About Spin-offs: Yangzijiang-Yangzijiang Financials

What follows is a feeble attempt to elaborate on the spin-off section that I wrote last week on my portfolio update, using a real life situation.

What I will try to add is my own 2 cents on the spin off of Yangzijiang Holdings. This would be a developing entry since the spin-off story is still very much in progress (i.e. not a done deal). 

A Summary

Yangzijiang (YZJ) is giving away, as a dividend, a share of Yangzijiang Financials (referred as YZJFH thereafter) for every share of SGX:BS6 held. YZJ Finance deals with mostly debts, and within those, largely corporate and government debt, while the rest lives in the risky world of micro-finance. Language in the introductory document suggest they will be changing their business to wealth management and giving equities a lot more weight. They would acquire GEM Asset Management (unfortunately, a related party transaction since Ren Yuanlin owns about 30% of it through "NewYard co").

Of particular interest to me is its board composition and an individual call Vincent Toe will be running this ship (pun intended). By reading his background, he seems suitably experience in both the nature of work (asset management) and familiarity with China. 

My personal opinion is that the elder Ren is handing over YZJ ShipArm to Ren LeTian (the son) for good.

Back of the Envelope Calculation

These are usual angles to look at a spin-off situation. 

(a) YZJ's valuation is weighed down by uncertainties due to YZJFH. Spinning it off, and hence relieving YZJ from risk of having it in its books, will revalue YZJ upwards. Personally, I don't think this is the case.

(b) YZJFH's value (and hence YZJ's own valuation, pre-split) is not given its deserving weight because it is obscured by YZJ's shipbuilding business. This is likely, imo.

(c) YZJ, as a mini-conglomerate of sorts, suffers from a conglomerate discount, and hence deserve a better valuation. If YZJ (as of writing, is priced at 1.64 a share) is spinning off YZJFH (with a net tangible asset of 1.0x), this means its remaining business is only rated at 60 cents a share. 

My notes tells me that YZJ has currently 3913.4145 million shares. Multiply 60 cents a share, this means the shipbuilding ("ShipArm") is given a market valuation of 2348m. My notes, taken since 2013's annual report, tells me that ShipArm has a CAGR of 2.44% topline (not relevant for a cyclical sector), and a return of asset of 7.8% to 13.8%. 

Pre-tax profits averaged at about 2.2B RMB. 

Depreciation charges averaged about 371.114m yearly, and addition to PPE (which is another way for me to guesstimate actual capex) is about 260m. So expenditure is about 300m RMB yearly.

Using a corporate tax of 25% (just throwing figures around), we looking at (0.75* (1900m RMB) )= 1425m RMB. 1 SGD is about 4.69 RMB, so we looking at 300m SGD profit after tax. 

What about YZJFH? I would not be too adventurous. Let's assume all of its debt will mature without... issues. That would mean 20.5B RMB (or 4.36B SGD) worth of assets is release, and these funds are available for reinvestment.

If I assign a price-to-book of 1.0 (fair given the ROA it was capable of), market cap would be 4.4B SGD. The company expects a market cap of 4.239B. A 10% difference in opinion or less is no opportunity to act on, imo.

In other words, assuming that the market believes that YZJFH is worth about 1 sgd a share, the market is giving YZJ ShipArm a valuation of 2348m, a profit of 300m SGD. 

I feel that this valuation for the ShipArm is a little to the high side.

What will happen post-spin off?

I going to put my neck out there. This is likely to happen:

The price of YZJ, post spin off, will sink. The market had already moved, and priced YZJ up, from 1.3x to 1.64 in a matter of weeks. I believe this is because the market think that financial asset management is after all more attractive and less cyclical. Personally, I still think the loans in YZJFH needs more scrutinizing.

My notes tell me that ROA of the finance arm is about 9%, there are some lean years where they return 4%, but I going to treat it as an outlier. From 9 year average figures, YZJFH had impaired about 200m RMB of its 16B assets (mainly loans). Figures do not include impairments that are later reversed (too much work for me). 

The Risk

Literature suggests that most of its loans will mature in Dec 2023, which feels like a lifetime ahead of us with all the problems of war and diseases still ever present. Debt assets is not a sexy thing in times of inflation, and certainly risky assets if you are dealing with high-yield (read: junk) bonds. 

Management, however, seems cautious. As I read, I note that about 3.8B of debt (of its 15B in the books) would not be transferred to YZJFH due to various reasons (page 78 of the introductory document). I have no reason to believe that YZJFH is not given every chance to succeed. 

In other words, YZJFH is not the 'trash'. In assessing spin offs, we want to know which coy is the treasure and which is the trash. But sometimes, there isn't any perceived treasure or trash, and hence there is no opportunity.

