China

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

In this briefing:

1. Weekly Oil Views: Crude Remains at the Mercy of Fickle Financial Markets
2. Healius And The (Likely) First Salvo
3. Big Banks – A Crisis of Investor Confidence
4. Chinese Market Sentiment at a Crossroad
5. TRACKING TRAFFIC/Chinese Tourism: Visits to Macau & HK Surge

1. Weekly Oil Views: Crude Remains at the Mercy of Fickle Financial Markets

It has been anything but a happy start to 2019 for the stock markets, which remained under pressure as trading resumed in the new year. A clutch of weak manufacturing data for December – from China to the eurozone and the US – soured the mood for investors through last week. 

That was followed by a rare revenue warning from Apple Inc (AAPL US) , citing slowing sales in China, which drew fresh attention to the vulnerability of American companies from the bitter trade war between the world’s two largest economies. The only assets that seemed to be in favour were the safe havens such as Gold (GOLD COMDTY) and the Japanese yen. 

Beijing provided the first major lift to market sentiment on Friday, by lowering the reserve requirement ratio for Chinese banks, in a bid to inject more cash into the system. US Fed Chairman Jerome Powell signalling a “patient” approach to monetary policy in a panel discussion in Atlanta later in the day and a strong US jobs report for December completed the trinity of factors that closed the week with a rally in stock markets as well as crude. 

Brent and WTI closed nearly 2% higher on the day, just above $57 and just under $48 respectively. Sentiment in the oil market was boosted by initial surveys showing a surprisingly large drop in OPEC production in December.

OPEC/non-OPEC cuts of 1.2 million b/d took effect on January 1 and should yield results in the coming weeks, but we expect crude to remain largely beholden to the twists and turns in the global economy. Just as in the broader financial markets, so in the oil markets, all eyes will now turn to the high-level trade negotiations between the US and China, due to be held in Beijing over January 7-8.  

2. Healius And The (Likely) First Salvo

Healius (HLS AU) (until last month known as Primary Health Care Limited), a leading owner of general practice clinics and pathology centres in Australia, announced an unsolicited and conditional proposal (including DD) from Jangho Group Co Ltd A (601886 CH) at A$3.25/share (~10x FY19 EV/EBITDA) in a A$2.0bn deal.  Jangho currently holds a 15.9% stake in Healius and has been on the shareholder register for two years.

The Offer price translates to a 33.2% premium to the undisturbed price but below the 12-month high of A$4.09 in March 2018. Optically and when referenced to closest peer Sonic Healthcare (SHL AU), the offer price appears light.

Reflecting the long laundry list of conditions attached to this indicative offer, such as securing debt financing and various regulatory approvals in China and Australia, notably data security, this indicative deal is trading wide at a gross/annualized spread of 25%/47%, assuming a deal completion date in early August.

This proposal does, however, indicate Healius was probably oversold.

This morning, Healius’ board rejected the proposal as it was considered opportunistic and fundamentally undervalued the company.

3. Big Banks – A Crisis of Investor Confidence

We analyse the holdings of the world’s largest banks by the 255 global equity funds in our analysis. For each region (America/EMEA/Asia), we have selected the 6 largest banks by total assets, as defined by the S&P Global Market Intelligence Report, 2018.

We find that overall, holdings in these banks are on the decline, and in some cases, investor flight has been acute.  Only 2 of the 18 banks are held overweight by global investors, with Citigroup Inc (C US) and Bnp Paribas (BNP FP) seeing the biggest exodus through 2018.

4. Chinese Market Sentiment at a Crossroad

Chinese equities face a crossroad to start the year as the market mulls a more serious phase in the structural decline in China’s economy balanced against renewed efforts to stimulate growth in 2019.  The US-China trade dispute and broader US policy shift to contain China’s economic ambitions in high tech industries have contributed to fears of a Chinese led global economic downturn.  But these concerns may ease as China and the US progress through trade negotiations restarted amidst a truce on tariff policy through 1-March.  The AUD and copper prices have been highly correlated with Chinese equities over the last year, highlighting the broader market implications of trade talks this week and renewed Chinese efforts to restore economic confidence.

