By Chan Quan Min
In part two of our series on China-based Bursa Malaysia listed companies, we take a closer look into the problems faced by Chinese stocks and speak to people familiar with the industry. Eager to shake off the bad image of Chinese stocks, finance professionals and a company chairman give their take on the reasons behind the poor valuations of Chinese stocks on the local bourse.
Dark clouds are forming over China-based companies listed on Bursa Malaysia. The reputation of Chinese stocks has been hit by a spate of delistings and regulatory infringements in stock exchanges overseas namely, New York and Singapore.
US news reports over the past few years have exposed one accounting scandal after another concerning China-based companies listed on the New York Stock Exchange.
The infamous short-selling equity research firm, Muddy Waters has floored close to ten such China-based NYSE listed firms, turning a tidy profit from its short-selling activities no doubt. Muddy Waters uncovered instances of fraudulent accounting which led to major sell-downs in many of the counters targeted by Muddy Waters.
US leaders in Washington have reached out to Beijing to propose an information-sharing deal. Reports suggest Washington wants Beijing to grant access to audit documents from Chinese accounting firms to improve the accounting transparency of Chinese firms with US listings.
Across the causeway, S-Chips, as China-based companies listed on the Singapore stock exchange are often termed have incurred a raft of trading suspensions. This happened after many S-Chip stocks were tainted by corporate governance scandals.
One thing has become apparent from the accounting scandals involving China-based companies listed on the New York and Singapore exchanges. There exists a huge gulf in legal and accounting standards between China and other countries (listing jurisdictions).
The allure of Chinese stocks has waned as investors the world over discover the inherent restrictions of cross-border listings. Operating at a distance and an international boundary away from the listing bourse, China-based companies easily slip outside of surveillance by regulatory bodies and market analysts, as reports of accounting fraud seemed to suggest.
“Growth in corporate governance has not kept pace with rapid economic development,” said Bill Tan of M&A Securities, referring to China’s rowdy business environment. M&A Securities helped facilitate the listing of a few China-based companies on the local stock exchange.
Naturally, Malaysian listed China-based companies have had to weather the bad publicity. Valuations are incredibly cheap, hovering around two to three times the price-to-earnings ratio, significantly below that of many small-cap stocks on Bursa Malaysia.
China-based Bursa listed companies have come under increasing scrutiny of late. Business publications and financial bloggers alike have gone through the books of Bursa-listed Chinese stocks and reported on the spectacular drop in value post-IPO (initial public offering).
Many also question the reliability of audited figures and wonder if the enormous cash reserves China-based companies declare in their annual reports really exists at all.
Checks on company documents performed by KiniBiz revealed that many China-based firms list big name accounting firms as their external auditors. For instance, both Xingquan International and China Stationery list Grant Thornton as their external auditor.
“Companies operating in China need to hold huge cash reserves because bank borrowings are hard to come by and cash is frequently used for big purchases,” Nigel Foo, a research analyst at CIMB Investment Bank explained.
The worst may not be over for China-based Bursa listings. Less than rosy forecasts for the consumer goods manufacturing industry in China could lead to lower earnings for Chinese sportswear manufacturers. Bursa Malaysia counts at least five such firms — Xingquan International, K-Star Sports, Multi Sports Holdings, Maxwell International and Xidelang Holdings — all specialising in footwear.
For the financial year ended 2012, K-Star Sports posted a loss of approximately RM13 million while the other Bursa listed Chinese sportswear manufacturers posted flat earnings.
In defence of Chinese stocks
There is no shortage of people in the industry who will eagerly offer to dispel what, according to them, are false or unfair perceptions.
“To put it simply, Chinese bosses don’t have an understanding of corporate finance. And this is exactly why their companies’ shares are underperforming the stock market,” said a source familiar with China-based companies listed on the local bourse.
According to him, this has led to management decisions by Chinese bosses of Bursa-listed firms that are at odds with Malaysian corporate practice. And a large part of this is due to a poor understanding of corporate finance.
The source, a prominent advisor on China-based equities, spoke to KiniBiz on condition of anonymity. He spoke enthusiastically about Chinese stocks in an office furnished with ornaments and artwork laden with feng shui symbolism.
“The larger problem and the cause of the continued bad perception plaguing China-based stocks is their poor ‘management’ of their share price,” said the industry source.
‘Managing’ the share price is an art if not a necessity, he said confidently. It is something local companies, especially small-cap counters on Bursa Malaysia understand. But unfortunately, not China-based companies and their bosses.
“When you look at local companies, they are far more concerned about movements in their share price. And when their stock tanks they are prepared to mop up shares”, he said. Otherwise, the stock could go out of control, he added.
