Honworld Group Shares Pledged by Chairman and Largest Shareholder
Closing Price (11/20/2015): HKD5.33
1 Year Avg. Daily Vol. (USD mn): 0.97
Estimated Annualized Return: 18.0%
In a November 20, 2015 announcement, Honworld Group announced on November 16, 2015, its chairman and largest shareholder “charged” 100.3 million shares representing just over 36% of his shareholding in Honworld and just under 20% of the total shares outstanding to a financial institution as security for its subscription of a note issued by Key Shine Global Holdings Limited. Key Shine is the chairman’s investment vehicle and the entity that hold his 278,169,750 shares in Honworld.
While the company used the word “charged”, this represents nothing more than a pledge of shares for a loan. Honworld stated it did not fall under Hong Kong Listing Rule 13.17, which would have required greater discloser. In the announcement, the company made no disclosure about the size of the debt or the reason for the debt.
This is a major corporate governance red flag. The company has not returned any communications regarding this or our continued requests for discussion about the company misallocation of capital to inventory. The company could have been more transparent with this transaction by disclosing the amount and the reasoning for pledging shares.
The pledging of shares by an owner is something that we look at during the research process into any new investment and if shares are pledged, particularly of this magnitude, we tend not to invest in the company. Pledging of shares greatly increase the risk of forced selling, which we would prefer not to be on the selling side, potential change of control, and potential conflict of interest between minority shareholders and the largest shareholder.
Every day the market provides a price for every listed company. The question we constantly ask is will we buy this company today? It takes into account a number of things such as current portfolio position, business quality, management strength, and valuations. Given this new event of shares being pledged, would we invest in this company? The answer is no. The company seems to have a very strong competitive position but this event, the poor allocation of capital to inventory leading to poor free cash flow generation, and the lack of communication greatly decreases our confidence in management. While the company has a strong competitive position and meets our requirement for expected return, there is no reason to risk capital if there are questions about management quality or corporate governance.
Given the company’s lack of communications, increased corporate governance risk, its misallocation of capital to inventory, and the lack of cash flow in the business, we are decreasing our stake in the company to 5% of our model portfolio. The shares are illiquid so it may take some time to get to 5% but once there more likely than not we will be selling all our shares.