China

In this briefing:

1. Last Week in GER IPO Research: Leong Hup, China Tobacco, Futu and Weimob
2. 2018 HK-Connect SouthBound In a Nutshell
3. Apple (AAPL): Reduces Prices in Mainland China – Right Action, But Not Enough
4. China Kepei Edu (科培教育) IPO – Regulation Poses Significant Near-Term Risks
5. Ten Years On – Asia’s Time Is Coming, Don’t Miss The Boat

1. Last Week in GER IPO Research: Leong Hup, China Tobacco, Futu and Weimob

We slide into 2019 with GER’s recap of our latest IPO research. This week, we talk chicken as Arun initiates on the IPO Malaysian poultry producer Leong Hup International (LEHUP MK). Secondly, Venkat initiates on China Tobacco International (GHALPZ CH) with a cautious view. In addition, Arun initiates on online broker Futu Holdings Ltd (FHL US)  and we remind of Arun’s valuation piece on Weimob.com (2013 HK) . 

Quote of the week 

Are you insane?

-Sky news presenter to UK MP Boris Johnson ahead of the Brexit parliament vote planned for today

Best of luck for the week and new year- Rickin, Venkat and Arun

2. 2018 HK-Connect SouthBound In a Nutshell

Since autumn of 2014, the HK-Shanghai Connect, and later the HK-Shenzhen Connect mechanisms have provided means for mainland investors to buy Hong Kong-listed stocks. 

We have been tracking the H/A relationships and the Southbound flows per name on a weekly basis and occasionally writing commentary about it since late 2016. 

This report provides a brief synopsis of the SOUTHBOUND flows into Hong Kong-listed stocks over the course of 2018, by sector, by average percentage change in mainland ownership of HK shares outstanding subject to the Connect mechanisms, and the top and bottom five names per sector per quarter.

3. Apple (AAPL): Reduces Prices in Mainland China – Right Action, But Not Enough

• Tim Cook passed the buck to the weak sales in China. However, we believe China’s retailing is running well based on our visits to shopping malls with Apple stores.
• Luxury goods sold better in China than all other major markets in the world in 2018.
• We believe that the price reduction in Mainland China is just taking market share from Apple Stores in Hong Kong, but not from competitors.
• We also believe that the app review process is the fatal shortcoming for AAPL.

4. China Kepei Edu (科培教育) IPO – Regulation Poses Significant Near-Term Risks

China Kepei Education (1890 HK) is looking to raise up to US$122m in its upcoming IPO. 

Overall, the company has continued to show that its undergraduate program is the driver behind its growth. It grew its 8M 2018 revenue and gross profit both by about 24% YoY. However, there are significant near-term risks if the MOJ Draft for Comments gets implemented. It may result in Kepei registering its schools as for-profit private schools which would shrink its net profit margin.

In this insight, we will provide updates on the company’s 8M 2018 financials and operating performance, the potential impact of policy change and compare its valuation to other listed education peers. We will also run the deal through our framework.

5. Ten Years On – Asia’s Time Is Coming, Don’t Miss The Boat

We noted in   Ten Years On – Asia Outperforms Advanced Economies Asia’s economies and companies have outperformed advanced country peers in the ten years to 2017.  Growing by 6.8%, real, through the crisis the region is 188% larger in US dollar terms while US dollar per capita incomes 170% higher compared with 2007. In this note we argue even though Asian stock markets have underperformed since 2010 and the bulk of global capital flows have gone to advanced countries, Asia’s time is coming. Valuations are cheap. Growth fundamentals strong. There are few external or internal imbalances. Macroeconomic management has been better than in advanced economies and the scope to ease policy to ward off headwinds in 2019 is greater. China has already started.

In this briefing:

1. China Housing: Are Prices Rising Faster Or Slower?
2. Early Investors Say “Xiaomi The Money” Post LockUp Expiry
3. Yaskawa Electric: We Are Probably Now Close to the Bottom for This LT Structural Growth Story
4. CRRC: Earnings Booming With Raised New Rail Line Delivery Target
5. Starbucks (SBUX): Could Starbucks’ Beans Start to Lose Their Magic?

1. China Housing: Are Prices Rising Faster Or Slower?

Today’s data from the National Bureau of Statistics (NBS) on new home prices for 70 major cities shows on average an accelerating year-on-year price growth and a slower month-on-month increase. This contrasts with a picture of a slowing price growth based on a different index from SouFun-CREIS.

2. Early Investors Say “Xiaomi The Money” Post LockUp Expiry

Xiaomi Corp (1810 HK) is likely to break HK$10 this morning again after a placement equal to about 1% of shares outstanding was proposed to buyers last night at a sharp discount to the close. This insight attempts to nail down the shape and size of the ongoing overhang.

After the HK Stock Exchange announced in late April 2018 that it would permit companies with Weighted Voting Rights (WVRs) to list on the HKEx, after sticking to the one-share one-vote principle for years (losing the Alibaba Group Holding (BABA US) listing to NASDAQ in the process), Xiaomi Corp (1810 HK) quickly raised its hand with the prospect of a US$10bn IPO and a US$100bn market cap – heady numbers even for a fast-growing company. This was quickly followed by the launch of the China Depositary Receipt program which saw a quick establishment and even quicker acceptance of a Xiaomi application, potentially setting up a situation where demand was pulled from HK to China. 

