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.
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