Description

I think 90% of the time markets are somewhat efficient. To outperform, you have to have special insights into a situation or company. But there are times when markets are clearly wrong, presenting great opportunities. I believe Hong Kong stock market currently offers such opportunities.

Till 06/12, The Chinese stock markets have experienced an amazing bull run, with major indexes doubled or even tripled within twelve months. This amazing bull market alone deserves a careful study. It started when the Chinese government, the main market manipulator in China in my opinion, decided to do everything in its power to inflate a stock market bubble. My best guess is the government wanted a bull market so all the over leveraged companies could sell shares and deleverage. Also as the real economy slowed, the government needed something to boost confidence. As the market went up, more and more institutional investors joined the party. Of course all the brokers sang praises of the bull market as well since it is considered politically correct and they make a lot of commissions along the way. Eventually, the small retail investors were lured in. Millions of new accounts were opened and people used heavy leverage to bet the market will continue to go up. According to the Financial Times, at one point Chinese markets had the highest leverage ratio in the history of all markets anywhere in the world.

Then came the crush, in the last month or so, the ShangHai index dropped about 30%. (It has since rebounded some) The crush was so severe that most investors in China were shocked. The government tried everything to stop the decline, but the force of margin calls were simply too strong. It was really quite a scene, at one point, almost 50% of the listed companies in China volunteered to stop trading, using any kind of excuse they can find, to avoid the brutal sell off.

As the mainland markets drop, HK was dragged down as well. Money flowed back to mainland from HK to meet margin calls. As trading of many companies in China were suspended, hedge funds had to sell their HK holdings to meet cash requirements. Also since HK is better connected to the rest of the world, it dropped due to situation in Europe as well.

All the desperation and forced selling generated amazing opportunities. Some stocks in Hong Kong dropped more than 50% in the matter of days. Some state owned enterprises which grow earning at 20%+ rate were trading at single digit PE. These companies have strong support from the state controlled banking system and would almost never go bankrupt. Most of them were also paying around 3% dividend as well. Small caps dropped even more.

Yeebo Group (HK: 259)

Yeebo Group was established in 1988, and has been engaged in developing, manufacturing and marketing of Monochrome LCD and LCD Modules. Its headquarter is located in Hong Kong, manufacturing facilities in Jiangmen, Guangdong province, China. The Group is organized into four divisions: LCDs, LCMs, LCD-related products and LCD-related optical products. The Company is able to grow revenue at about 5% rate, but gross margin is under pressure mainly due to shortage of workers and rising labor costs in China. The company took some steps to alleviate the margin pressure, including increase selling price, cut costs, and set up new facilities in Guangxi province where wages are much cheaper. All in all, the core businesses are stable and generate about $50M profit annually. Assuming 10x PE, I think it is worth $500M. Since a clean shell company with no operation at all usually sells for $200M to $400M in HK, I believe the $500M valuation assigned to the core businesses is conservative.

The Company also owns 37.5% of Nantong Jianghai, a A-share listed company with current price of about $20 per share and market cap of $6.5B RMB. So the company's share is worth about $2.4B RMB ($3B HKD). The current market cap of Yeebo is about $1.9B HKD

Nantong Jianghai is in the business of making and selling aluminum electrolytic capacitors and related components, and making and selling of aluminum formed foil for high-performance aluminum electrolytic capacitors.

Admittedly, even though the price of Nantong Jianghai has come down from the recent high of $30, it is still overvalued when measure against fundamentals. Jianghai is growing both revenue and earning at high single digit rate but the demand for aluminum electrolytic capacitors has weakened since q4 2014 and competition is heating up. Jianghai is ramping up production for two new product lines and will have to incur initial costs. Consider all the factors, the current 45x PE is definitely too high, but I think 20x PE or a $10 stock price is reasonable for the following reasons:

Valuations are generally higher in Chinese markets, you'd be hard pressed to find companies trading below 10x earning. There are couple of reasons for this: first, though slowing, the economic growth rate is still higher in China than developed countries. More importantly, the government still largely controls who gets to list as public company and at what price. Once you are listed, you essentially have a license to print money, since it is easy to manipulate your own stock prices and you can buy good assets from unlisted companies with your inflated shares. So a clean A-share shell will sell for much more than a shell in Hong Kong. Among A-share listed companies, the average PE excluding financials are in the 30x-40x range. Jianghai was trading between $8-$10 before this bubble started. Assuming 20x PE or half the current market cap for Nantong Jianghai, Yeebo's share is worth about $1.24B RMB, which is $1.55B HKD compare to Yeebo's current market cap of $1.9B HKD

Yeebo also owns 43.87% of Visionox, a company making Organic Light Emitting Display (OLED) products using technology developed by Tsinghua Unversity, one of the best universities in China. I consider this part a valuable option.

Visionox was founded in 2001 by Dr. Qiu Yong. Its goal was to build the Chinese OLED industry and promote OLED technology within China. Although OLED has not developed as fast as people hoped, Visionox has made concrete technical progresses and filed more than 1200 patents domestically and overseas. Previously Yeebo has written down its investment in Visionox to zero. But I think things are starting to change at Visionox.

Chinese government is encouraging domestic technology companies to make more advanced products and take on foreign competitors. China considers a lot of technology sectors strategic and would rather have the domestic markets owned by domestic companies rather than foreigners. The government is providing a lot of support such as cheap financing, cheap land, and favorable policies to support domestic technology companies and I think Visionox will be one of the companies to benefit.

The founder of Visionox, Dr. Qiu Yong, was accepted by the Chinese Academy of Science in 2013 and later become the President of Tsinghua Unversity. This is actually a big deal. Tsinghua university is probably the best university in China and both Present Xi and former President Hu graduated from Tsinghua university. And in China relationships and connections still count a lot when it comes to doing business.

In this Feb, two AMOLED lines owned by Visionox has started production. My best guess based on talking to channels and people in the industry is Visionox will make a small profit this year. It is difficult to say how much Visionox is worth and the range is quite wide. Under the worst scenario Visionox is zero. Under the best scenario Visionox could become a public company within couple of years and the valuation will be at least $500M RMB, this is how much an empty shell company will sell in China. I guess the truth is somewhere in between, the good thing is we are not paying much for it.

Catalyst

Visionox turning around

The company sells its Jianghai shares