Abaci's Common Sense Investing

This comes later than usual because I was waiting for the annual report of PCCW, not because I was expecting something groundbreaking to be said by Richard Li but rather a better breakdown of the segmental figures. However in the end I found there's none and the information there was just as convoluted.

(previous analysis at http://abaci-investing.blogspot.com/2007/02/pccw-8-now-is-time.html for the unfamiliar)

The item I was curious to know more was $600m of unallocated expenses, which was quite sizable considering its mysterious nature and that 2006 pre-tax profit was only $2.5b. The weird thing was that there was no such item in the interim report, i.e. somehow all unallocated expenses found its ways into the different business segments at interim, and then reappeared as unallocated in the annual report.

Earnings were down from $1.9b to $1.6b. Management's explanation was lower investment income and disposal gains. There was no elaboration and the slightest hints I picked up were the $100m derivative loss (vs. $300m gain last year) and $150m lesser disposal gain last year. I had no way to know which way these items will show up next year so I take it'll be same this year. Fixed line and internet business was flat or in nicer term consistent. NOW and PCCW mobile provided much of the bleeding. The consulting arm on the other hand was a surprise turnaround. Interest cost as expected did drop by $200m as higher cost debt were refinanced and interest income increased by $200m as well.

I'm not concerned about the prospect of NOW as I'm sure the EPL license will bring in sufficient subscribers to cover the costs. Many of us have had enough experience with Cable TV's lousy picture and customer service. I don't see there's any other killer programming to stop this migration. Knowing the habit of our fellow honkies, the switching should occur at the last minute and at the same time in September. I read that some equipment will be upgraded to broadcast matches in HD, if it's true it'll draw an even larger crowd. Just 350k new subscribers to the sports channels (less than half of Cable TV users) at $179 a month will bring in over $750m revenue a year, even though the license alone will cost some $500m a year.

I have lesser comfort in PCCW mobile, for mobile market is too crowded and no one is earning decent income. In fact the mobile division was the loss leader, increasing from $126m in 2005 to $700m last year, albeit $500m of it was depreciation, amortization and interests. My expectation of lower costs from consolidating Sunday and PCCW outlets and staff didn't happen yet in 2006, but I'm sure it'll take place this year as increasing revenue (vs. cost cutting) will be a more difficult task. I'll stick to my previous guess of $200m saving for this year.

Earnings excluding PCPD and amortization this year may be $1.6B-1.8b so recurring p/e is 16-18x, not attractive enough if you are an income collector. I hoped PCCW would go into a quiet debt reduction mode which would grow the company value internally. But looking at the recent developments it looks like big cash will always be spent and there will always be deals, buy or sell, to make the headlines to entice buyers for PCCW. So I've changed my view and labeled PCCW as a pure M&A play, meaning it isn't exciting and you won't know when it'll happen. The good thing is it'll hold its value against general market fall.

DISCLOSURE: I hold 8 at time of writing.

This one is gonna be really brief as there's not much to talk about.

As far as I know only 3 units of Tomson Rivieria (TR) have been pre-sold and Tomson has collected $100m. I also read from the internet that a neighboring development in Pudong is planning to be sold at $60k-80k per sqm. This can be good news for a floor price is established for TR, or bad news as potential buyers may be drawn to the cheaper offer.

There are other developments in Pudong that Tomson is developing including villas around the Tomson golf course (75,000 sqm to be sold this year) and apartments in the Zhangjiang Hi-Tech Park (which have been sold out). These will provide interim earnings before the sale of TR and may actually turn in some impressive figures too given the low land costs. I have not accounted for these profits in my analysis so when it becomes due it'll be bonus.

The big question of LAT remain unresolved. Tomson has provided $246m but it's more likely not to have included provision for TR judging from the size of the provision. Management has made it clear that two blocks will be kept for rental purpose (whether it can be rented is another matter) so it may suggest sale of two blocks before early 2008 when the LAT is due. And how much LAT is gonna levied in the end is anybody's guess but I'm sure Tomson should have no problem borrowing against TR should the funding need arises, and in any case Tomson is in a net cash position so it can raise further debt too.

So the basic story remains intact - Shanghai financial district luxury property developer is trading at only 70% of unadjusted book value. I don't see the need to change view.

