This post is the second in a series on Investing in Asia.
In August 2014 the Forager International Shares Fund invested in CST Mining (SEHK:985), netting a 140% return in less than a year.
CST was an ‘asset play’ listed in Hong Kong. When we purchased it, CST had US$750m of financial assets. These were mainly cash and a 17% stake in profitable gold miner G-Resources (SEHK:1051). It also had net operating assets of US$200m. CST’s market capitalisation was US$170m, a whopping 80% discount to its Net Tangible Assets (NTA).
Markets across Asia are currently full of similar stocks. The accompanying chart shows the percentage of stocks (of more than US$250m capitalisation) in various markets trading at a discount of 20% or more to their NTA.
These stocks were an obvious place for value investors like us to begin our research in Asia. Some of the ‘asset plays’ we analysed were Wheelock (SEHK:20), Playmates Holdings (SEHK: 635), Asia Orient Holdings (SEHK: 214), Keck Seng Investments (SEHK: 184) and the one we eventually plumped for, CST Mining.
But, despite our triple-digit return on this investment, we remain sceptical about investing in such companies. Even more so after the G-Resources board recently sold the mine that underpinned CST’s value for a song, to a consortium affiliated with its vice-chairman. And then, refusing to pay the proceeds to shareholders, management decided to reinvest them in financial products instead.
These ‘asset plays’ hold a lot of appeal at first glance. They typically have little or no debt and own a lot of property and financial assets such as cash and securities. The values of such assets are relatively easy to approximate and they usually represent a large proportion of the NTA backing.
Yet, there are sound reasons for investors to discount them. These companies usually have a controlling shareholder, complex corporate structures and many related party transactions. In addition, they are frequently involved in several unrelated businesses. More often than not the shares are illiquid.
In Asia, shareholder activism, leveraged buyouts and spin-offs are rare. So, the gap between price and NTA usually persists.
In those cases, minority shareholders must rely solely on dividends to earn a return. Unfortunately, if they are paid at all, dividends are usually small and only paid when it suits the controlling shareholder.
It would be unfair and lazy to categorise all such stocks as ‘value traps’. Yet our conclusion is that the majority of them are exactly that (stocks that look cheap but stay that way for good reasons). In those situations, the investment case almost always revolves around a reduction in the discount, rather than a projected large increase in the underlying value.
Meanwhile, we’ve also found a number of well-managed Asian companies with a clear area of expertise. We will highlight one of them in our next post in this series.
7 thoughts on “Asian Asset Plays – Bargains or Traps?”
Back in 2010, I looked at an Asian-based asset play listed on the ASX called GLG corporation (GLE), I ended up deciding to not invest because it didn’t pass the smell test. Since then, the stock has gone nowhere, and after taking another look at it last year, I came to the conclusion that there is a real possibility that it is a fraud.
There are plenty of decent asset plays on the ASX (KAR, NGE, MPO and HAW are my picks), where both corporate governance standards and corporate activity levels are higher, which ought to mean that discounts to NTA get closed faster.
With emerging markets, the principles are the same as for the ASX, but obviously the margin of safety needs to be a little wider to compensate for the issues that you raised.
The intrinsic value of a stock in the hands of a minority investor is not necessarily the same as the intrinsic value of a stock in the hands of a controlling shareholder. If the management does right by shareholders, the two are broadly the same. However, if the controlling shareholder is determined to actively screw minorities, then the difference can be stark – 80-90% less, or worse.
One therefore has to subtract from the intrinsic value of the company/assets, post a typical buffett/graham approach, the estimated ‘present value of future minority shareholder value destruction’. If that is actively considered part of the value calculus, then a stock trading at a sharp discount to NTA is not necessarily cheap (but may be). After all, what is a treasure chest with $1m inside worth if you don’t have a key and can never open it? If this part of the analysis is ignored, then for sure – value traps many will prove to be.
That said, in this instance you made 140%! Not exactly a great datapoint to prove your case – the difference between outcome and process notwithstanding. This experience highlights that there is still potential value in these things and a favourable risk/reward – provided the market price in incredibly low. The stock gets priced like an option. It’s a bit like Gazprom – at 2-3x PE and 0.3x book, the market is capitalising bad, politicised capital allocation into the indefinite future (it is only capitalising the 25% of earnings it pays out as a dividend). It becomes a free option on eventual corp governance reform. You can play the odds, but position sizes need to be kept very small.
