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."
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