DISCLOSURE: I hold 258 at time of writing.

This is the 1st report card about this blog and the investment picks, mostly for my record.

Today is 4 months and 1 day since this blog was started back in December last year. Looking back I think it was a right decision because it really forced a lot of discipline into my life. I wanted to do a review earlier, probably at quarter end, but the hectic reporting season has precluded it until now. (Note: the other reason is I'm scared the market will turn and wipe out most of the gain)

Up to today there have been 6,600 visitors, working out to be around 55 visitors a day. This is quite a small group but the quality of the comments received suggests big thinkers. Say 'bravo' to yourself if you are reading and I thank you for your support.

Summarized below are the companies which I've covered so far and their share price performance since. The proper way to do this is to include the financial performance as well but that's too much work for one person. I have also put down which companies I hold shares in for better disclosure. While I have thought about whether I should only include those which I hold shares in or have suggested a buy, even as a speculation, in the end I've decided to list them all out since I figured I'd never spent time writing about a company if I wasn't interested in it at the 1st place. And I trust my readers to be competent enough to make their own decisions.

Please note this is NOT a recommended buy list.

(dividends are not added back except stated)
(* means present holding)

Dec 18 06
China COSCO (1919)*
up by 77% from $3.887 (adj. for bonus shares)

OOIL (316)*
up by 55% from $48.5 (adj. for dividends)

Dec 20 06
Tomson (258)*
up by 5% from $2.05

Dec 27 06
WKK (532)*
up by 40% from $1.12

Jan 2 07
Dickson (113)*
up by 17% from $7.91

Jan 8 07
Man Yue (894)*
up by 21% from $2.03

Fujikon (927)*
up by 2% from $1.80

Arts Optical (1120)*
up by 18% from $2.58

Yip's Chemicals (408)*
up by 11% from $3.82

VSC (1001)*
up by 20% from $0.98

Jan 9 07
Chalco (2600)*
up by 29% from $6.95

Jan 16 2007
SH Petrochemicals (338)*
up by 13% from $4.07

Jan 24 07
Meadville (3313)
down by 21% from $2.25

Jan 29 07
Xinyi Glass (868)
up by 21% from $3.71

Jan 31 07
ZJ Glass (739)
up by 180% from $1.68 (this'll likely be my 'miss' of the year)

Feb 2 07
LSH (238)
up by 3% from $3.40

Feb 13 07
PCCW (8)*
up by 3% from $4.67

Feb 16 07
HKCG (3)
up by 5% from $17.48

Mar 22 07
Sinopec (386)*
up by 10% from $6.07

Mar 27 07
COSL (2883)
up by 4% from $6.11

Mar 28 07
Hendersen Investment (97)*
up by 5% from $15.52

April 3 07
Proactive Technologies (8089)
up by 52% from $7.27

April 12 07
China Glass (3300)
up by 13% from $3.40

Apr 16 07
Shui On Construction (983)*
up by 1% from $17.40

Not a bad start with only one loser from Meadville, which was an IPO so there wasn't a lot of damage. The super bull market has helped a lot. Of course I'm also proud of my achievement of finding you an IPO loser which is next to impossible these days.

Hope the adjustment won't be too severe and we'll all have as much luck for the remainder of the year.

DISCLOSURE: I hold those shares with * at time of writing.

Can the underdogs go any deeper? Can the superstars get any more out of reach?

This is a market as divided as ever. If you happen to sell inside China, you're automatically treated like a Hollywood celebrity. If you happen to sell outside China, you're banished into the dog house.

Of course I'm crying out loud for my favorite industrial plays, which I've picked to outperform the market in 2007. (http://abaci-investing.blogspot.com/2007/01/every-dog-has-its-day-my-industrial.html)

So far they have delivered excellent results against all hostilities (RMB, oil price, wages, tax reform, blahblahblah) but the market is clearly turning a blind eye on it, while busy worshipping the latest batch of superstars (note they come in batches).

Just a look at the figures will tell you the whole story.