Chan Fung @ Kwan Wing Yin
At a later date, in another equally well-appointed office, KiniBiz spoke to Chan Fung @ Kwan Wing Yin. Chan is the chairman of China Stationery Limited, a Chinese company listed on Bursa Malaysia. He answered in his native Cantonese:
“The stock market moves up and down like the ebb and flow of the tides,” he explained when asked if he was concerned about the sorry performance of his company’s stock.
It was clear Chan was unperturbed by the deep slide in the share price of his company, although he spoke very fondly of his company, China Stationery.
Since listing, China Stationery has fallen tremendously in value and is worth little more than a price-to-earnings ratio of three times.
China Stationery listed on Bursa Malaysia early last year in February. This was its first and only listing. The IPO (initial public offering) was successful at a retail price of 95 sen per share. From February until November last year, the stock traded in the range of RM1.00 – RM1.60.
After that, it was all downhill for China Stationary. The stock has been on a downtrend since November 2012 and last traded at 28 sen, accurate to July 9. This is one-third of the stock’s IPO price.
Penny wise pound foolish
Foo, the CIMB Investment Bank analyst reckons a sizeable part of the poor valuations plaguing China-based companies is due to poor investor confidence.
Foo has covered Xingquan International for several financial quarters and shared his view on the lacklustre performance of the counter:
“They have to learn to find a balance between growing their business and returning profits to the shareholders,” Foo said referring to the reluctance of many China-based Bursa listed companies to pay dividends according to a regular schedule and quantum.
“It all boils down to the perception game,” Foo added. Chinese bosses need to provide a catalyst to spur interest in the stock, and they can begin by showing cautious investors they have the funds to be able to pay good reliable dividends.
Oddly enough, China-based consumer goods manufacturers listed in Hong Kong are able to command higher price-to-earnings ratios of between six to eight times rather than the two to three times common to Bursa listed China-based companies, according to data provided by Foo.
The same industry source mentioned earlier in this article believed that the majority of Bursa-listed Chinese companies represent good value for the investor. However, according to him, Chinese companies continue to undermine the value of their shares on the open market.
“Chinese companies have a habit of paying professional fees and charges in shares,” he said, citing this as a deeply flawed corporate finance practice common to China-based Bursa-listed companies.
Quite literally, prior to an IPO, shares would be distributed to local partners, underwriters and bookmakers as payment for their services, he explained.
According to him, this practice of paying in shares meant Chinese companies could come to local shores and list their company for very little outlay.
“And do you know what happens once the company is listed? All these people drop their shares and very quickly the share price drops,” he said.
This practice of paying in shares instead of cash is not restricted to IPO deals.
In October 2012, China Stationery announced they were acquiring a 9.79% equity stake in Pelikan International Corporation, a Malaysian owned and run stationery manufacturer popular in European markets. The deal was worth RM50 million, to be paid for in newly issued shares.
In a note to Bursa Malaysia, China Stationery detailed the financial mechanics of the deal as follows:
“Acquisition by China Stationery of 9.79% equity interest in Pelikan International Corporation for a total purchase consideration of RM50 million to be satisfied via the issuance of 47,169,812 new ordinary shares in China Stationery at an issue price of RM1.06.
“An additional 3,000,000 new CSL shares at the issue price as payment for the professional fees to the joint project managers, Kenanga Investment Bank and Sadec Advisors Sdn Bhd.”
On Nov 9, Bursa Malaysia wrote to approve the listing and approval of the share issue. The project managers were paid entirely in shares at a total value of approximately RM3.18 million.
It was understood that the market’s response to news of the partnership was limited.
Reportedly, Pelikan sought the deal as part of a joint effort with China Stationery to improve its market position in Asia:
Loo Hooi Keat
“With proper coordination we believe this can be achieved at a much faster and cost effective phase. At the same time we can look into their manufacturing facilities as a source of our future needs,” said Loo Hooi Keat, the CEO and President of Pelikan.
All in all, both parties in the deal stood to benefit from operational synergies. But such a significant expansion of the issued share capital of the company was bound to dilute shareholders’ value.
Not surprisingly, China Stationery’s stock continued on its downward slide.
Curiously, China Stationery’s latest annual report reported close to a billion ringgit in cash reserves. Why the company chose to issue new shares as payment instead of digging into their pockets is baffling.
The thousand-mile horse
Chan Fung, the chairman of China Stationery attributed the poor performance of China-based stocks to bad publicity associated to the S-Chips accounting fraud scandal in Singapore.
He said investors should not paint with broad strokes and assume that all Chinese companies are the same.
Unfazed by China Stationery’s poor performance in the stock market, Chan recounted the popular Chinese legend of the thousand-mile horse.
He likened China Stationery as the elusive thousand-mile horse, hidden among a herd of other, more ordinary horses. The legend says that only the renowned horse tamer Sun Yang was gifted with the ability to pick out the thousand-mile horse from the herd.
Correspondingly, he said that China Stationery, although sound financially, is yet to be noticed by investors.
Tomorrow: How China-based Bursa Malaysia listings have fared
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