5. TRACKING TRAFFIC/Chinese Tourism: Visits to Macau & HK Surge

A year ago we began publishing Tracking Traffic/Chinese Tourism as the hub for all of our research on China’s tourism sector. This monthly report features analysis of Chinese tourism data, notes from our conversations with industry participants, and links to recent company news and thematic pieces. Our aim is to highlight important trends in China’s tourism sector (and changes to those trends).

In this issue readers can find:

Although we remain positive on the long-term growth of Chinese tourism, it’s clear that near-term demand has weakened substantially. We continue to take a negative view of travel intermediaries like Ctrip, which face intensifying competition from many sources. We are more positive on the prospects of actual owners of Chinese travel and tourism assets, like hotel chain Huazhu Group (HTHT US) and Air China Ltd (H) (753 HK). 

In this briefing:

1. China Autos: A Few Thoughts on 2018 Industry Demand and Initial Expectations for 2019
2. Chengdu Expressway (成都高速) Post-IPO – Low Liquidity and Tiny Adjusted Free Float
3. Weimob IPO Trading Update – Existing Shareholders to the Rescue
4. Last Week in GER IPO Research: Leong Hup, China Tobacco, Futu and Weimob
5. 2018 HK-Connect SouthBound In a Nutshell

1. 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.  

2. 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.

3. 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.

4. 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

5. 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.

In this briefing:

1. Apple (AAPL): Reduces Prices in Mainland China – Right Action, But Not Enough
2. China Kepei Edu (科培教育) IPO – Regulation Poses Significant Near-Term Risks
3. Ten Years On – Asia’s Time Is Coming, Don’t Miss The Boat
4. Weekly Oil Views: Crude Back in a Bull Market but Cheer Momentum Wanes
5. HK Connect Discovery Weekly: China Tower, Tencent, New China Life (2019-01-11)

1. 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.

2. 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.

3. 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.

4. 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.

5. 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).

In this briefing:

1. Big Banks – A Crisis of Investor Confidence
2. Chinese Market Sentiment at a Crossroad
3. TRACKING TRAFFIC/Chinese Tourism: Visits to Macau & HK Surge
4. Growing Pains & PBoC Cut/US-China Clash/Railways & Airports & Bonds/More Babies Please/Moon Landing

1. Big Banks – A Crisis of Investor Confidence

We analyse the holdings of the world’s largest banks by the 255 global equity funds in our analysis. For each region (America/EMEA/Asia), we have selected the 6 largest banks by total assets, as defined by the S&P Global Market Intelligence Report, 2018.

We find that overall, holdings in these banks are on the decline, and in some cases, investor flight has been acute.  Only 2 of the 18 banks are held overweight by global investors, with Citigroup Inc (C US) and Bnp Paribas (BNP FP) seeing the biggest exodus through 2018.

2. Chinese Market Sentiment at a Crossroad

Chinese equities face a crossroad to start the year as the market mulls a more serious phase in the structural decline in China’s economy balanced against renewed efforts to stimulate growth in 2019.  The US-China trade dispute and broader US policy shift to contain China’s economic ambitions in high tech industries have contributed to fears of a Chinese led global economic downturn.  But these concerns may ease as China and the US progress through trade negotiations restarted amidst a truce on tariff policy through 1-March.  The AUD and copper prices have been highly correlated with Chinese equities over the last year, highlighting the broader market implications of trade talks this week and renewed Chinese efforts to restore economic confidence.

3. TRACKING TRAFFIC/Chinese Tourism: Visits to Macau & HK Surge

A year ago we began publishing Tracking Traffic/Chinese Tourism as the hub for all of our research on China’s tourism sector. This monthly report features analysis of Chinese tourism data, notes from our conversations with industry participants, and links to recent company news and thematic pieces. Our aim is to highlight important trends in China’s tourism sector (and changes to those trends).