(2006 earnings; EPS growth; p/e; yield)

Stars
Minth (425) - $269m; 6.8%; 25x; 1.2%
Shandong Molong (568) - $139m; 59%; 25x; 0.66%
Enric (3899) - $97m; 0.2%; 23x; nil

Dogs
WKK (532) - $250m; 37.2%; 4.4x; 1%
Arts Optical (1120) - $166m; 72.1%; 6.7x; 4.8%
Man Yue (894) - $122m; 15%; 8.7x; 2.2%

Valuation gap this big has not been seen since the last IT craze when industrials, including Techtronic, were ignored and all eyes were fixed on China Mobile and PCCW. By the way, coincidentally HSBC is once again being ignored.

For those, including myself, who have missed out the rally last time, now is the chance to redeem. But one cautionary note, not all industrials are created equal and management quality really matters in tough times like now. Choose wisely.

DISCLOSURE: I hold all 3 dogs and none of the stars at time of writing.

My salute to the tenacity of Senta Wong to rip us off!

For proper introduction and to put things back in perspective before we begin, check out http://abaci-investing.blogspot.com/2006/12/failed-privatization-follow-chairman.html.

WKK (532) was suspended on Mar 19 with a note that there'd be a substantial disposal. At first I thought some private equity funds were buying the PCB business and so it should be good news. But then not a single word came out since. Then I noticed the 2006 results were scheduled for release yesterday and realized probably the Stock Exchange had requested the two announcements to go hand in hand to the shareholders (this was one of the few things the HKEX had done correctly) given the closeness of the two event.

It turned out the buyer was interested in buying everything WKK had, and the buyer was no one other than Senta Wong himself. So this is yet another privatization in disguise and was done in a cheeky manner again. The last offer was timed right before the release of interim results and this time it was right before the final results. The purpose was all the same: to avoid having the latest results, which were excellent, included in the shareholder's circular and to shorten the decision time as much as possible (since there'll be probably be a delay in publishing the circular if the annual report is to be included).

This time the deal is structured as a sale of assets as opposed to a privatization offer, the difference being that the approval threshold is lowered from 90% to 75% of independent vote. And the deal can also fall outside the jurisdiction of the SFC. Since the deal was only marginally voted down last time, Senta Wong must feel pretty confident to succeed this time and hence offer a price ($1.65) only 20% higher than his last offer of $1.38. And to save interest further he even offers part of the consideration paid in promissory note to be settled in cash 3 months after completion (note: in normal takeover deals you would see a stand-by facility arranged by a bank ready at time of offer).

All these moves are really low class acts. If there's a financial or legal adviser behind, shame on them too!

Do I even need to mention the financial results? I guess not much since as you can see Senta Wong is so smart that I can really rely on his judgement.

EPS was up by 37% in 2006 and earnings were $250m. In this sense the offer hasn't really been improved but only reflected the increase in profit, or is it the opposite? The last offer was made at 5.3x p/e of 2005 earnings while the new offer is only made at 4.7x 2006 earnings! This offer is even worse than the last one.

In the results announcement the tone was as downbeat as it could be, citing all the difficulties facing the industry but contradicting all the underlying figures nonetheless. This shows symptom of a divided personality.

I strongly recommend everyone who holds WKK to vote and block this deal. There's no need to even consider any offer below $2 a share.

A side note, from this repeated exercise and that David Webb's buying into Sinotronics (1195), I'd say one shouldn't miss out the PCB industry. Other choices include Meadville (3313), Daishomicroline (567), Hannstar (667), or the upstream Kingboard twins (1888) and (148). Logical extension includes capacitor maker Man Yue (894). Pick wisely.

DISCLOSURE: I hold 532, 1195, & 894 at time of writing.

Construction business
This is the old build and deliver construction business, which is unexciting and earns little profit. Profits for the last 2 years were more or less $50m. Most businesses are in HK and Macau but future opportunities will come from referral from SOL and the distressed property division in China. Since the scale now is really small I'll simply give it a 8x p/e valuation at $400m and move on.

Distressed property (or what Shui On calls DAD)
This is the newer and more interesting business as it's similar to what SOL does but on a micro level. DAD team will buy up abandoned or half-finished property sites from distressed owners or creditor banks and then complete it and sell for profit. Up to now there's 5 projects of similar nature being developed and 2 more projects will commence later this year (and there's 5 more on the pipeline being negotiated). Each deal is structured in form of a JV with different partners like JP Morgan and other institutional investors.

