This is my submission for VIC membership. Data might be slightly outdated. The share price actually has declined since my write up, which makes the share a better investment now.

 

Hanny Holdings (HK: 275) is one of the classic special situation investment opportunities, with potential return >300%. It trades around its cash value on the balance sheet and 20% of its book value. Its balance sheet is pretty solid, if not pristine. It has two significant real estate investments in mainland China, which are carried around or maybe under the market value. It runs two small non-core business (river sand mining and water supply) which generate some small positive cash flow. If you strip out the net cash position, at today's price you are essentially getting two real estate assets in China for free.

The deep discount to the Net asset value rooted from Hanny's history as part of holding companies control by Charles Chan, and further exaggerated by distorted supply/demand balance. Charles Chan used to be right hand man of Li Kan Shim, the richest man in Hongkong. Chan eventually made his fortune by buying and selling publicly traded companies. Those companies cross hold shares and bonds. The common stocks of these company already traded at heavy discount (~50%) to net asset value reflecting the lack of clarity of these inter-company holdings. Since last year, Allan Yap, Chairman of Hanny, decided to split Hanny off the Charles Chan network. ITC group, the majority shareholder controlled by Charles Chan, dividend out all the Hanny shares to its shareholders. Allan Yap subsequently bought out Charles Chan's entire stake in Hanny's, 250M shares at the price is around 30 cents. Allan Yap also then contributed another 61M in the current round of equity raising. In all, he paid around 125M for 21% of the company. Hanny also sold out its stake in ITC property, another company within Charles Chan' empire, and redeemed the ITC property's convertible bonds, which Hanny used to buy 50% interest in a real estate project in Guangzhou from ITC property. After these transactions, Hanny will no longer have direct connection with Charles Chan, except for the 50% JV in ITC property.

The stock price is further depressed by two subsequent events. As price of an illiquid asset in a less efficient market is set primary by supply/demand balance. Before the split off, ITC holdings held 240M shares and converted its Hanny convertible bonds to 463M shares. ITC then distributed 701M Hanny shares to its share holders as stock dividend (every 10 ITC shares receive 9.3 shares of Hanny holdings), which representing roughly 43% of the share outstanding and more than 50% of the float. Hanny's share declined more than 50% from the time of announcement to the distribution of the Hanny shares. The shares continued to be under severe selling pressure, after distribution, as ITC shareholders paid essential nothing for Hanny share (ITC share traded roughly at the same price after the stock dividend as before the distribution.). As more than 50% float are held by people who passively got long the share at close to zero cost. The continuing declining in the price of Hanny create more selling pressure, as people are rushing to lock in their big paper profit into cash. Hanny decided to raise new equity to fund the new real estate development project in China. They executed a 1:10 reverse split and then issued 8 new shares for every existing shares at 0.30 a piece. At the time the stock (pre plit) was around 0.35, so shareholder have to pay 68 cents cash for every dollar of the Hanny shares they held. Also from a portfolio management stand point, no one likes to have an illiquid position to unwillingly increase 70%. This not surprisingly created another wave of selloff. The stocks were down 40% in couple weeks. The majority of the selling came from smaller retail investors, who often do not have the liquidity to fund the equity raising. In summary, the unique situation of undervaluation in Hanny's common share is a result of uneconomic sellers, whose decision to sell bears little consideration of price/value relationship. I think once the supply/demand balance reaches new equilibrium , share price should gradually reflects the true economic value of the company.

At today's price, the company trades at less than 500M. Hanny had 342M cash as of Sept.2010, it subsequently sold its investment property for 283M (an office room and 4 parking spot in the BoA tower in HK carried at 242M on its book) and its marketable securities (shares of ITC property) for 78M and it received 300M for new share issuance. I estimate it should have around 876M in cash. On the liability side, It has 133M bank borrowing (48M of which is due within a year) and 678M convertible bonds. 342M of the convert was held by ITC holdings, which redeemed all the converts into new shares. Hanny will issue 300M new convert to retire the remaining maturing bonds. Hanny has more than 500M net cash after the equity raising, higher than its market cap. So you are getting all the other hard assets on Hanny's book for free.

The major assets on Hanny's book are real estate projects in GuangZhou's Yuexiu district. The real estate market in Guangzhou is much less bubblish than other ist tier cities like Shanghai or Beijing. The two projects are in Yuexue district in Guangzhou, which is one of the top commercial locations in the city. The per sq meter price is less than ½ of the prices in similar locations in other top tier cities. In 2009 and 2010, Hanny acquired a retail/luxury condo project from BestSmooth in two sequential transaction. The lot is in the Yuexiu distriction of Guangzhou (between ZhongShanWu road Jixiang road). The size of the lot is 7974 sq meter and is zoned for commercial and residential use (thus it is not subject to the new housing regulation in China). It paid 604M for 60% interest in the project and then paid 460M for the remaining 40% in 2010. Best Smooth acquired the land 10 years and subsequently ran out of cash during the development. The foundation of the building was built, but the project was on hold for nearly 10 years. Hanny obtained building permit last year (number# ?2010?2298). It will build a 9 story shopping mall and 26 story luxury condo with a 5 story underground structure connected to subway station. The total area is 123.7K squre meter (93.7K above ground+29k under the ground.) Management expect to invest another 540M to complete the project. They will start the pre-sale in the 4th quarter. The secondary market around that area is between 10k-20k Yuan per sq meter for residential apartment and the retail space is 25-35k Yuan per sq meter. Hanny's building should be in the higher end of this range, as its retail space is directly connected to subway station (more traffic) and residential units are targeting higher end customers. Hanny acquired 50% interest in real estate project in the same area (literally across the street to the first project and connected with each other through subway station.) Hanny acquired the interest from ITC property with the cash from redemption of 386M ITC property convertible bonds and 94M additional cash.The acquired asset is valued at 1248M on ITC property's book at the date of acquisition.

There are some non-core assets on Hanny's book (river sand mining and water supply). As a total, they generates some positive cash flow over the years, and Hanny has stated publicly that they are looking for opportunities to exit these business to focus on real estate development in mainland China. To be conservative to my valuation, I will just assign zero value to these assets.

This invest does not require a rising Chinese property market, since you are paying virtually nothing for the two real estate asset which worth more than 2.5B in the current market. There is very little leverage on the wholly owned project. Hanny has sufficient cash to fund the project. The balance sheet of the 50% JV with ITC property is less clear. I will just assume they paid a fair price for the stake. The downside of this investment is well protected, as the price is less than both net cash and liquidation value of the company, even assuming a real estate market crash in China.

As the Hanny re-establish itself as an independent real estate developer and the supply/demand of its common shares restore its equilibrium, I expect Hanny to be trading at a similar discount (~50%) to net asset value like other small cap real estate developers traded in Hongkong, which should imply 1.2 HKD per share valuation or 300% higher than the current price. Furthermore as Hanny start to pre-sale in the 4th quarter of this year, they will have chance to market to asset to the market value and start to generate cash flows.