Then investors got cold feet, and what was a $100bn valuation dropped to $90bn then $70bn.  The CSRC also pushed back on the possible CDR issuance to such an extent that Xiaomi withdrew its application, and then pricing delivered a valuation of approximately US$50bn at a sharply reduced IPO price of HK$17/share. 

Day1 saw a 6% fall on the open and the shares closed down 1%. After the Day 1 close, fast-track inclusion into the Hang Seng indices was a pleasant and somewhat unexpected surprise for IPO buyers and responded by rising almost 12% on Day 2 on sharply higher volume. MSCI did not follow suit (it had not been expected) but several days later on inclusion day, the stock was 25% higher than the IPO price. 10 days later the over-allotment option had been fully-exercised.

Xiaomi last year grew its ecosystem and its hardware base, but saw lower market share in China (13%) than in 2017 (14%) according to several sources, including Counterpoint Research quoted in the media. The company, which has targeted 50% of revenue from overseas is now just shy of that mark at 44% after ramping up sales in India, Europe, and MENA. 

Global weakness in handsets on mobile tech led by Apple did not spare Xiaomi, but MOST notable was the sharp drop in the share price in December from HK$14.30-50 area to just below HK$13 at year end. The first day of the new year saw the shares fall 5.5%, and the next day the price fell another 3.6%. The shares fell a little more in the next few days but somewhat stabilised until the morning of the 8th. 

Then the volume picked up. The lockup had expired.  

In five days, the shares have traded 880mm shares, and that is before a large placement proposed after the close on 15th January. 

“Xiaomi The Money” was the title of David Blennerhassett‘s initial pre-IPO insight ( Xiaomi The Money!), followed when details came out by Xiaomi the Ecosystem!

3. Yaskawa Electric: We Are Probably Now Close to the Bottom for This LT Structural Growth Story

Following Yaskawa’s second downward revision at 3Q earnings, we are shifting towards a more positive stance on the stock, even from a long-term perspective. We had been negative on the stock from late 2017 and as the stock tumbled we maintained that it was still too early buy for the long-term, though by mid-late 2018 we did (incorrectly) feel that there was the potential for a short term rally due to the severity of underperformance.

With the stock selling off harshly in the recent market fall but rebounding following its weak earnings we feel that much of the bad news is now priced in and expectations have corrected to the point where this is once again interesting on the long side.

4. CRRC: Earnings Booming With Raised New Rail Line Delivery Target

Based on CRC’s (China Railway Corporation) 2019 plan on rail investment, CRRC’s earnings from rail business might be better than estimated. With a 45% increase on new rail delivery mileage, and significantly increase on HSR train (Multiple Units) repair demand, we estimate CRCC’s EPS increase by another 20% yoy to RMB0.53 in 2019E, following a 17% yoy increase in 2018E.

Also, a better earnings outlook might trigger a mild valuation re-rating. The stock trades at 12.8x P/E 2019E (our estimates), attractive vs. its 15.5x historical P/E average since the merger in 2015.

5. Starbucks (SBUX): Could Starbucks’ Beans Start to Lose Their Magic?

Three key emerging risks to the Starbucks’ growth story: 1) New entrant poses a threat to China growth story; 2) New CEO is missing the magic of the beans; and 3) New Uber partnership could erode Starbucks’ brand equity.

In our January 8 research note, we cautioned that Starbucks had outperformed the NASDAQ by 37% since we turned positive on August 8 but we were concerned about two new developments that we viewed as red flags: shelving of Reserve coffee bar expansion and aggressive China expansion plans of Luckin Coffee. While we do not believe this represents a short opportunity, we do believe it foreshadows emerging risks to Starbucks’ long-term growth story.

In this briefing:

1. Weekly Oil Views: Crude Back in a Bull Market but Cheer Momentum Wanes
2. HK Connect Discovery Weekly: China Tower, Tencent, New China Life (2019-01-11)
3. 2019 M&A/IPO Preview: Chinese Express Sector Quickly Building Out ‘Last-Mile’ & Int’l Capabilities
4. Trade Talks/Commercial Spying/Cars ‘N Consumers/Easier Credit/Yuan Rise
5. AAC Tech (2018): Damage Is Done While Business Remain Intact – BUY

1. Weekly Oil Views: Crude Back in a Bull Market but Cheer Momentum Wanes

A nine-day winning streak until Thursday, January 10, had put Brent and WTI back in the bull market (gains of >20% from their 52-week lows). It was capped by a highly volatile trading day and a lower close of the benchmark crude futures on Friday, pointing to a return of uncertainty and indecisiveness in the market.

US-China trade talks over January 7-8, which were extended to January 9, set last week off to a flying start. There were no deals for sure, but the two sides appeared to have narrowed their differences. That was enough to send the stock markets climbing, with crude prices in tow.

Follow-up negotiations at a higher level are expected in the US later this month, though no dates have been announced yet. For now, it seems the financial markets, probably in gloom fatigue and perhaps oversold, needed any excuse to recover and a baby step towards the resolution of the US-China trade dispute was as good as any.

Of course, one can’t ignore the US Fed’s dovish turn, which also provided a major boost to sentiment. US Federal Reserve Chairman Jerome Powell said on Thursday that the central bank would be “patient” over future rate hikes. It was music to investors’ ears.