It certain looks like this DAD business is really promising that SOC is planning to spin it off on a stock exchange, maybe on the London AIM market since Deutsche Bank London branch will be the placing agent. This move is logical since SOC has the reputation and experience (it gained from SOL) to source enough deals but not the capital to secure it (SOC itself is pretty loaded with debt already). And it'd be time consuming to find partners and negotiate a separate JV agreement for every deal. Plus SOC gets to benefit from putting on a second hat as a fund manager and can earn additional fees.

According to preliminary information, property interests and shareholders loan valued at $2.3b (of which SOC portion is $1.1b) will be injected into the listco. DB London is expected to raise $4.3b cash from listing. SOC will subscribe some new shares too in cash subject to a cap of $1.2b and that it'll hold no more than 49% of the listco. I note that these properties cost SOC only $460m and thus it'll make 100%+ profit upon listing. I hope this will look impressive enough to the investors in London, where property prices are on a very high plateau already.

The listing is expected to close before the end of May. If everything runs smoothly the fund will have a NAV of $6.6b (note: I use 'fund' as the listco is like a closed-end fund). SOC will be both the fund manager and the chief contractor earning income from both sides. Management fee will be 2% on net equity (less 0.5% for expenses) and 20% performance fee on the portion of return above 10%. The all-in fee should be 2.5% p.a. assuming an average annual return of 15%, or $165m in dollar term. I don't know if or where taxes are to be paid so I'll simply discount it by 20% to get after tax earnings of $132m. Contractor fees will be 4% on each budget and some incentive fee from cost savings. This calculation is a bit tricky so I won't bother.

Remember SOC has injected $1.1b worth of assets into this fund too. After management fee, SOC will earn 12.5% (15% return less 2.5% fees) on investment, or $138m in dollar term.

The two add up to about $270m earnings a year. Note that SOC will earn just as much from the fund management side using OPM (other people's money) as from its own investment. I've not included any return from SOC's additional $1.2b subscription in the fund yet, which could be earning up to another $150m a year. No wonder SOC is very eager to market this DAD concept abroad. One should really have a close eye on the progress of the listing.

For valuation I'll put a sticker of $2.5b. It's a little below 10x p/e for a $270m earnings but I'm really guessing.

Summary

We have $4.9b for SOL, $2.25b for cement, $400m for construction, and $2.5b for DAD, which adds up to $10b. SOC has $3b of gross debt so the net value should be about $7b. At current price of $18, the capitalization (enlarged by CB conversion) is $6b. So there's some scope for appreciation (IF the spin-off goes through). Or you can see it as a cheaper way to buy into SOL with some freebie call options on DAD and cement.

DISCLOSURE: I hold both 272 and 983 at time of writing.

SOC runs 4 businesses, the biggest of which is property development which has been spun-off and become 18% holding in Shui On Land, next is some cement plants in southwestern China, then there's distressed property development, and finally the old school construction business. There's also some venture capital funds but since the profit contribution is small yet unpredictable, I'll skip here.

Shui On Land (272)
This is Tony Measor's favorite pick for 2007 which he expects has the most chance to double. But instead its price has dropped by 5% so far this year. I think the share was listed at $5.35 last year, making the gain up to now about 20%, very modest compared to other China property plays. One reason seems that people believe locals are more experienced and informed in their homeland and hence can better run the business. And Vincent Lo being a HK citizens is thus regarded as second grade at best, even the fact is he already invested in China as early as in the last property slump in the 90s, and I guess many of the new crop of local Chinese property developers didn't even exist back then. So much for the local is better myth for me.

Quite the contrary the 'foreigner' status of Shui On Land gives me more confidence, for Shui On group has a long listing history in HK (3 listed companies) and a reputation to rely upon. And its track record has been respectable and the Shanghai Xintiandi is a fine example. I'd rather buy into Vincent Lo than many new Chinese property tycoons whom I don't really know much about, especially those who seem to get too rich too quickly. I initially thought many foreign funds would follow this logic and found SOL a more reasonable and reliable investment than the Chinese counterparts. Again the market logic beats me and I don't have a clue.

