Friday, February 08, 2008

Reality Bites

In one of our recent presentations to a group, a line was emblazoned across the slides: "Price is what you pay, value is what you get".

Turn back the clock about one year to the time when the mass media were all dishing out their top stock picks for 2007, MOS, in our true contrarian fashion, played the party popper by picking a stock which we felt investors should exercise caution with. In a post titled "Priced to Perfection" on 2 Jan 2007, we warned investors about the valuations of CapitaRetail China Trust (CrCT). When we posted our piece, CrCT was trading at S$2.10.

We were made to look like conservative old farts with pies on our faces when CrCT soared to over S$3.00 several months later. In fact, it hit a high of S$3.34 in 1 Oct 07. Hence, an investor who acted in contrary to us would have pocketed a cool 60% if he had entered on 2 Jan 07 and exited at the high. This is of course analyzed with the benefit of hindsight [With 20/20 hindsight, I would have (i) bought several units of The Sail during its launch, (ii) dated and married the sweetest girl in class and achieved just that little bit more in my life]. Unfortunately, not everyone is blessed with such perfect foresight. An investor who did not exit on the high in October will soon be caught in a rapid downward slide as "Mr Market" shunned the stock in the subsequent months. It's ironic that CrCT closed exactly at S$2.10, exactly one year later on 3 Jan 08. If you had fast forward another month out, you would note that CrCT closed at S$1.55 on 6 Feb 08.

We ferret out this past post not to pat ourselves on the back and make others look foolish. In fact, we believe that the heart of value investing philosophy requires one to be humble and be critical of ourselves. Rather, we like to pull out and go through our past "hits and misses" so as to improve ourselves.

In this festive period, the traffic cops on this island are all out in force reminding that mixing booze and driving kills. In our case, overpaying "kills" too, or at least will burn a fat hole in the pocket. For this example, the perfect market timer would have exited with a 60% gain. On the other hand, a less savvy individual who bought at around the high of S$3.00 would be staring at a 50% loss on the eve of the Lunar New Year 08. For the latter to recover this loss, paper or otherwise, CrCT would have to deliver a whopping 100% (not 50%) return in the months ahead. It's a tall order, if you ask us. So, after several long winded paragraphs, this illustration highlights why it is crucial to know what you are stumping out for; particularly in the case of CrCT at 2x NAV, which meant that for every dollar paid, 50 cents went into what we then sarcastically termed to be purchasing "Chinese air until the growth materialises".

This exercise also shows how difficult it is to "invert" the value investing framework to short overpriced securities. As an institutional investor, shorting attracts financing cost and requires the payment of dividends to the lender. The other issue clearly is timing, where in the case of CrCT, prices continued to rise for several months after January 07. Hence, a short position would have entailed expensive covering before reality set in.

P.S. I Love You: Thank you to all who took the time to drop us a short line or two welcoming us back into the fray after the rocketing valuations in 2H07 forced us into a hiatus. We are delighted to receive these encouragement and yes, if you where the sweetest girls in town hang out, do let us know too. ;)


Wednesday, February 06, 2008

A Lunar New Year Angpow

The Lunar New Year of the Rat is upon us. Whilst the Chinese associate a splash of the color red with an abundance of good fortune and luck, the recent spate of blood letting in the markets is something which we could do with less of.

In the coming year, we hope all investors have good health and wealth. We, here at MOS, thought it would be opportune to attempt to offer you a "red packet" by introducing a cash rich company which has the potential to offer shareholders a special dividend "angpow".

Lion Asiapac Limited (LAP) (Bloomberg: LAP SP, SIN:L08) is a holding company with diverse business lines. It has been listed on the SGX since 1981. It is now engaged in the manufacturing of electronics and automotive components and limestone processing. The bulk of its revenue comes from the electronics business, which as you would expect, isn't wildly profitable.

However, what distinguishes LAP from other companies is its strong balance sheet. The balance sheet is clean and has little liabilities. It presently has a net cash position of S$0.05 per share. In addition, LAP holds a 6.16% stake in Anhui Jianghuai Automobile (AJA). AJA is listed on the Shanghai Stock Exchange. In fact, the stake in AJA is worth more than the market capitalization of LAP! At this point, we believe value investing enthusiasts are starting to appreciate why we are getting excited.

In a move which may unlock its hidden value, the management of LAP has recently announced that they intend to dispose of their entire stake in AJA. AJA is trading in the market at about RMB8.21 today. But assuming the entire stake is disposed at the desired minimum price of RMB7.50 (about 30% below present market price), the net cash per share on LAP's books will swell to S$0.44 per share. This is S$0.17 above the current market price of LAP.

There are obviously risks in every investment. This trade is no exception. The first that comes to mind would be the inability to place out the AJA block given the poor market sentiment. Another would be that the cash is trapped in LAP and not returned to shareholders. To this end, it is noted that the circular explaining the disposal indicated that the proceeds would be used for working capital and deployed into money market instruments. Hence, LAP may not distribute the excess cash to shareholders in the form of an "angpow" or special dividend.

As with every new year, everyone has renewed hopes and aspirations. Should the disposal be successful, minority shareholders will all be hopeful that the management of LAP would offer some festive cheer by doling out a payback to supplement the historical 3.7% yield. Could this be the reason why LAP closed flat at S$0.265 when the STI plummeted over 100 points today?