OPEC heavyweight Saudi Arabia repeated its promise to slash exports, with the energy minister providing specific figures for the benefit of the media and the market, and fundamentals had done their bit to help crude’s rally.

However, macroeconomic data and business outlook from companies across the world continues to be weak and disappointing. And crude remains firmly in the grip of the economic sentiment, maintaining a very strong correlation with the equity markets since last October.

2. HK Connect Discovery Weekly: China Tower, Tencent, New China Life (2019-01-11)

In our Discover HK Connect series, we aim to help our investors understand the flow of southbound trades via the Hong Kong Connect, as analyzed by our proprietary data engine. We will discuss the stocks that experienced the most inflow and outflow by mainland investors in the past seven days.

We split the stocks eligible for the Hong Kong Connect trade into three groups: those with a market capitalization of above USD 5 billion, those with a market capitalization between USD 1 billion and USD 5 billion, and those with a market capitalization between USD 500 million and USD 1 billion.

We see the Financials sector led the outflow by mainland investors last week with 201 million USD of net selling. We also highlight a few companies this week: China Tower (788 HK), Tencent Holdings (700 HK), New China Life Insurance (1336 HK), and Ping An Good Doctor (1833 HK).

3. 2019 M&A/IPO Preview: Chinese Express Sector Quickly Building Out ‘Last-Mile’ & Int’l Capabilities

A year ago we published a note that described how we expected corporate activity in China’s domestic express  sector to play out in 2018 (see 2018 M&A/IPO Activity Preview: Chinese Express, Logistics Sectors Hit by Slower Growth & BABA Vs JD). In this new piece, we look back at how things actually played out in the sector last year and look forward to 2019 and beyond. 

We’ve divided this year’s piece into four sections:

1. A quick review of our expectations from 2018, and how things actually played out
2. New (and ongoing) trends we expect to see in express sector M&A this year
3. The continued battle for leadership between Alibaba Group Holding (BABA US) and JD.com Inc (ADR) (JD US)
4. Potential IPO candidates for 2019 and beyond

We expect Chinese domestic express demand to continue to moderate in 2019, and in response we expect the express companies to increase their investments in ‘last-mile’ and international delivery, which will probably create a drag on profitability in the medium-term. Although we believe e-commerce giants Alibaba and JD.com would like their growing portfolios of logistics investments to become self-funding sooner rather than later, we foresee somewhat limited investor appetite for more large Chinese logistics IPOs in 2019, since many high-profile offerings have faltered since going public.

4. Trade Talks/Commercial Spying/Cars ‘N Consumers/Easier Credit/Yuan Rise

China News That Matters

• Progress, yet trade war still morphing into tech war
• Economic espionage: US targets Chinese spying
• Tesla dreams big in China despite consumption fears
• Bank funding beckons for SMEs
• Yuan leaps as hopes fade for US rate hikes

5. AAC Tech (2018): Damage Is Done While Business Remain Intact – BUY

The recent trade talk meeting between the US and Chinese government went into an extended unplanned third day which could be seen as a positive development – a sign that both sides are serious on getting a deal done. President Trump’s  recent tweet citing “”Talks with China are going very well!” has been responded positively in Asian equities market. Is it all just that or are there more in the company?

In this briefing:

1. Much Ado About Credit
2. Xiaomi Placement – The Selling Continues
3. China Autos: A Few Thoughts on 2018 Industry Demand and Initial Expectations for 2019
4. Chengdu Expressway (成都高速) Post-IPO – Low Liquidity and Tiny Adjusted Free Float
5. Weimob IPO Trading Update – Existing Shareholders to the Rescue

1. Much Ado About Credit

• Global financing conditions could tighten further
• Credit demand is deteriorating; credit risks are rising; Eurodollar costs are edging higher
• A de-escalation in trade tensions and a Fed pause could ease the pain
• Will Fed recently turning more dovish (possible shift to slower QT & Fed rate cut in 2019?) + concomitant USD drift provide sufficient respite to put a floor under risk assets?

2. Xiaomi Placement – The Selling Continues

An undisclosed institutional shareholder of Xiaomi Corp (1810 HK) is looking to sell 231m shares of the company for approximately US$273m. 

There will likely to be more selling pressure in the near term. The 594m shares sold down by Apoletto and the anonymous shareholder who sold at a 14% discount does not inspire confidence. Furthermore, there will be even more overhang to come from the twelve-month lock-up expiry. The deal also scores poorly on our framework owing to its expensive valuation and the lack of information on the seller. 

3. China Autos: A Few Thoughts on 2018 Industry Demand and Initial Expectations for 2019

China’s 2018 auto demand came to 27.8m units according to CAAM’s published statistics, bringing the YoY decline to 3.9%.  The results were consistent with our expectations since 1H18, that:

1. In the absence of government stimuli in 2H18, FY18 demand is likely to see a decline, not low single digit growth as consensus was anticipating at the time (see March China Auto Demand: 28.9M SAAR – 2H Could Face Some Headwinds , April China Auto Demand: Implied NEV SAAR Reaches Above 1.0m Units for the Second Time).
2. We also argued that NEV demand growth based on YTD selling rate strength would not be able to compensate for the weakness we were seeing in the ICE segments (see May China Auto Demand: Weak SAAR Leaves Lingering Headwinds for 2H ). 