There's no much to really look into SOL because it's not a simple business to understand. It's like the city redevelopment council here in HK except it's without government funding. Valuing this type of long term property projects which may run anywhere from 5-10 years or even longer is nearly impossible. But here one can count on the long term trend of the Chinese property market which is up, and the proven Shui On management quality. The long duration of the projects can also soothe out the impact of any interim fluctuation in the property market.

Lastly, the less precise value of the business can really give scope for imagination and fuel speculation.

Cement business
SOC runs the plants mostly via a 45% owned JV with the french cement company Lafarge. It aims at the upscale market with plants in Chongqing, Sichuan, Guizhou, and Beijing. Separately SOC runs plants in Guizhou and Nanjing under its own name. Last year's results were hampered by an one-off provision of old equipment of $170m. Discount that the JV would have been profit making already. The cement market has come around if you look at the latest results or share price of Anhui Cement. Business should prosper with much construction activities going on in central/western China and in Beijing for the Olympics (note SOC's plants are all nearly by).

Profit is not easy to predict for a turnaround play. So for valuation I'll arbitrarily but conservatively give it 1/20 of the capitalization of Anhui Cement, although SOC (cement division) had more than 1/10 of the turnover. This will give a value of $2.25b.

To continue...

DISCLOSURE: I hold both 272 & 983 at time of writing.

I took another look at the glass makers as there's been quite some activities going on with these counters, which unfortunately mean higher prices too. More people are buying into the recovery story after 2 years of oversupply and price war, and demand should pick up strongly from growth in both the auto and the construction sector. Speaking of construction materials, the glass counters are also a lagger after others like steel, aluminum, copper, cement, which all have had their run.

Those who are reading about the glass companies for the 1st time should also look at my work done back in January on Xinyi and ZJ Glass.

Xinyi (868)
The 2006 results were a surprise as it showed very strong growth in construction glass in the 2nd half, which helped counter the slower growth in auto glass. And it finally put its upstream float glass plant in operation after some delay. Bottom line showed excellent 50% growth but EPS growth was more moderate at 40% because of dilution from new shares issued last June. One can't really pick on these results in any way but my only concern about its strange cash management practice remains. I thought cashflow was tight when Xinyi had to raise $180m from a placement to build a solar glass operation. But then Xinyi declared roughly the same amount as dividends. Maybe the management really has a distaste for debt or maybe the outlook was really blurry at the time of placement when they didn't expect things to turnaround that quickly. But the market isn't troubled by this and Xinyi is now trading at 19x p/e. This one looks like is becoming a growth share.

ZJ Glass (739)
Nothing new came out since my last look but price has climbed by 40% in 2 months' time, which was respectable but no longer spectacular these days. 2006 results will be published on the 27th but all eyes are apparently already on 2007 and beyond, since there's nothing to cheer about the past year. Capitalization is now $1.8b so if ZJ Class can really recover to its previous peak earning of about 200m a year in 2007 (note: it made a loss in $76m 2006 interim), the p/e will be 9x, not bad if this kind of growth can maintain. I'd say for now the price has got ahead of earnings a bit, but those early birds might really know something which I don't.

China Glass (3300)
This one is complicated and so far I've not been able to make much sense out of its reports. It started out as a small glass makers and was listed in 2005. Since beginning of last year it have had a series of M&A taking up 6 or 7 other glass makers. Now it claims itself to be the biggest glass maker in China!

It attracted me because of its relatively small capitalization of about $1.3b, comparing to Xinyi's $7.5b and ZJ Glass's $1.8b. And it had good backing too with Nippon Glass as a strategic partner holding 29.9% and IFC holding like 3% plus Casanove (a good name in this business) helped place some shares recently at $2.75 (too bad now the price is $3.6 already). So it seemed a good bet on the recovery story. But after going through the numbers I found myself lost completely, even as simple as to the size and earnings power of the enlarged China Glass group. Of course it didn't help much when Everbright Capital was the IFA advising the minority shareholders in these acquisitions (for their opinion provided no useful insight).

To me it seems China Glass has been swapping shares with others to enlarge itself as opposed to straight acquisition, and it doesn't have majority control over most of these newly acquired businesses. The plus side is little cash is required and the company appears larger than it is. But the minus side is that it's hard to manage so many operations and to get consensus with so many heads on top. China Glass Group should properly be called China Glass and the group of companies. If you look at the balance sheet you'll find minority interest to be just as big, if not bigger, as the owners' equity!

