This week, some updates on some of the stocks mentioned in my previous entries.
- Brilliance China
Stock had collapsed since my last update . BMW has announced that it will increase its stake in the JV from 50% to 75%. It will pay Brilliance China about US$4bn for the stake or 7.8x PER18. This is slightly higher than the current depressed valuation of Brilliance China of 6.6x PER when the deal was announced on 11 Oct 18. (Share price was at HK$10.76). If the management pays out the entire proceeds in special dividends, shareholders would receive HK$6.60 per share in return for the sale of the stake. In fact, before the news was announced, the management had promised to do exactly that. In addition, it said that only minority shareholders would be allowed to vote on the deal.
However, as it turns out, when the deal was announced, the notice to the HKEx gave management the leeway not to pay the entire proceeds out in special dividends and it did not say that the major shareholders will not vote in the deal. Shareholders were shocked at the about turn and sold down the stock. Last close for the stock was HK$6.90. The stock had lost 71% from it’s recent peak of close to HK$24 this year! Not that the business itself is actually doing very badly. Consensus estimates are expecting the company to grow 34% in 2018 and 22.7 % in 2019!
Lessons to self: Valuations and fundamentals of a company is one thing but the possibility of being disadvantaged as a minority share holder is another. These things happen in a random fashion and short of having insider information, it is not possible to foresee such outcomes. That is why it is important to diversify. Why should the major shareholders sell its crown jewels at a pittance? Remember that the company is a State Owned Enterprise whose real motive is not to maximise shareholder returns but to serve their political masters. In this case, Prime Minister Li Keqiang has promised the world that China was serious about opening up its economy to foreign countries and he has mentioned publicly that the test case would be the Brilliance-BMW JV. The deal had to be done this year despite its very bad commercial timing. And minority shareholders were not going to be allowed to vote the deal down. BMW obviously realised this and pressed it to their advantage, promising to bring more investments into the country and increasing employment, especially in the North Eastern region of China where the economy was weak.
Would this repeat itself in the case of Daimler-BAIC Motor? Here are the reasons why I think it might not happen the same way. First, notice the shareholding structure of Brilliance China. Unlike Daimler (which holds a direct stake of 30% at the listed entity level of BAIC Motor), BMW does not hold a direct stake in the listed entity and parent Brilliance China but instead holds the stake at the JV level. This means that if the interest of BMW and the minority shareholders of Brilliance China are not aligned i.e. if the share price of Brilliance collapse, BMW will not feel the pain. Second, BAIC Motor is owned by the central government (Beijing) whereas Brilliance is owned by the regional government. It can be argued that the financial position of Beijing is much better than in the Liaoning province where Brilliance is based. Therefore they should be in a much better bargaining position. And finally, the showcase deal in the auto sector is already done and there as less pressure for the Chinese government to do another deal so quickly.
2. BAIC Motor
Just a quick update on the stock. The share price has declined since our last note on the stock. This was dragged down by fears that the company might suffer the same fate as Brilliance China. The entire auto sector has also entered into an unprecedented period of slowdown. This is the longest stretch of negative monthly yoy decline in auto retail sales since the global financial crisis (6 months). Even longer than during the stock market crash years of 2015-16. There are many possible explanations for this. The first is that the rising property prices in the last 2 years have taken a toll on disposable income. I have heard the same even from my younger friends working in the finance industry in Shanghai. Many young people are forced to buy a piece of property as soon as they can raise the downpayment before home prices goes even higher. Normally, if their parents could afford it, they would pay the downpayment amount for their kids (~30% of the value of the property) while their kids are responsible for the monthly installment. Even then, many complain that more than half of their monthly salary is going into the installments, leaving precious little for everything else. One interesting phenomenon we see this year is that while retail sales is hardly growing this year, luxury auto sales are growing at 15-25% YTD. In other words, only the rich can still afford to buy cars.
A word on the valuations. At the current share price (HK$4.48), the stock is trading at 5x PER18 and 3.5x PER19 and is expected to pay 7.8% in dividend yield. What I find more extraordinary is that when you look at the cashflows generated by the company, the current valuation looks even more ridiculous. The company is trading at 1.25x EV/EBITDA this year. Last year, it generated free cash flows of roughly US$2.9bn. Even assuming that the company doesn’t grow this year and the next and generates the same amount of FCF, this is ridiculous considering that the market cap is only slightly more than US$5bn!! At the rate the share price is declining, they might as well give away the company for free. Either the company is going to go bust or this thing looks like it should be priced a lot higher than the value that the market is giving it now. I must say that this is probably the only really consistently cash generative stock that I have seen that it trading this cheap. Most of the time you will see crappy small caps, unknown companies trading at these valuations. But this is a real company, earning real cash paying real dividends. To be honest, I’m pretty stumped by this. I would be keenly following the subsequent developments in this company just to see if the market is really right in pricing the perceived risk with this company. Indeed I have done a quick screen of all the companies listed in the Asia Pacific markets above US$1bn market cap and this was indeed one of the cheapest stocks at the current moment! And remember, the company is not even forecasted to have declining profits this year and the next! Go figure…
Finally, another quick update on MyEG mentioned in this last note. The stock took another dive this week on 19 Oct 18 Friday closing down 25% in less than 2 hours before it was suspended. It was mentioned in a piece of news on the arrest of former Malaysian Deputy Prime Minister Ahmad Zahid Hamidi on charges of money laundering and corruption. It appeared that bribes were paid to him by 2 companies Datasonic and MyEG to secure government contracts. However, MyEG later issue statements to the exchange that it was not the one paying the bribes but it was someone paying the DPM the bribe in exchange for a possibility to get a contract with MyEG. Subsequently they also issued another statement saying that the Malaysia Anti-Corruption Commission (MACC) clarified that the company was indeed not a target of the investigation.