We estimate that the acquisition tax reduction for 1.6L and smaller engine displacement vehicles in 2016 and 2017 front-loaded about 2.0-2.2m units to PC demand in those two years, similar to the impact of tax reduction effect seen in 2009-10.  This is a segment that saw 1.1m units in volume reduction in 2018 which should be seen as a natural result of the end of the tax subsidies.  In fact we believe that these after-effects of front-loaded demand were most likely more influential on China’s 2018 demand downturn than any headline narratives about negative impacts of trade wars.

Our initial expectations for 2019 are:

1. The 1.6L and smaller engine displacement segment should see stable to slightly lower annual demand, but there is nothing currently in the statistics that suggests that higher segments should also see declines.  This should at least partly be a natural pattern of second and third time car buyers trading up.
2. As we have pointed out in May China Auto Demand: Weak SAAR Leaves Lingering Headwinds for 2H , CV SAAR was unusually strong in 1H18 so this could be an obvious segment of weakness going into 2019, especially if 4Q average CV SAAR of 3.7m units (vs. 4.2m unit FY18 demand) is any indicator of what to expect going forward.

While we expect some residual effects of the 1.6L and lower segment tax subsidy ending in 2017 to remain in effect in 2019 we do not expect its impact to be as large as it was in 2018.  Our low single digit decline scenario considers a lower CV SAAR in YoY terms which appears likely as we head into 2019.  

4. Chengdu Expressway (成都高速) Post-IPO – Low Liquidity and Tiny Adjusted Free Float

Chengdu Expressway Company Limited (1785 HK) raised US$112m at the fixed price of HK$2.20 per share. We have previously looked at the IPO in Chengdu Expressway (成都高速) IPO Review – Well-Managed but Unexciting.

In this insight, we will update on the deal dynamics, implied valuation, and include a valuation sensitivity table.

5. Weimob IPO Trading Update – Existing Shareholders to the Rescue

Weimob.com (2013 HK) IPO was priced at the low-end at HKD2.80/share. The retail tranche was 0.79x covered while the institutional tranche was slightly over-subscribed.

I’ve covered most aspects of the deal in my earlier insights: 

• Weimob Pre-IPO – Can Be Steamrolled by Tencent, Anytime
• Weimob IPO Quick Take – Less SaaS, More Ads -> Lower Valuation

In this insight, I’ll provide an update on the deal dynamics, valuations and provide a table with the implied valuations at different share price levels.

In this briefing:

1. Extraordinary Fiscal and Monetary Policies Have Disrupted the Global Economy
2. China Tower: More Details on Non Telco Growth Suggest Further Upside to Share Price
3. New Oriental (EDU): Educator License Not A Concern
4. Would a Sale of Founder’s Holdco NXC Corp Trigger a Tender Offer for Nexon (3659 JP)?
5. USD Peaking with the Economic and Political Cycle

1. Extraordinary Fiscal and Monetary Policies Have Disrupted the Global Economy

In their public presentations, central banks seem to be contemplating the use of neutral interest rates (r*) in addition to unemployment/inflation theories. R* has the advantage of appearing to be subject to mathematical precision, yet it’s unobservable, and so unfalsifiable. Thus, it permits central banks to present any policy conclusion they want without fear of verifiable contradiction. R* is the policy rate that would equate the future supply of and demand for loans. It rises and falls as an economy strengthens and weakens. Long-term observation during the non-inflationary gold standard, period indicated that r* in an average economy was 2% plus, which would become 4% plus with today’s 2% inflation target. The Fed may soon end this tightening cycle with the fed funds rate at or near 2¾%, which would be r* if the rate of lending and borrowing in America remained stable thereafter. Rising (falling) lending would indicate a higher (lower) r*. 

2. China Tower: More Details on Non Telco Growth Suggest Further Upside to Share Price

After initially being very skeptical of the China Tower (788 HK) IPO given it is essentially a price take to its three largest shareholders, we changed our view in early December to a more positive outlook. What changed our view has been series of calls and meetings with the company that suggested a more shareholder friendly approach than expected and a real opportunity to reduce capex substantially through the use of “social resources” (e.g. electricity grid, local government sites). These can be used to deliver co-locations without building towers and poles and imply much lower capital intensity at a time when revenue growth will be accelerating as 5G is rolled out.  Management has also given more detail on non-Tower business prospects which can generate higher returns (not under the Master Services Agreement). While small now (2% of revenue) they are growing rapidly. With lower capex than initially guided and a more shareholder friendly management (i.e. higher dividends are possible) we reduce the SOE discount and raise our forecasts (again). We remain at BUY with a new target price of HK$2.20

3. New Oriental (EDU): Educator License Not A Concern

• The Education Ministry of China promulgated Burden Relief Measures for Students in Primary and Secondary Schools (中小学生减负措施).
• The market is concerned about “Article 15” on the educator license.
• We note that a large number of teachers in part-time schools took the educator exam in November 2018.
• We expect that the incremental passers of the educator exam will be many more than the number of EDU’s vacancies, and that most of the passers will prefer to work for giants such as EDU or TAL (TAL) as opposed to other part-time schools.

