Daily Clueless Musings 5/13

CPI had another firm increase last month. Headline number rose 0.42% on the back of higher food and energy prices. The core CPI increased 0.19% and has risen at a 2.1% annual rate over the last three months, already above Fed's target range and trending higher. Ironically, the ongoing double dip in the housing market "helped" lowering the core CPI. Tenants' and owners'' equivalent rent increased a modest 0.07% last month and have generally decelerated since last Fall. The Five-year-ahead inflation expectations in the Michigan consumer confidence report also rose from 2..9% to 3%. Europe GDP report printed even stronger at 3.3%q/q saar, boosted by strong performances of the core countries. The strong number will cause ECB to raise rates faster. However Euro was sold off in the middle of the day, as market was concerned about bad headline news on Greek credit over the coming weekend. As risky assets are sold off again, Eurodollar back contracts rallied in a panic mode. Futures seem to habitually trade up in response to any panic sell in risky assets. On the other hand, as the volatility in risky assets increases, there is tremendous amount of cash parked in short duration security. As a result, volatility in the short duration is artificially low, which helped to attract more cash in a positive feedback loop. However the margin for error is extremely. Vols are very low and still remain above realized volatility. However the low volatility environment in the short duration securities could prove to be illusionary. Just as the ever appreciating housing prices in the previous cycle, the longer market remain artificially stable, the more complacent people will become. The more complacent people get, the more volatile the market is going to be ,when things turn.

Daily Clueless Musings 5/10

Futures finally had its first down day in a while. Import Price Index is 2.2% higher than last month and up 11.1% year on year, lead by higher imported food prices, which is up 20%, the biggest jump since 1977. It is not much of a surprise given the declining dollar in April. CPI and PPI later this week will give a better picture of inflation. The recent bust of commodity bubble will not show up in the April data, but it is going to ease the pressure on headline number. Lower energy and food prices are stimulative to consumer demand, which might create some upward pressure to core inflation. It seems likely that commodity prices will stabilize at a lower price level. China reported a widening trade surplus in April, due to lower than expected imports. The volume of all the imported major raw materials are down from last year, which is consistent with the recent slowdown of Chinese economy. Dollar looked still very weak. Even as Euro is dragged down by the sovereign credit problems, dollar index still cannot break the 75 level. Stocks decoupled from another risky assets and continue to rally on thin volume. Despite the reverse of the recent upward trend, vols remained very cheap. Paper are still putting on bullish option trades. They bought 0N 91-2 Call 1 by 2 and 0z 91-3 call 1 by 2, which kept the upside gamma very cheap, even as futures traded lower.

Daily Clueless Musings 5/09

Greece did not exit EU over the last weekend as some had speculated. Rating agencies took the opportunity and tried to jump in front of the curve. All the big three rating agencies warned multiple downgrades of Greek debt. It is pretty clear that the Greeks are not happy that everyone else (the Irish and the Portuguese) are getting a better deal in the bail outs. European officials are engaging in a fig leaf operation to extend maturities without inflicting net present value losses on its creditors. It is amazing how the stock market behaved so fearlessly today. Stocks were up and vix was lower. Fixed incomes are higher today. Weaker euro helped US dollar to firm up from oversold level, which helped US dollar based interest rates. The front end performed strongly on the uptick relatively the back end of the curve, as the flight to safety trade resumes. The long end of the curve seems to be losing its safe asset status, as market is more confident on Fed on hold than inflation and deficit risk.