In this issue readers can find:

Although we remain positive on the long-term growth of Chinese tourism, it’s clear that near-term demand has weakened substantially. We continue to take a negative view of travel intermediaries like Ctrip, which face intensifying competition from many sources. We are more positive on the prospects of actual owners of Chinese travel and tourism assets, like hotel chain Huazhu Group (HTHT US) and Air China Ltd (H) (753 HK). 

4. 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

In this briefing:

1. 2019 M&A/IPO Preview: Chinese Express Sector Quickly Building Out ‘Last-Mile’ & Int’l Capabilities
2. Trade Talks/Commercial Spying/Cars ‘N Consumers/Easier Credit/Yuan Rise
3. AAC Tech (2018): Damage Is Done While Business Remain Intact – BUY
4. Screening the Silk Road: Q1-2019 Small-Mid Cap GARP (Zulu Warrior Screening)
5. ECM Weekly (12 January 2019) – Futu, China East Education, China Kepei Education, Viva Biotech

1. 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.

2. 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

3. 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?

4. 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.

5. 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

In this briefing:

1. Gold: Trade Agreement Could Change the Bullish Narrative

1. Gold: Trade Agreement Could Change the Bullish Narrative

INVESTMENT VIEW:
The same macro factors which knocked more than a third off Apple Inc (AAPL US)‘s share price have lifted Gold (GOLD COMDTY) prices by nearly 10% since Sept-18.  However, we believe the market narrative could swiftly reverse if the US and China reach a trade agreement in the coming weeks.  We would look to press our short on Gold…and even go long Apple. 

In this briefing:

1. Uranium – About to Enter Its Own Nuclear Winter
2. China East Education (中国东方教育) Pre-IPO – The Company Known for Its Culinary School
3. Korea M&A Spotlight: Will the Nexon Group Sell the Korean or the Japanese Company?
4. Asian Frontier Monitor: One Belt New Road – Here Comes America
5. Futu Holdings Pre-IPO – Great Metrics but in a Commoditised Industry

1. Uranium – About to Enter Its Own Nuclear Winter

• Quantifying nuclear statistics with substantial discrepancies
• LT contracts & speculative hoarding driving recent 40% spot price increase
• Primary/secondary Uranium supplies currently 112% of 2017 demand
• Uranium supply deficits extremely unlikely before 2022
• Global Uranium demand to fall 25-40% by 2050
•  Primary Uranium sector LT SELL

We have independently audited global nuclear construction statistics in order to determine future Uranium demand.  Although near-term statistics match those in the public domain, long-term demand determined via construction pipeline illustrates substantial discrepancies.  Compiling planned plant construction, operational extensions, nameplate upgrades, versus decommissioning announcements/events, and in many cases, public policy inertia; has led us to believe that despite historical primary supply shortages, global nuclear demand peaked in 2006.

Since plateauing and despite strong Chinese growth, nuclear power generation has fallen <2% over the past two decades, a decline that is predicted to accelerate as a number of developed and developing nations pursue other energy options.

The macro-trend not replacing existing nuclear infrastructure means (dependent on assumptions), according to our calculations, global uranium demand will decrease between 20 to 40% by 2050.

As opposed to signifying a fundamental change in underlying demand, we believe that recent Uranium price increases are the result of producers closing primary operations, and substituting production with purchases on the spot market to meet long-term contract obligations.  In addition, hedge funds are buying physical uranium in order to realise profits on potential future commodity price increases.  Critically, we determine that primary and secondary supplies are more than sufficient to meet forecast demand over the next four to five years; before taking into account substantial existing global uranium stocks, some of which are able to re-enter the spot market at short notice.