4. Would a Sale of Founder’s Holdco NXC Corp Trigger a Tender Offer for Nexon (3659 JP)?

It was reported on January 3rd that Korean founder and heretofore effective controller of Nexon Co Ltd (3659 JP) Mr. Kim Jung-Ju and family, who exercise their ownership of Nexon through near 100% (98.64% according to Douglas Kim) control of NXC Corp (Korea) and NXC’s control of NXMH B.V.B.A (Belgium), planned to sell their stakes in NXC for up to 10 trillion won (US$8.9 billion).

Those two companies – NXC Corp (Korea) and NXMH (Belgium) – own 253.6mm shares and 167.2mm shares respectively, or direct and indirect ownership by NXC of just under a 48% stake in Nexon (3659 JP). Yoo Junghyun (Kim Jung-Ju’s wife) directly holds another 5.12mm shares at last look. 

The speculation is that it might be sold to Tencent Holdings (700 HK) or another global buyer because it might be too big a mouthful to swallow for NCsoft Corp (036570 KS) and Netmarble Games (251270 KS), each of which have a market cap in the area of 10 trillion won themselves. 

Nexon was founded in Korea in 1994 and moved its headquarters from Seoul to Tokyo in 2005, listing itself on the TSE in December 2011. The company is a well-known gamemaker (over 80 PC and online/mobile games), with famous games such as MapleStory, Dungeon & Fighter, and Counter Strike.

Douglas Kim has started the discussion of this situation in Korea M&A Spotlight: Nexon’s Founder Plans to Sell; Will Tencent Buy Nexon? and Korea M&A Spotlight: Will the Nexon Group Sell the Korean or the Japanese Company?. 

The Korea Economic Daily said in its report on the 3rd of January that Deutsche Bank and Morgan Stanley had been selected as advisors to run a sale process, and a formal non-binding offer to potential bidders was expected next month. A Korea Herald article suggested that “potential buyers, according to industry speculation, include China’s Tencent, Korea’s Netmarble Games, China’s NetEase and Electronic Arts of the US.”

The Big Question

In the second piece, Douglas Kim questions whether Kim Jung-Ju would sell NXC (and NXMH) as reported by the local press, or whether NXC and NXMH would sell their stakes in Japan-listed Nexon, the implication being that if they sold the stake in Nexon, it would mean buyers would get a large stake in a single company, whereas there is a bunch of other stuff floating around in NXC and its subsidiaries. 

The other question is whether Tencent or another buyer buying NXC would trigger a mandatory Tender Offer for the shares in Nexon in Japan. The letter of the law in the TOB Rules changed a bit over 10 years ago would indicate not, but there are questions (and precedents) here.

Discussion ensues.

5. USD Peaking with the Economic and Political Cycle

Out-performance in the US economy, as was seen in 2018, seems much less likely in the year ahead.  Lower oil prices and slowing high tech sectors will dampen activity and assets in the US more than many other developed and EM countries.  The boost to equities and growth from US tax policy has passed its peak.  US politics is set to become increasingly partisan over the next two years of the Trump administration.  US trade policy has softened in the wake on the sharp fall in US equities in Q4.  Several EM countries have resolved their deep political distractions, and their economies have improved since mid-year.  We can see the USD reversing more of its gains in the last year as the global economic outlook stabilises and the Fed enters an extended pause in rates policy.

In this briefing:

1. Screening the Silk Road: Q1-2019 Small-Mid Cap GARP (Zulu Warrior Screening)
2. ECM Weekly (12 January 2019) – Futu, China East Education, China Kepei Education, Viva Biotech
3. Chinese Telcos: 5G Launches in 2019. Buy the 5G Beneficiary (China Tower).
4. Are Chip Oligopolies Real?
5. Global Banks: Some New Year Pointers

1. Screening the Silk Road: Q1-2019 Small-Mid Cap GARP (Zulu Warrior Screening)

• Value made a comeback, but growth remains core: In May 2018, we examined the divide between value and growth stocks, ( Notes from the Silk Road: Small-Mid Cap Screening for Zulu Warriors). As Q3 unfolded, this eventuated with a +7.5% reversal in favour of value stocks, only to see growth resume dominance in October and November.
• The optimal value/growth style dynamic: We feel exposure to growth at a reasonable price (GARP) coupled with a healthy FCF yield (via our amended Zulu Screen) should provide some healthy medium to long term returns for investors.
• The Screen’s Risk: The Zulu Screen relies on analyst estimates. When market sentiment is weak and forecasts are not amended in a timely manner, the screen is susceptible to mis-selection.
• Q2 2018 screening list succumbed to volatile markets: This was seen in our May screen with our list posting on average a 30% decline in share price, relative to the broader Asia-Pacific Ex-Japan declining 13.6% and the Asia Pacific index by 11.8%.
• Are there reasons for the underperformance? 10 of the 19 stocks in the May screen were from Hong Kong, which saw the Hang Seng Index (HIS) decline 16% over the same period. The decrease seems due to concern over trade wars and doubts about the China economy. Our key approach to stock selection is to take a medium-to-long-term view as well as focus on quality ranked stocks relative to their peers. This is highlighted via the average stock rank of the group declining only 15.8% from 89.6 to 75.5 points.
• Our Q1 2019 screen selected only 9 stocks. Of the 9 stocks identified, the average PEG Ratio was 0.4x, the price to FCF yield was 11% and ROCE was 25%. Stocks were selected from Australia, New Zealand, India, Korea, Japan, Hong Kong, Taiwan and Singapore. Cowell Fashion Company from Korea was the only remaining stock from our May screening.