Daily Clueless Musings 4/18

Today is pretty crazy. The well known secret in Europe is Greek debt is unsustainable and some form of default is inevitable. WSJ reported IMF Believes Greece Should Consider Debt Restructuring By 2012 this weekend. Greek officials continued to deny that restructuring was an option. It is like hiding fire in the pants. We all know whose pants will be on fire. Greek officials must wish they had the money printing press that US has. US Treasuries traded higher, after S&P change the outlook on US debt to negative, which implies 1/3 of probability of downgrading in 2 years. Rating agency has repeatedly lagged market in pricing credit risk. It seems to be the case again. Real yields has been on the rise since Obama extended Bush tax cuts. Market seems to perceive today's downgrading might push government to cut back on fiscal stimulus and take more austerity measures this year, instead of kicking the can down the road. Just like UK did their austerity measure last year, this is likely to slow down the current recovery. Fed might be forced to be more accommodative to compensate the cut back of fiscal stimulus. Or like UK, Fed is going to be squeezed by higher inflation and slow growth. And therefore dollar was strong today, as people unwind their carry trade position in risky assets. Yield curve is flatter in the front, as market is pricing a slower recovery without fiscal simulus.

Deep value investment: Hanny Holdings (275.hk)

Hanny Holdings (HK: 275) is one of the classic special situation investment opportunities, with potential return >300%. It trades around its cash value on the balance sheet and 20% of its book value. Its balance sheet is pretty solid, if not pristine. It has two significant real estate investments in mainland China, which are carried around or maybe under the market value. It runs two small non-core business (river sand mining and water supply) which generate some small positive cash flow. If you strip out the net cash position, at today’s price you are essentially getting two real estate assets in China for free.

The deep discount to the Net asset value rooted from Hanny’s history as part of holding companies control by Charles Chan, and further exaggerated by distorted supply/demand balance. Charles Chan used to be right hand man of Li Kan Shim, the richest man in Hongkong. Chan eventually made his fortune by buying and selling publicly traded companies. Those companies cross hold shares and bonds. The common stocks of these company already traded at heavy discount (~50%) to net asset value reflecting the lack of clarity of these inter-company holdings. Since last year, Allan Yap, Chairman of Hanny, decided to split Hanny off the Charles Chan network. ITC group, the majority shareholder controlled by Charles Chan, dividend out all the Hanny shares to its shareholders. Allan Yap subsequently bought out Charles Chan’s entire stake in Hanny’s, 250M shares at the price is around 30 cents. Allan Yap also then contributed another 61M in the current round of equity raising. In all, he paid around 125M for 21% of the company. Hanny also sold out its stake in ITC property, another company within Charles Chan’ empire, and redeemed the ITC property’s convertible bonds, which Hanny used to buy 50% interest in a real estate project in Guangzhou from ITC property. After these transactions, Hanny will no longer have direct connection with Charles Chan, except for the 50% JV in ITC property.

The stock price is further depressed by two subsequent events. As price of an illiquid asset in a less efficient market is set primary by supply/demand balance. Before the split off, ITC holdings held 240M shares and converted its Hanny convertible bonds to 463M shares. ITC then distributed 701M Hanny shares to its share holders as stock dividend (every 10 ITC shares receive 9.3 shares of Hanny holdings), which representing roughly 43% of the share outstanding and more than 50% of the float. Hanny’s share declined more than 50% from the time of announcement to the distribution of the Hanny shares. The shares continued to be under severe selling pressure, after distribution, as ITC shareholders paid essential nothing for Hanny share (ITC share traded roughly at the same price after the stock dividend as before the distribution.). As more than 50% float are held by people who passively got long the share at close to zero cost. The continuing declining in the price of Hanny create more selling pressure, as people are rushing to lock in their big paper profit into cash. Hanny decided to raise new equity to fund the new real estate development project in China. They executed a 1:10 reverse split and then issued 8 new shares for every existing shares at 0.30 a piece. At the time the stock (pre plit) was around 0.35, so shareholder have to pay 68 cents cash for every dollar of the Hanny shares they held. Also from a portfolio management stand point, no one likes to have an illiquid position to unwillingly increase 70%. This not surprisingly created another wave of selloff. The stocks were down 40% in couple weeks. The majority of the selling came from smaller retail investors, who often do not have the liquidity to fund the equity raising. In summary, the unique situation of undervaluation in Hanny’s common share is a result of uneconomic sellers, whose decision to sell bears little consideration of price/value relationship. I think once the supply/demand balance reaches new equilibrium , share price should gradually reflects the true economic value of the company.