So there you have it, my view on the three glass counters. All have merits not without doubt. I have a slight preference for China Glass for now but that can go away easily with a swing in price. This is a sector which I think is promising and worth taking some risk.

DISCLOSURE: I don't hold 868, 739, 3300 at time of writing.

I've always read successful people are proactive in life and pursuit of everything, and they never wait for things to happen. So this may be one fine inspiring example, how about growing a company by 150 times in capitalization from $20m to $3b in less than 4 months?

Here is a company which used to be in the telecom software business. It was listed on GEM in 2002 and shares were held by management shareholders Tsang, Lam, and Lau. It even had attracted a fund, Pacific Technology Partners, as a strategic investor. But things apparently turned bad after listing as financial performance deteriorated in the next few years. Then at some point in time things became discouraging enough that the owners decided to sell their stakes, one by one.

First, Lau, the COO, exited and sold his shares at 9.2 cents in July 2005. But lucky was he there was a buyer (Century Dragon) for his minority interest and the deal was done off-market. 9 months later in April last year, Lam, the co-founder, exited and he was also lucky to find a buyer (Gorgeous Overseas) for his shares at 8.75 cents off-market. One month later in May last year, Pacific Technology Partners probably sensed trouble and wanted out, but be not desperate as it too found a buyer (Homerun Business) and sold out off-market at 6 cents. Finally in November last year, Tsang, the remaining co-founder, sold out his stake at 8 cents to, how hard could it be, yet another off-market buyer, Well Support. Well Support was indeed very well supported as the name Kingston Finance and Ms. Chu showed up in the SFO disclosure. My guess is they were the financier because their names were subsequently cleared off the shareholders' record in February this year.

Bear in mind the 4 buyers were unrelated and we must give praise to whoever the broker was because it was one hell of a job to clear those GEM stocks in 4 non-controlling blocks. In total, 139.7m shares (60%) were changed hands at an average price of 8.2 cents for $11.4m, more or less the price for a GEM shell.

Now the proactivity began, trading volume and price started to go up in the same month of November, with no apparent reason. By this time Gorgeous Overseas must be feeling gorgeous as it was selling down its stakes (from 40m shares to 23m shares) at 28 cents, making more than 3 times of cost or 200% profit. A placing was then done at 24 cents raising $46.4m. No names of the placees were disclosed.

Things continued to go wild after the placing and before anyone knew it, the price was up by 400% to over a dollar in the 2nd trading day into December. Remember proactive people don't wait for things to happen. An announcement then came out and mentioned talks were being held with some companies under the China Railway department about potential co-operation in logistics and transportation. It then settled down for a while, but for not long, before climbing by 400% again to $4 in this January! But it didn't stop there and continued to reach $7 this month! $7 was 87 times of the original investment cost of 8.2 cents! Early birds must be very full by now.

Full details about the co-operation and the agreements eventually came out on 12 March. The company will be injected a 49% effective interest in a JV with China Railway (HK), GD Railway, Pacific Telecom and Networks, and BJ Run Tong as partners on two shareholding levels. The business will be railway cargo transportation operator. I wrote 'will be' because the JV is not yet in operation and is still trying to obtain the necessary regulatory approval to operate. But that didn't apparently deter anyone. The consideration was $680m which will be 99% satisfied by issue of new shares at $7.11, yes, seven-eleven. And so another shareholder Cheung emerged. There are now 5 shareholders introduced into this company and they don't know each other! Maybe proactive people have a tendency to find one another.

Okay you might say it's just a rubbish for rubbish deal since there's little cash involved. But 7-11 is never a quiet place, under the same deal 55m new shares were also placed at $7.11 via China Construction Bank to a number of institutional investors including at least two investment funds, Indus Capital and Gandhara Master Fund. UBS's name showed up too but it's more likely to be a broker of either of the fund. So now there's real money backing this surreal railway venture.

Apparently you should know by now I'm not the proactive type since I only brought to you this company when its price is over $7. So don't expect me to tell you what'll happen next.

What's the purpose of this post? Of course I'm jealous of others getting immensely rich! I'm all red eye now.

And what's the name of this company? Proactive Technology Holdings (8089).

DISCLOSURE: I don't hold 8089 at time of writing.