My assessment is to wait until the spin-off is completed, and re-assess how the market values each company. Personally, at present, 1.6x a share of YZJ does not represent a good risk-to-reward ratio to take advantage of. The opportunity is only going to be present if YZJ remaining coy (ShipArm) is sold down way too much.

=== update on 24-April ===

While YZJFH will only trade on 28-Apr, YZJ itself have a very humble sell down of only 40% thereabouts. The price reflects market opinion that YZJFH is only worth about 60 cents a share, which is puzzling, and also to me, an opportunity to accumulate should YZJFH falls on day 1.

Is market perceiving YZJFH as the "trash" and are glad that it is finally out of YZJ's books? I find it puzzling. The ShipArm should be more cyclical.. a much harder bet.

On a sidenote, YZJFH would be regarded as a member of the index, and hence it is unlikely to be discarded by closet indexers. I would be highly surprised if YZJFH does get sell down on day 1.

===Update on 30-April ===

YZJFH began trading on 28-April, 1pm, at $0.69 a share.

In less than two hours, it lost 16% of its value to 0.58 a share, and recovered towards the end of the day at 62.

The selldown resume the next day, from 62 cents to 57.5 cents in the first half hour. Volume lessen significantly compared to its maiden day of trading. A volatile last hour of trading saw it lost another 12% of value eventually, closing at 54.5 cents a share.

So I was completely wrong in my guess. YZJFH is, in the eyes of the market, the "trash," while YZJ ShipArm is the treasure. With the investment portfolio mainly of debt instruments, and credit worries ever present in China, this is rational.

So since the market has presented its case, my work is to look at the introductory document (if I have the energy) and determine if this is an opportunity. It does look like about 70% of its loans are back by collateral of various forms, such as land use, property, etc. Mathematically, this tells me that it would be prudent to discount at least 30% of its books.

With an NTA of about 1 dollar, YZJFH is now trading at just above half of it. So we are talking about a possible 16 cents per share of "discounted fair value." 

April 2022 Portfolio Update

S&P 500 Index Fund: -11.04% -> -4.32%

Hong Kong Tracker Fund: -19.99% -> -5.53%

Straits Times Index Fund: 3.06% -> 8.26%

My portfolio: -15.38% -> -4.22%

The onslaught to the Hong Kong market recovered unexpectedly with comments by Vice Premier Liu He, promising to support the market among other things. Markets rallied incredibly, but with some hindsight, levels are still depressed when compared to 6 months back.

Hang Seng Tech ETF 3067

The Hong Kong Tracker Fund

I have no love for Hong Kong tech as I felt that they are excessively valued, despite their long term promise. It was a clear example of what happens when you are a buyer of something when is too popular. How do you know if it is too popular?

5 years ago, you have to depend on the news to tell you so. Now, we have:

-Youtubers 

-creation of "sector" ETF (created solely by financial institute to capture the interest through fees from assets under management) to "cater to the needs of investors"

-daily chatter, as observed from chat groups.

Mainland tech firms not only have to contend with regulation and growth in mainland itself, but deal with the narrative of having to expand out of China one day. That could be way more difficult than their present ordeals. From my layman valuation techniques, and that generally people around me are still very hopeful of these companies (a good gauge of market sentiment), I would avoid increasing my position in Alibaba unless valuation declines.

Notable Transactions

-Purchase of Embecta, a spin off from Becton, Dickinson and Co.

Fell from 40.x to almost 27 at one point.

The basic reasons why spin-offs sold down in the initial phase usually follows this narrative:

a) A huge company, ideally an index constituent, decided to spin off a much smaller division/branch of its business.

b) For Embecta's case, existing share holders of BDX gets 1 share of Embecta for every 5 shares it owns.

c) Embecta gets sold off "indiscriminately" by share holders for the following reasons:

-Embecta runs a business that could be perceived by BDX share holders as unexciting (an opinion), of low growth (certainly). 

-Stock gets sold because of disinterest. After all, they might be seen as "dividend" from the parent.

-Embecta is not a member of the index and is under 2B market cap (contrasting BDX's market cap of 78B presently). For e.g. a fund manager might be forced by mandate to only hold stock of market cap x and above.

-The spun-off entity could be transferred undesirable assets, such as debt, or legal issues.

The basic reasons why it is a good idea to buy a spin-off:

a) existing management is incentivized to do well since they now hold stock options, and have clearer and more public standards to live up to (stock price, targets to meet to receive additional remuneration, etc)

b) The sell-off could bring prices to conservative levels (main reason for buying Embecta).