At today’s price, the company trades at less than 500M. Hanny had 342M cash as of Sept.2010, it subsequently sold its investment property for 283M (an office room and 4 parking spot in the BoA tower in HK carried at 242M on its book) and its marketable securities (shares of ITC property) for 78M and it received 300M for new share issuance. I estimate it should have around 876M in cash. On the liability side, It has 133M bank borrowing (48M of which is due within a year) and 678M convertible bonds. 342M of the convert was held by ITC holdings, which redeemed all the converts into new shares. Hanny will issue 300M new convert to retire the remaining maturing bonds. Hanny has more than 500M net cash after the equity raising, higher than its market cap. So you are getting all the other hard assets on Hanny’s book for free.

The major assets on Hanny’s book are real estate projects in GuangZhou’s Yuexiu district. The real estate market in Guangzhou is much less bubblish than other ist tier cities like Shanghai or Beijing. The two projects are in Yuexue district in Guangzhou, which is one of the top commercial locations in the city. The per sq meter price is less than ½ of the prices in similar locations in other top tier cities. In 2009 and 2010, Hanny acquired a retail/luxury condo project from BestSmooth in two sequential transaction. The lot is in the Yuexiu distriction of Guangzhou (between ZhongShanWu road Jixiang road). The size of the lot is 7974 sq meter and is zoned for commercial and residential use (thus it is not subject to the new housing regulation in China). It paid 604M for 60% interest in the project and then paid 460M for the remaining 40% in 2010. Best Smooth acquired the land 10 years and subsequently ran out of cash during the development. The foundation of the building was built, but the project was on hold for nearly 10 years. Hanny obtained building permit last year (number# 〔2010〕2298). It will build a 9 story shopping mall and 26 story luxury condo with a 5 story underground structure connected to subway station. The total area is 123.7K squre meter (93.7K above ground+29k under the ground.) Management expect to invest another 540M to complete the project. They will start the pre-sale in the 4th quarter. The secondary market around that area is between 10k-20k Yuan per sq meter for residential apartment and the retail space is 25-35k Yuan per sq meter. Hanny’s building should be in the higher end of this range, as its retail space is directly connected to subway station (more traffic) and residential units are targeting higher end customers. Hanny acquired 50% interest in real estate project in the same area (literally across the street to the first project and connected with each other through subway station.) Hanny acquired the interest from ITC property with the cash from redemption of 386M ITC property convertible bonds and 94M additional cash.The acquired asset is valued at 1248M on ITC property’s book at the date of acquisition.

There are some non-core assets on Hanny’s book (river sand mining and water supply). As a total, they generates some positive cash flow over the years, and Hanny has stated publicly that they are looking for opportunities to exit these business to focus on real estate development in mainland China. To be conservative to my valuation, I will just assign zero value to these assets.

This invest does not require a rising Chinese property market, since you are paying virtually nothing for the two real estate asset which worth more than 2.5B in the current market. There is very little leverage on the wholly owned project. Hanny has sufficient cash to fund the project. The balance sheet of the 50% JV with ITC property is less clear. I will just assume they paid a fair price for the stake. The downside of this investment is well protected, as the price is less than both net cash and liquidation value of the company, even assuming a real estate market crash in China.

As the Hanny re-establish itself as an independent real estate developer and the supply/demand of its common shares restore its equilibrium, I expect Hanny to be trading at a similar discount (~50%) to net asset value like other small cap real estate developers traded in Hongkong, which should imply 1.2 HKD per share valuation or 300% higher than the current price. Furthermore as Hanny start to pre-sale in the 4th quarter of this year, they will have chance to market to asset to the market value and start to generate cash flows.