2. ECM Weekly (12 January 2019) – Futu, China East Education, China Kepei Education, Viva Biotech

Aequitas Research puts out a weekly update on the deals that have been covered by Smartkarma Insight Providers recently, along with updates for upcoming IPOs.

Accuracy Rate:

Our overall accuracy rate is 72% for IPOs and 64% for Placements 

(Performance measurement criteria is explained at the end of the note)

New IPO filings

• China Tobacco International (Hong Kong, US$100m)
• China East Education (Hong Kong, US$400m)
• Ebang International (Hong Kong, re-filed)
• MicuRx Pharma (Hong Kong, re-filed)

Below is a snippet of our IPO tool showing upcoming events for the next week. The IPO tool is designed to provide readers with timely information on all IPO related events (Book open/closing, listing, initiation, lock-up expiry, etc) for all the deals that we have worked on. You can access the tool here or through the tools menu.

News on Upcoming IPOs

• Urban Commons plans IPO of up to US$500m at Q1-end
• Viva Biotech plans IPO in the second quarter
• CStone Pharma plans US$400m IPO in Feb
• Global Switch plans about US$1bn HK IPO
• China’s Wanda files for US IPO of sports unit to raise up to US$500m

Smartkarma Community’s this week Analysis on Upcoming IPO

• Futu Holdings IPO Preview: Running Out of Steam
• Futu Holdings Pre-IPO – Great Metrics but in a Commoditised Industry
• China Tobacco International (IPO): The Monopolist Will Not Recover
• China Tobacco International IPO: Heavy Regulation, Declining Margins – A Bit Late to IPO Party
• IPO Radar: AutoCorp, Honda’s Avatar in Thailand 

List of pre-IPO Coverage on Smartkarma

3. Chinese Telcos: 5G Launches in 2019. Buy the 5G Beneficiary (China Tower).

We highlighted in a recent note Chris Hoare‘s positive outlook for China Tower (788 HK). Our view takes into account the 5G build-out commencing this year, improved capex efficiency from using “social resources”, the rapid growth in non-tower businesses that lie outside the Master Services Agreement (MSA), and the valuation benefit from what looks like surprisingly investor friendly management. 

This note focuses on four key issues facing the Chinese telcos in 2019:

• 5G capex (March) (this is by far the most important),
• Regulatory newsflow (February/ March),
• Operating trend improvements (August), and
• Emerging business opportunities driving future growth (August).

We remain positive on the telcos which trade at low multiples. China Unicom (762 HK) continues to trade at a discount, yet is most exposed to the positive story emerging at China Tower. We switch our top pick among the telcos from China Mobile (941 HK) back to China Unicom as a result. Alastair Jones thinks China Telecom’s (728 HK) premium multiple is at risk if management execution on the cost base doesn’t improve. It is our least preferred telco at this stage. Overall, we expect China Tower to outperform all telcos and it is our top pick.  The upgrade to China Tower flows through the telcos (valuation and costs) and our new target prices are as follows: China Unicom to HK$14.4, China Telecom to HK$5.4 and China Mobile to HK$96. 

4. Are Chip Oligopolies Real?

In the semiconductor industry, particularly in the DRAM sector, there has been significant consolidation leading some to hypothesize that there’s now an oligopoly that will cause prices to normalize and thus end the business’ notorious revenue cycles.  Here we will take a critical look at this argument to explain its fallacy.

5. Global Banks: Some New Year Pointers

Here is a look at how regions fare regarding key indicators.

• PH Score = value-quality (10 variables)
• FV=Franchise Valuation
• RSI
• TRR= Dividend-adjusted PEG factor
• ROE
• EY=Earnings Yield

We have created a model that incorporates these components into a system that covers>1500 banks.

In this briefing:

1. China Consumables in a Sluggish Economy
2. Asia Gaming Preview 2019: Part Two Picks: Galaxy, MGM China and Nagacorp
3. China Tobacco International IPO: Heavy Regulation, Declining Margins – A Bit Late to IPO Party
4. China Tobacco International (IPO): The Monopolist Will Not Recover
5. RRR Rate Cut in China

1. China Consumables in a Sluggish Economy

The PBOC’s desire to loosen up China’s economy is relying on consumers to keep spending. However, as seen in the data below, consumers just are not spending. From cars, to cameras and retail, consumers are increasingly avoiding big ticket items, as China’s consumers look for breathing space.

2. Asia Gaming Preview 2019: Part Two Picks: Galaxy, MGM China and Nagacorp

• Global and Asia headwinds still rattle the gaming sector, but these three companies remain undervalued despite market sentiment.
• Macau’s solid year end performance continues to defy projections, producing a 14% y/y GGR increase.
• Galaxy will benefit disproportionately from the HKMB bridge traffic growth, MGM’s single digit market share will ramp up to double digits and Nagacorp may be the single most siloed gaming operator in all of Asia.

3. China Tobacco International IPO: Heavy Regulation, Declining Margins – A Bit Late to IPO Party

China Tobacco International (GHALPZ CH) is a subsidiary and offshore unit of China National Tobacco Corp., a state-owned enterprise (SOE). The company procures tobacco leaves from regions around the world and exports tobacco leaf products and branded cigarettes to the duty-free outlets outside China’s customs area and in Southeast Asia.