At my purchase price of Embecta at 30.8 USD per share, the company's market cap is 1.7B.

It bears a debt of about 1.6B

The last three years of profit is about 300-400m.

If one were to disregard debt, which is convenient enough when credit is cheap, the company is worth only 5x PE at worst. Since one should never disregard debt and value a company like a private owner, Embecta actually cost 3.3B (1.7B market cap + 1.6B of debt).

That isn't a bad price by itself since you are paying 10x earnings. 

Unfortunately, my position in Embecta is very modest. Last evening, perhaps the market had realised its folly, and the stock went up 10%, 14 at one point. It is just the problem with the way I inject capital-- very small amounts. I only buy more when the stock plunges 10%-15%.

-The significant amount of Alibaba purchase did not actually materialised last month. How I wish it had! I simply wrote a put contract at strike price of 87.5 HKD, right before the selldown begins. Alibaba went from 100+ to 71 HKD, and the contract spiked up to 800% in value.

(my bad luck with option contracts continues after the Didi Global episode, where I failed to cover my put by 1 or 2 pips that night. The next day, Didi's management announced that they are delisting from America and re-listing in Hong Kong. Its price plunged 20+%, and the option contract spiked 1900%. Very poor luck... never go to sleep before you covered your put!)

I have no luck with options. Thinking that it would be exercised, I wrote prematurely that I had purchased stock. After market rallied (Alibaba went back above 100), obviously the contract holder did not exercise his rights. Unfortunately, that means I only bought 200 shares of Alibaba (direct purchase from market) that month, albeit at a very fortuitous price of 71.8 HKD a share.

-Token purchase of Clifford Modern Living. After which, dividends are cut from 0.027 to 0.022 HKD a share. If I have to guess: illiquidity and its boring, property services business kept the share price from plunging. 

Market capitalization is 490m. Growth is modest and its cashflow is reliably positive, averaging 60m a year for the last 8 years. Dividend payout is on the low side, but still respectable at 4.6% yield currently.

-Token purchase of Central China Real Estate-- it is still far from the previous amount of stock that I sold down from. It appears that the situation at CCRE is indeed better than other property developers-- at least they got their financial statements out! Sunac and Evergrande remains in suspension by HKEX...The central china coys positions remains a bet on Mr Wu Po Sum...

-Token purchase of IGG (I Got Games). After a huge profit warning at the start of this year, the stock looks something like this: 

The stock gapped down from 6.2 HKD to 5.09 in a single day. The sell down was relentless and continues after result release. If you had bought at 5.09, you would still be looking at a loss of 33% today!

Presently, the price per share is 3.37 HKD a share. The problems (I am always attracted to problems) overhanging as follows:

a) Results paled when compared to the year before, particularly with the divestment of XD at huge profit last year; its current position in its 2 funds are not doing so well.

b) Increasing capex: marketing on existing games, construction of a HQ, as well as R&D on upcoming games

c) Losses from operating in "Russian-speaking" countries due to sanctions.

d) No interim dividend this year. I think this is prudent.

All of these problems, in my opinion, should be temporarily (with exception for the Ukraine invasion). If it continues, IGG could declare an impairment. That could be an opportunity.

Despite looking downtrodden, IGG still has a huge cash position of 1.9B, and the current market cap is 4B. 

Figures from Stock.cafe

This is a company has a decent track record. Current prices mirrored what it was priced at 2013, which in that year it was able to make 100+m in cash flows. If the cash-burn continues for 1 more year, my worst assumption is that it will take another billion dollars out of its coffer. Hence we could be paying for 4B market cap - 1B of cash= 3B in the future.

The stock would be priced on the high end of fair value (almost to overpriced region of 30x for me) under such pessimistic assumptions. The lifetime of its most popular game, Lords Mobile, is reaching the end. Its second breadwinner is achieving revenues nowhere near to Lords Mobile, and the most promising game, Project Yeager, will only be release much later this year. The stock is, imo, cheap, but not irrationally priced down.

Looking Forward

Performance this year should be dull at best, supplemented by an agreeable sum of dividends. Positions adopted this month have increase the number of holdings to 16, which is way more than I like. Top 5 positions contribute to 70.8% of the entire portfolio, and they are:

1. OKP (28.83%) - hopefully the outcome of the arbitration will be positive. There should be news this Sep.

2. Central China Management (11.68%)

3. Alibaba Group (11.27%)

4. Centurion (9.6%)

5. Carpenter Tan (9.44%)

I have (over)subscribed to the rights issue for Lendlease REIT and the results should be unveiled by 20-April (shares are credited on 21st). These positions are for my parents...

Till next month.