If nobody will touch something at any price, provided it’s not going imminently bankrupt, it’s still worth looking at. Almost everything has a price where the odds are favourable. And stocks which no one is willing to own and which make people squeamish are prone – from time to time – to the sort of 140% rally you enjoyed. One has to see these things for the cigar butts they are though, and take profits and move on. They are no Coca-Cola!
Spot on LT3000, you are clearly thinking like a true value investor. Graham advised against “secondary issues” for the minority holder for exactly the reasons you raise.
Sounds like Forager got lucky with that investment, personally when I make money from a mistake like that I don’t trumpet it but go whew!
Ah, foreign white man investing in asia and going to make a packet…
Been done so many times before, and foreign white man goes home looking slightly foolish in most cases.
Now not all Asia is the same, but there are some common characteristics: Most of asia is populous, and everyone wants to get ahead. It is therefore INTENSELY competitive. It’s also where things get done based on relationships, and sometimes merit comes into the picture. Foreign white men are generally thought of as fools, mugs, exploiters, or nitwits. Finding a partner you can trust is difficult – the locals see a mug coming and have little scruples in exploiting the fool.
Just go for a walk – an actual real walk – around some of the industrial areas in Hong Kong. It’s an eye opener. When there are people who collect cardboard for a living, you realise you are in a different universe.
Finally, China. Perhaps the best quote I ever saw was from a China businessman, who said: “You foreigners are crazy, you want to find a partner in China you can trust. I’m a Chinese businessman, and I don’t trust ANYONE I do business with. So why should you trust your Chinese partners?” And well put this is too.
All this makes asia a bear pit for investing in – there are things go on you don’t know about, the competition is horrid, margins can be very slim, operations are opaque, and you can’t trust anyone. Interesting to visit, but take great care investing your money there.
To some extent correct. I’m a ‘white man’ that’s been working and investing in Asia for 5-6yrs so I have some experience with this.
In my perception, the key issue is that when you grow up in a wealthy, developed country – and particularly a reasonably egalitarian one like Australia or New Zealand – you have a different relationship to money. It is nice to have more, sure, but having more is mostly the difference between having a comfortable life and very comfortable life; or having more social status vs. less.
In poorer countries, by comparison, having money is a matter of survival. It’s a matter of being able to feed you kids properly so they are not stunted. It’s a matter of being able to afford to educate your kids so they don’t have to live in poverty there entire life. It’s about having enough money to live in sanitary conditions and avoid malnourishment so you do not die a premature death. It’s about having enough money to hospitalise your ill child instead of watching them die a preventable death.
Consequently, it is no surprise that acquiring money at any cost, and without any ethical constraint, is given greater priority in these countries. Being able to be honest in one’s dealings & lacking the temptation to try to get ahead at others’ expense is a luxury being brought up in a privileged, wealthy society grants you. You instinctively know you will never seriously want for anything key to your survival, so you lack the temptation to compromise your ethical standards for an extra dollar. You might behave differently if you were a few lost paychecks away from starvation.
For this reason I don’t judge. I think morality is relativistic, not absolute. It’s easy to be honest when you’re well educated & privileged. People, on the whole, are pretty similar. Circumstances are different. Change the circumstances and you change the behaviour.
Developed countries are developed because they have – over multiple generations – developed strong institutions and a high level of societal trust and a spirit of co-operative competition. Much like playing sports – it’s intensely competitive, but most people play by the rules, and the rules are generally agreed to be one of fair play. The culture is of trying to get ahead by seeking ‘win wins’.
However, there are two ways to make money – creating value (win win), and transferring value from others to yourself (win lose; zero sum). Poorer countries haven’t developed a win-win culture – in a large part due to institutional failings which do not reward merit and hard work. That is why they are poor. As a result, the culture is one of trying to get ahead through exploiting win-lose opportunities. Indeed, if the pie is small and not growing, and it’s not a meritocracy, its the only way to get ahead. And unfortunately, even those that have already grown rich can often find it hard to shake that psychological bent.
What this means is that one ought not judge, but one does need to be aware of these issues when investing/travelling/living in poorer countries. You can’t assume the same culture of trust and openness exists in a poor country as exists in a developed country. If you do, you are being naive and you indeed be screwed.
PS as Buffett once said, “I’ve never stolen a loaf of bread in my life, but I’ve never had to”.
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