The IPO is expected to raise US$100M and the company expects to use the proceeds to expand market share, acquire new cigarette brands, working capital, and other corporate purposes.                      

4. China Tobacco International (IPO): The Monopolist Will Not Recover

• China Tobacco International (HK) Co. Ltd. plans to go public on the Hong Kong Stock Exchange.
• The state-owned company holds monopolistic positions in tobacco leaf export, tobacco leaf import, and cigarette export.
• Both revenue growth and margins declined year-over-year in the first three quarters of 2018.
• We believe the China cigarette market will not recover, as all signals suggest weak demand.

5. RRR Rate Cut in China

The big news in Chinese finance was the PBOC announcing Friday that it was cutting the RRR rate. Rather than what you can read in the press, we want to focus on a variety of factors which may not be as widely recognized.

In this briefing:

1. FX Reserves in China
2. Healius (HLS AU): Bid Rejection Provides Option Value
3. Ten Years On – Asia Outperforms Advanced Economies
4. Futu Holdings IPO Preview: Running Out of Steam
5. Asian Credit Monitor: 2019 Portfolio Strategy, US Rate Trajectory, China Reform Pause

1. FX Reserves in China

FX reserves are up by about 10 billion dollars, which against a back drop of the size of FX and the Chinese economy is basically no change. They have been oddly flat over the past two years. Yet, the noise is really just that, the FX increase is so small that we believe it is a non-starter.

2. Healius (HLS AU): Bid Rejection Provides Option Value

Healius (HLS AU), formerly known as Primary Health Care (PRY AU), is a leading Australian owner of GP clinics and pathology centres. Healius just took four days to reject Jangho Group Co Ltd A (601886 CH)’s 3 January 2018 proposal of A$3.25 cash per share as it “is opportunistic and fundamentally undervalues Healius.”

3. Ten Years On – Asia Outperforms Advanced Economies

You might be surprised to learn that in the ten years to 2017 Asia has outperformed advanced economies. Despite extraordinary monetary and fiscal stimulus and the damaging dollar-demand deflationary policies of the ECB, BoJ and BoE, the region is 188% larger in US dollar terms compared with 2007 while US dollar GDP per capita income is 170% higher. The parallel numbers for the advanced countries – the US, euro-area and Japan combined- are 19% and 13%. Asian stock markets have underperformed since 2010 but we believe that investors are still to fully acknowledge Asia’s strong growth fundamentals. Combined with cheap valuations there is significant upside for Asian equity markets.

4. Futu Holdings IPO Preview: Running Out of Steam

Futu Holdings Ltd (FHL US) is the fourth largest online broker in Hong Kong. Futu has filed for a Nasdaq IPO to raise $300 million, down from an earlier indication of a $500 million raise according to press reports. Futu is backed by Tencent Holdings (700 HK) (38.2% shareholder), Matrix Partners (6.1%) and Sequoia Capital (4.0%).

5. Asian Credit Monitor: 2019 Portfolio Strategy, US Rate Trajectory, China Reform Pause

If we had to make a base observation for Asia credit markets over 2018, it was certainly caught “wrong-footed” like most of its other risky asset counterparts. The combination of a more hawkish Fed in 2018, global quantitative tightening, late-cycle economic conditions, volatility and a strong USD have all served to impact almost all the asset classes negatively. According to some asset allocators, the only asset class which returned positive in 2018 was cash, every other traditional asset class saw losses.

USD direction will further dictate the impact on overall Asian risk, in our view, with many undervalued Asian currencies following their sharp declines in 2018. One of our scenarios includes a range-bound USD in 1H19, followed by a possible reversal in 2H19 on any dovish Fed policy/US economic weakness. In this case, it has the potential to attract incremental portfolio inflows back into Asian risk. We expect a slightly tighter bias in monetary policy in most Asia ex-Japan nations which is supportive for their respective currencies.

In 2019, risk-reward dynamics have improved particularly for Asian investment grade (“IG”) where we see more limited MTM pressure. We expect a more defensive market at least in 1H19 which supports our heavier IG bias. We suspect larger investors would continue to reallocate depending on the outcomes of the China-US trade dispute and their view on US risk (arguably near its last late-cycle expansion legs). We continue to be extremely selective in Asian high yield (“HY”) which have been impacted by idiosyncratic situations including credit deterioration and rising defaults. Exogenous factors such as the potential for “fallen angel” risk (i.e. a migration from issuers on the cusp of IG, “BBB-”  into HY) as well as net portfolio outflows from HY, EM and leveraged loan funds are ongoing concerns. Despite cheaper valuations in Asian HY, we still see skewed risk-reward (with larger potential risks).

In the US, our base case expects the Fed to hike 1-2 times (quarter point each) for 2019, premised on still below-trend inflation and external factors. We think it is near the tail-end of its current tightening cycle, but we would continue to monitor the US supply-side (labour markets, employment gaps, prices) for further clues. A sustained upshot to the previous factors may have the potential to prolong the Fed’s tightening cycle.

On China’s side, we have seen a critical reversal in policy towards selective expansion/accommodation again as economic reforms instituted 3 years ago have been reprioritized. China’s difficult task to balance growth targets and restructure its economy is a perennial issue. We would also expect defaults to remain elevated domestically/internationally as a new paradigm of credit investing takes root in China.

