Category Archives: Corporate Action

Miko International and Honworld Position Size July 30, 2016

Miko International and Honworld Position Size July 30, 2016

 

Miko International released its unqualified 2015 year end results after four months of delay. During the delay, the Hong Kong Stock Exchange halted trading on the company’s shares.  The company’s previous auditor KPMG resigned due to incomplete information provided by Miko International. KPMG’s statement from the resignation letter follows.

 

‘‘In respect of our audit of the Company’s financial statements for the year ended 31 December 2015, there are a number of unresolved issues relating to receipt of satisfactory evidence and information, which remain outstanding. We have been communicating since early February 2016 with management on outstanding matters. The outstanding matters have been communicated to the Company’s management, Board of Directors, and the Audit Committee, details of which are set out below.

 

As at the date of this letter, we await satisfactory information in respect of the following matters:

 

  1. We await receipt of the draft 2015 consolidated financial statements from management.
  2. We await access to original bank statements in respect of one of the group’s bank accounts to be provided directly to us by the bank, which had a year end balance of RMB400 million, together with supporting documents in respect of security given over some of the group’s bank accounts.
  3. In respect of the group’s distribution channels, information is awaited relating to how the acquisition price was determined in respect of the distribution channels acquired during 2015 at a cost of RMB107 million, the signed valuation report and supporting documents in relation thereto, as well as supporting agreements and information relating to amendments made during the year to certain other distribution arrangements.
  4. In respect of the prepayment of RMB13 million as at 31 December 2015 for the group’s enterprise resource management system supporting information is awaited relating to the determination of the purchase price.
  5. In respect of the acquisition of a property in Shanghai during 2015, information is awaited in respect of the determination of the acquisition price, signed year-end valuation report, explanations relating to the difference between the year-end valuation and the acquisition price, and other documents in respect of the acquisition.
  6. Site visit and interview with an OEM Supplier.’’

 

Miko International hired HLB Hodgson Impey Cheng Limited (HLB) to audit its financial statements. HLB seems to be an auditor of last resort for fraudulent companies.

 

HLB also stepped in and gave China Solar Energy’s financial statements a clean audit opinion when the previous auditor Deloitte resigned in February 2012. China Solar is now considered to be a fraud and the shares have not traded since 2013.

 

HLB again stepped in when Deloitte resign in July 2015 as auditor of Sound Global. Sound Global received a clean audit from HLB. The company later found RMB2 billion missing from its books.

 

Other concerning evidence includes the resignation of the CFO and three independent directors within a few month time span including an independent director that resigned a month after joining.

 

There is significant evidence that Miko International is a fraud and we will be selling all our shares at the resumption of trading.

 

What can be learned from the poor investment in Miko International? We have decreased our position sizes on all investments to reflect the limits to our knowledge.  Additionally, we are any peripheral evidence will receive more attention. We also must admit when an investment is bad a take a loss.  Our gut told us there was a problem but we ignored it due to inconsistency avoidance and loss aversion.

 

Chinese companies must also be given a discount and smaller position due to the prevalence of fraud within the country. Given this we are decreasing our position size in Honworld to 5.0% as there is significant evidence of a passion owner operator with competitive advantages and credible financial statements (recent investment by a private equity firm), but there is the China discount that needs to be used in the form of a less aggressive position size. We will only be selling Honworld shares above HKD4.75 per share.

 

 

Company 9/8/15 Position Size April 13, 2016

Company 9/8/15 Position Size April 13, 2016

We have completed the sale of just over USD3.3 million of Company 9/8/15.  Its current position size of 4.7% better reflects the deep value nature of the position as the risk associated with the position.

Reperio Capital H1 2015 Review

Reperio Capital H1 2015 Review

 

Reviews on a quarterly basis are too focused on the short term, therefore, going forward; reviews will be made on semi-annual basis.

 

H1 2015 Performance

 

As illustrated above, the second quarter of 2015 saw our model portfolio decline by 0.9% leading to overall first half of 2015 performance of 2.7%. Since inception (5/23/2014), the model portfolio is up 15.6%.

 

 

Holdings

H1 2015 Positions

 

PC Jeweller was the largest position at the end of the first quarter of 2015 and the first half 2015. It remains an extremely strong performer up 76.8% in the first half of 2015 and 199.7% in US dollar terms since recommendation. In the second quarter, we sold 25% of our PC Jeweller position with a goal of selling half our position size and reaching roughly a 5% portfolio position. The company continues to execute very strongly and there is a clear path for growth with new store openings and continued efficiencies, but the level of undervaluation is not as outrageous. We plan to maintain at least a 5% position given the company’s strong operational execution, growth outlook, and reasonable valuations.

 

Peak Sport Products is the second largest position at 7.0% at the end of June 2015. We built a 9.8% position only to see the share price decline due to a share issuance announcement and a general decline in all China related stocks. We will maintain our holding without any increase or decrease. The company has a 5-10% per year growth outlook with a strong ROIC and is trading below its liquidation value but the recent share issuance announcement with the amount of cash on the balance sheet is baffling and dents management’s reputation.