2. China East Education (中国东方教育) Pre-IPO – The Company Known for Its Culinary School

China Xinhua Education (2779 HK) listed in Q1 of 2018 and we wrote in our insight that the founder had vocational schools that have been separated from China Xinhua that seemed to be his prized asset. Fast forward to December 2018, the prized asset has finally filed its draft prospectus under the entity China East Education (CEE HK) and it is looking to raise US$400m in its IPO.

In this insight, we will analyze the company’s financial and operating performance, compare it to listed education companies, and provide some questions we have for management.

3. Korea M&A Spotlight: Will the Nexon Group Sell the Korean or the Japanese Company?

According to a local media outlet called Chosun Daily, it stated that one of the bankers in the deal (Deutsche Bank), already sent teaser letters of this deal to Tencent Holdings (700 HK) and KKR and in the teaser letter, it mentioned about potentially selling nearly 47% of Nexon Co Ltd (3659 JP) (Japan).

The question about whether or not Kim Jung-Joo decides to sell NXC Corp (Korea) or Nexon Co Ltd (3659 JP) (Japan) has important consequences not just for him and his family but also to the minority shareholders of Nexon Co Ltd (3659 JP). If Kim Jung-Joo decides to sell NXC Corp (Korea), there may not be much upside for the minority shareholders of Nexon Co Ltd (3659 JP) since current regulations do not require the buyers to pay potentially additional control premium to the minority shareholders as well. 

However, if Kim Jung-Joo decides to sell Nexon Co Ltd (3659 JP) (Japan), there may be an opportunity for the minority shareholders to gain from an additional control premium. We think that this is one of the reasons why Nexon Co Ltd (3659 JP) shares are up 13% YTD as some of the investors may think that there could be a higher probability that Kim Jung-Joo ends up selling Nexon Co Ltd (3659 JP) (Japan), instead of NXC Corp (Korea). 

4. Asian Frontier Monitor: One Belt New Road – Here Comes America

In our third report in the Belt and Road Initiative (BRI) or One Belt One Road (OBOR) series, we examine a brand-new US strategic initiative to finance emerging markets economies, including OBOR, African, and Latin American countries.

The on-going trade war between China and the US makes the issue very political. Rightfully so, we believe the creation of the International Development Finance Corporation (“IDFC”) could be politically-motivated, but IDFC is no competition to the BRI as the latter deploys much greater funding (about USD40bn a year).

However, we see the merits of IDFC and the positive effects on Emerging Asia. After all, more competition for influence and more fund flow will help fund projects, and, perhaps, help reduce poverty (if good governance is observed). We also expect IDFC’s USD60bn fund to create more investable projects for institutional investors and lower funding cost for countries that need large infrastructure funding and countries that have been suspicious of the BRI such as India, Indonesia, the Philippines, Vietnam, and Sri Lanka.

5. 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.

In this briefing:

1. ECM Weekly (12 January 2019) – Futu, China East Education, China Kepei Education, Viva Biotech
2. Chinese Telcos: 5G Launches in 2019. Buy the 5G Beneficiary (China Tower).
3. Are Chip Oligopolies Real?
4. Global Banks: Some New Year Pointers
5. Extraordinary Fiscal and Monetary Policies Have Disrupted the Global Economy

1. 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

2. 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. 

3. 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.

4. 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.

5. 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*. 

In this briefing:

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

1. 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

2. 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.

3. 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.

4. 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.

5. A Golden Future?

The ability to have stable prices has great value.

According to Edward Gibbon, the decaying Roman Empire exhibited five hallmarks: 1) concern with displaying affluence instead of building wealth; 2) obsession with sex; 3) freakish and sensationalistic art; 4) widening disparity between the rich and the poor; and 5) increased demand to live off the state. Most DMs and many EMs display similar symptoms today because fiscal and monetary policies, the foundation of both ancient and modern societies, are identical: increasing welfare outlays by artificially inflating the money supply. The Roman Empire took more than four centuries to destroy what the Republic had built in the previous five centuries because clipping and debasing coins inflated currency supplies slowly. Entering debits and credits in the books of commercial and central banks is much more efficient.