Finally, we would like to wish our readers luck in investing and trading in the year ahead.

In this briefing:

1. Futu Holdings Pre-IPO – Great Metrics but in a Commoditised Industry
2. This Week in Blockchain & Cryptos: A Bitcoin Reversal; More Red Flags for Bitmain
3. HK Connect Discovery Weekly: CR Beer, Great Wall Motors, and Kingsoft (2019-01-07)
4. Tencent Music: Short Idea on Consumption Slowdown Angle
5. Geely: Worst Case Priced In, Waiting for Sector Headwinds to Abate

1. Futu Holdings Pre-IPO – Great Metrics but in a Commoditised Industry

Futu Holdings Ltd (FHL US) plans to raise around US$300m in its US IPO. The company is backed by Tencent Holdings (700 HK) , Matrix Partners and Sequoia, who together own over 45% of the company.

The founding team comes mostly from Tencent, which might explain Tencent’s large stake in the company. Growth for the company has been stupendous despite the jittery markets, with margin financing adding to the top-line growth. 

While its low costs will help it to steal clients from the more traditional brokers, other new low-cost brokers seem to be offering similar services at comparable rates. In addition, the company is not licensed or regulated by any entities in China, despite the majority of its client base being Chinese nationals. Furthermore, the company plans to expand into newer overseas market where it doesn’t seem to have much of a cost advantage.

2. This Week in Blockchain & Cryptos: A Bitcoin Reversal; More Red Flags for Bitmain

The year 2018 was not the brightest for cryptocurrencies; Bitcoin (XBTUSD CURNCY) fell around 70% during 2018 and top altcoins like Ethereum (ETH BGN CURNCY), Ripple and Bitcoin Cash were also down around 80%, 85% and 95% respectively during last year. While it is difficult to pinpoint a single reason for this, a number of factors including, rising security concerns, increased scrutiny, failed institutional support and Bitcoin Cash hash wars have collectively contributed to this bearish sentiment in the cryptocurrency markets last year.

In this note we take a look at several top cryptocurrency and blockchain developments from last year, to see how they would fare going into 2019.

This is a collaborative report between Douglas Kim and myself.

3. HK Connect Discovery Weekly: CR Beer, Great Wall Motors, and Kingsoft (2019-01-07)

In our Discover HK Connect series, we aim to help our investors understand the flow of southbound trades via the Hong Kong Connect, as analyzed by our proprietary data engine. We will discuss the stocks that experienced the most inflow and outflow by mainlanders in the past seven days.

We split the stocks eligible for the Hong Kong Connect trade into three groups: those with a market capitalization of above USD 5 billion, those with a market capitalization between USD 1 billion and USD 5 billion, and those with a market capitalization between USD 500 million and USD 1 billion.

In the past week, there were only three and a half days trading on the Hong Kong Stock Exchange last week. Hence the flow numbers were not as significant as a typical 5 trading day week. Having said that, we find it interesting that the Chinese were buying China Resources Beer Holdin (291 HK), Great Wall Motor Company (H) (2333 HK). In addition, Yichang Hec Changjiang Pharm (1558 HK) is a rare health care stock that experienced inflow last week despite overall poor sector performance last week. 

4. Tencent Music: Short Idea on Consumption Slowdown Angle

• Tencent Music Entertainment (TME US)‘s social entertainment services (discretionary consumption in nature) face more headwinds due to ongoing China (macro) consumption slowdown.
• Moreover, high consensus earnings expectation would make material earnings downgrade a major narrative for TME throughout 2019, in our opinion.
• We initiative coverage on TME with Short/Sell recommendation, with 12-mo PT of US$9.80/ADR (representing a 25% downside potential).

5. Geely: Worst Case Priced In, Waiting for Sector Headwinds to Abate

Geely announced its Dec 2018 car sales volume at 93,333 units (down 39% yoy) and its FY2018 sales volume at 1.5mn units, 6% lower than our estimate of 1.59mn units.

Meanwhile management sets its FY2019 sales target at 1.51mn units, which surprised the market as the market consensus stood at around 1.8mn units. The stock price corrected by 11.3% on Jan 8th, right after the announcement.

In our view, it is reasonable for the management to give a cautious guidance for 2019E. After all, 2019E China’s auto sales volume might drop by 8% yoy.( China Auto Outlook 2019 – Keep Warm, Winter Is Here! )

However, would Geely’s aggressive new model launches sales offset the weak demand on existing models in 2019E? If not how bad it could be? In this report, we have done a scenario analysis. Our analysis shows that the possibility that Geely missing its 2019E guidance is low. Even assuming our worst case scenario, the stock would be at 7.1x P/E and no medium term downside from current levels. 

In this briefing:

1. Growing Pains & PBoC Cut/US-China Clash/Railways & Airports & Bonds/More Babies Please/Moon Landing

1. Growing Pains & PBoC Cut/US-China Clash/Railways & Airports & Bonds/More Babies Please/Moon Landing

China News That Matters

• PBoC responds to disappointing start to another year of slowing growth
• Talks planned but US-China “clash of civilisations” deepens
• Ever faster trains, new airports from Beijing to Antarctica – and more debt
• Two-child policy fails to avert demographic crisis
• Beijing nails first ever landing on moon’s far side