 

Zensar Technologies is the third largest holding at 5.1% at the end of June 2015. The company continues to perform well improving margins after a few weak years following a large acquisition.  In addition, digital as a share of revenues continues to grow. The company expects to grow it top line at a double digit pace with improving margins.  Despite this growth, the company trades on an EV/EBIT of 8.2 times.

 

Honworld Group is a position we are building. The company is the leading cooking wine producer in a market growing at 20% per year. The company has strong management who are leveraging their size advantage to outspend peers on marketing, distribution, and R&D. The company has a high quality product that garners a price premium due to a unique naturally brewed production process. Honworld has traded lower since our initial recommendation as Chinese related stocks are being affected by the fall in Chinese stock markets. The company trades on an EV/EBIT of 9.2 times. Given the growth in the market, the company’s profitability (ROIC = 16%, suppressed due to growth expenditures), and the potential for a sustainable competitive advantage, if the company’s valuation remains below 10 times EV/EBIT, we will continue to build up to a 10% position.

 

Miko International  is our latest recommendation. It is a brand company in the fast growing children’s apparel market. The company’s top line grew by 20% in 2014 and the company is very profitable with an ROIC of 33%. The company’s profitability will probably wane as competitive pressures increase as the market slows but the current valuation is too attractive. The company is trading on an EV/EBIT of 1.21 times and trading at its liquidation value. We will continue to build a 10% position.

 

 

Peak Sport Share Issuance Announcement June 2015

Peak Sport Share Issuance June 2015

 

Event

 

On June 23, 2015, after trading hours, Peak Sport Products announced it would issue 280 million new shares at HKD2.48 per share representing a 15.4% discount to the June 23, 2015 closing price of HK$2.93 and a discount of approximately 8.1% to the average closing price of HK$2.70 over the last ten trading days prior to the announcement. The shareholding pre- and post-issue is listed below.

 

Shareholder Structure Before and After Share Issuance

 

It is expected that there will be no fewer than six new shareholders who are independent professional, institutional and/or individual investors. It is not expected that any new shareholders will become a substantial shareholder of the company immediately after the issuance. All new shareholders are independent and not associated with company shareholders.

 

Peak Sport Products will use the proceeds from the share issuance for funding sponsorship and promotional activities, funding daily operations, and repayment of bank loans.

 

Since the announcement, Peak’s share price has fallen by 27.3% with a 19.1% fall on June 24, 2015 alone.  Given the fall, why did we wait to pen our thoughts.   By waiting, we try to give ourselves time to collect our thoughts and let the emotion of the moment dissipate so the best decision can be made.

 

 

Thoughts

 

This is a negative event for a number of reasons listed below.

 

  • Issuing new shares dilute existing shareholders
  • Raising cash despite a significant cash balance
  • Issuing shares when the company is undervalued
  • This is the first significant capital allocation by the company

 

Peak issued new shares diluting existing shareholders by 13.28%. For shareholders, what matters is the value of a company on a per share basis. If a company generates $100 million and has 100 million shares outstanding, its EPS is $1. Assuming a ten multiple, it should be worth $10. If the company has only 1 million shares outstanding and has an EPS of $100, using the same multiple the company is worth $1,000. With the transaction, Peak devalued the company’s per share intrinsic value by 13.28%.

 

At the end of 2014, Peak has a net cash position of RMB2.70 billion, HKD3.37 billion, or HKD1.58 per share. The fact the company had such a large cash position makes the issuance of share very curious and raises the question does management have any intention of distributing cash to minority shareholders.

 

The proceeds will be used for promotional activities.  Promotional activities are fixed costs and the company is smaller than peers meaning it is competitive disadvantage and cannot spend as much as larger peers like ANTA. If the competitive environment is increasing the required spending on fixed costs, Peak’s profitability will weaken. The increased fixed costs and promotional spending could also mean the company is increasing its growth by increasing the promotional spend in existing markets or international markets.

 

The company issued shares at HKD2.48. Management is signaling shares are overvalued.  At HKD2.48, the market is valuing Peak just above its liquidation value and an EV/EBIT of 4.0 times, which seems undervalued for a company growing between 5-10% with a net cash position and a 2014 ROIC of 32%. The poor judgment of issuing shares is amplified given the undervaluation at the time of issuance. Either management does not understand valuation, it is getting bad advice and listening, or something more nefarious. All are not good for shareholders.

 

Issuing shares is a significant misstep for a management team.  Since the IPO in 2009, there has been no history of issuing shares other than a small amount of options or any other missteps. This misstep decreases the trust minority shareholders have with management.

 

 

Recommendation

 

The reason for raising cash at such a low valuation will eventually be understood. If the competitive pressures are increasing requiring higher fixed expenses, this is very concerning as normalized earnings will be lower than current levels. In addition, the decreased trust in management’s judgment significantly dents the investment thesis. A share price of HKD2.13, the June 26, 2015 closing price, values Peak at 104% of its liquidation value and on an EV/EBIT of 2.62 times. As mentioned above the company seems significantly undervalued given its net cash position, its profitability and growth outlook.  We will not be reducing our position given valuations provide significant support, nor will we be increasing our position size given new concerns over management quality.