Henderson Land, Swire Properties) ranges from 0.6-0.65 based on weekly observation. This is reassuring as we’d rather pick a stock that is mistakenly undervalued after declining along with its peers, than one that is trading at low valuations for company-specific reasons.
In our opinion, here are the neutral points
- An analyst is covering the stock. That’s DBS with a HOLD call and a target price of HK$5.19 as of 28 May 2020. See their latest report (HOLD rating) here. See their older report (BUY rating) here.
In our opinion, here are the negative points
- IQ is personally quite bearish on Hong Kong property developers right now. With the US looking into revoking Hong Kong’s special status, the riots continuing, IQ sees a situation where there might be an exodus on Hong Kongers and a lack of Chinese mainlanders coming to buy Hong Kong property.
Given the points above, IQ is keeping Tai Cheung on our watchlist for now. We may buy the stock when our views on the Hong Kong property sector change.
APPENDIX 2 (remaining stocks)
G-Resources Group (1051 HK)
The InvestQuest’s View: IQ wouldn’t invest in this stock right now. First, it has a history of corporate governance issues according to news reports (refer to Section 2). Second, its current business of providing financial services is a bit worrisome to us (refer to Section 2). Third, it has had negative enterprise value for several years (refer below). Fourth, the chance of a privatization looks relatively low to us with the largest shareholder only holding 28.38% (refer to Section 2). Fifth, it has relatively low trading volume (<US$100k daily).
Background: G-Resources Group Limited provides financial services. The Company focuses on principal investment, financial services, money lending, and real property business. G-Resources Group serves customers in Hong Kong. (From Bloomberg)
WeiQiao Textile (2698 HK)
The InvestQuest’s View: I wouldn’t invest in this stock right now. First, there’s a history of corporate governance red flags (refer to Section 2). Second, it has had negative enterprise value for several years (refer below). That said, I do rank the privatization probability as fairly high (refer to Section 2).
Background: Weiqiao Textile Company Limited manufactures and distributes textile products. The Company produces cotton yarns, grey fabrics, and denim products. (From Bloomberg) Founder billionaire Zhang Shiping passed away in May 2019.
Cosco Shipping International Hong Kong (517 HK)
The InvestQuest’s View: I wouldn’t invest in this stock right now. First, it has had negative enterprise value for several years (refer below). Second, IQ is generally negative on the shipping industry due to the ongoing supply glut. See Moody’s rating cut for the sector.
Background: Provides shipping related services. The Company offers shipping, logistics, shipbuilding and ship repair services, ship trading agency services, marine insurance brokerage services, marine equipment and spare parts, coating products, and marine fuel and other related shipping products. COSCO International serves clients around the world. (From Bloomberg)
Maruhachi Holdings
The InvestQuest’s View: I wouldn’t invest in this stock right now. First, because it has had negative enterprise value ever since listing! (refer below). Second, there’s a lack of qualitative information on English and the lack of indicative corporate actions (like share buybacks).
Background: Maruhachi Holdings Co., Ltd. is a holding company which manufactures and sells Japanese-style bedding and living supplies. The Company also engaged in real-estate leasing business. (From Bloomberg)
China Rare Earth Holdings (769 HK)
The InvestQuest’s View: I wouldn’t invest in this stock right now. First, because it has had negative enterprise value for quite a long time! (refer below). That said, it appears that the stock does respond to flares in trade war tensions and can be an interesting play depending on how US-China trade tensions progress. See article: The stock soared 108% in two days in May 2019, after a visit by Xi Jinping to a rare eaths facility.
Background: Manufactures and wholesales rare earth products and refractory products. (From Bloomberg)
Life Care Capital SPA (LCC IM)
The InvestQuest’s View: I wouldn’t invest in this stock right now. First, because its main business has to do with investing in other companies (see Section 2). Second, because it has had negative enterprise value ever since listing (refer below)! Third, there’s a lack of qualitative information on English and the lack of indicative corporate actions (like share buybacks).
Background: Life Care Capital S.P.A. operates as a special purpose acquisition entity. The Company focuses on investment, share exchange, acquisition, amalgamation, asset management, and other financial services. Life Care Capital serves the health and life care sector in Italy. (From Bloomberg)
Changshouhua Food Co Ltd
The InvestQuest’s View: I wouldn’t invest in this stock right now. First, mainly because it has had negative enterprise value for three years (see below). Second, it has pretty low trading liquidity of less than US$100k a day.
Background: Changshouhua Food Co Ltd manufactures edible corn oil products. The Company’s products are produced for domestic or export bulk sales mainly to other companies selling edible corn oil under their own brands and for domestic sales under China Corp’s own brand. (From Bloomberg)
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