Value Investing - Making it work in China and Asia by Mr. Cheah Cheng Hye

[yeokiwi]

Outstanding speech by Mr. Cheah Cheng Hye from Chairman and Co-Chief Investment Officer, Value Partners Ltd.

The speech was referred by Bluechipstamp san in Midas Holdings thread but I think it is more appropriate to reside in this category.

This is the transcript of the speech.

http://www.kraemerschwab.com/en/document.../view.html

[Qiaofeng]

Outstanding speech by Mr. Cheah Cheng Hye from Chairman and Co-Chief Investment Officer, Value Partners Ltd.

The speech was referred by Bluechipstamp san in Midas Holdings thread but I think it is more appropriate to reside in this category.

This is the transcript of the speech.

http://www.kraemerschwab.com/en/document.../view.html

He referred to Peace Mark in his speech.
I was also vested in Peace Mark thru the scrips given out by Sincere when they delisted; the takeover was a combi-offer of PM scrips and Cash.
Altho I made quite some money from the cash portion, I am left holding worthless Peace Mark scrip when they collapsed.
According to Cheah Cheng Hye, he is still looking for the scion of the majority owners of Peace Mark .
Mind you, he is not from China, but was a very successful and well known HK biz man.
So I am actually quite in agreement with CCH, if you are Warren Buffet, you probably need a handful of picks in your portfolio.

But those investing in Asia need to work harder and the portfolios need to be more diversified.
The culture and environment is just different; altho we are evolving and getting better.

[d.o.g.]

He referred to Peace Mark in his speech.
I was also vested in Peace Mark thru the scrips given out by Sincere when they delisted; the takeover was a combi-offer of PM scrips and Cash.
Altho I made quite some money from the cash portion, I am left holding worthless Peace Mark scrip when they collapsed.
According to Cheah Cheng Hye, he is still looking for the scion of the majority owners of Peace Mark .

I looked at Peace Mark a while back. Anyone doing an Excel spreadsheet on it would have realized something was very wrong given the persistently negative free cash flow and continuous share placements (154m shares in 2000, 993m in 2007).

Despite reported profits rising over 17x(!) in 7 years, from HKD 17m in 2000 to HKD 300m in 2007, book value per share was actually LOWER after 7 years, HKD 1.82 in 2007 versus HKD 2.91 in 2000. So despite the reported accounting profits, the management had actually destroyed shareholder value due to excessive share placements.

Other fishy signs: the continuous rise in gross margins (13% in 2000, 32% in 2007), and the continuous rise in ROE (4% in 2000, 17% in 2007).

IMHO the failure of Value Partners to avoid the Peace Mark debacle suggests a weakness in their "mass manufacturing" approach to investing. In my personal view, it is not realistic to hand a checklist to someone fresh out of school and expect them to become a competent investor immediately.

[yeokiwi]

IMHO the failure of Value Partners to avoid the Peace Mark debacle suggests a weakness in their "mass manufacturing" approach to investing. In my personal view, it is not realistic to hand a checklist to someone fresh out of school and expect them to become a competent investor immediately.

I suppose that is balanced by reducing each investment to not more than 1 to 2% of the portfolio or more than 80 to 110 companies in each portfolio. I think he recognizes that his "mass manufacturing" approach does introduce weakness in letting in a few rotten apples.

We
have 100 companies and we still have the
resources to come up with 100 top-notch ideas;
and that is what we are doing. Keep it diversified,
be able to withstand the unexpected bad guy who
smiles at you, shakes hands with you, and then
disappears with all your money very suddenly,
you know

We all know talents are difficult to find and normally a talent will likely to leave for a better offer or opportunity. So, what value partners is doing is to use a value investing process on ordinary folks. At least, in the way, the performance of the fund will not collapse overnight even if the brightest employee decides to leave for a greener pasture.

The same applies to ordinary investor like me. It is probably a much better strategy to have more diversified portfolio than a small and heavily researched portfolio. I can sleep better and I can enjoy buying any stocks that meet my criteria without adhering to a few eggs in the basket strategy.

[weijian]

I suppose that is balanced by reducing each investment to not more than 1 to 2% of the portfolio or more than 80 to 110 companies in each portfolio. I think he recognizes that his "mass manufacturing" approach does introduce weakness in letting in a few rotten apples.

We
have 100 companies and we still have the
resources to come up with 100 top-notch ideas;
and that is what we are doing. Keep it diversified,
be able to withstand the unexpected bad guy who
smiles at you, shakes hands with you, and then
disappears with all your money very suddenly,
you know

We all know talents are difficult to find and normally a talent will likely to leave for a better offer or opportunity. So, what value partners is doing is to use a value investing process on ordinary folks. At least, in the way, the performance of the fund will not collapse overnight even if the brightest employee decides to leave for a greener pasture.

The same applies to ordinary investor like me. It is probably a much better strategy to have more diversified portfolio than a small and heavily researched portfolio. I can sleep better and I can enjoy buying any stocks that meet my criteria without adhering to a few eggs in the basket strategy.

hi yeokiwi, thanks for posting the link to this article here! it is an excellent read and there r several lessons i hv picked up.
Nonetheless, i would like to humbly disagree with ur conclusion that it would be better for ordinary investors like us to hv a diversified portfolio.. Unless, we r doing it full time, it wld be very time consuming to own anything >10 stocks...If we take the 'value approach', we approach each buy like buying a piece of the business and hence there is really alot of time spent on OWNing it.

of course, as ordinary folks, we also cant risk getting blown out by concentrating on a few 'bets'..

[Qiaofeng]

He referred to Peace Mark in his speech.
I was also vested in Peace Mark thru the scrips given out by Sincere when they delisted; the takeover was a combi-offer of PM scrips and Cash.
Altho I made quite some money from the cash portion, I am left holding worthless Peace Mark scrip when they collapsed.
According to Cheah Cheng Hye, he is still looking for the scion of the majority owners of Peace Mark .

I looked at Peace Mark a while back. Anyone doing an Excel spreadsheet on it would have realized something was very wrong given the persistently negative free cash flow and continuous share placements (154m shares in 2000, 993m in 2007).

Despite reported profits rising over 17x(!) in 7 years, from HKD 17m in 2000 to HKD 300m in 2007, book value per share was actually LOWER after 7 years, HKD 1.82 in 2007 versus HKD 2.91 in 2000. So despite the reported accounting profits, the management had actually destroyed shareholder value due to excessive share placements.

Other fishy signs: the continuous rise in gross margins (13% in 2000, 32% in 2007), and the continuous rise in ROE (4% in 2000, 17% in 2007).

IMHO the failure of Value Partners to avoid the Peace Mark debacle suggests a weakness in their "mass manufacturing" approach to investing. In my personal view, it is not realistic to hand a checklist to someone fresh out of school and expect them to become a competent investor immediately.

My thots….
1) Peace Mark (PM) when it took over Sincere initially wanted to keep it listed. That was in Dec 2007. Then it did an about-turn, choosing to delist for 80% cash and 20% PM scrips; paying SGD 2.564/shr.
In delisting they kept Tay Liam Wee (TLW) on the PM Board and allow him to manage Sincere Ops.
http://www.sincere.com.sg/about/AnnualRe...esults.pdf
It was buying Sincere at P/E 22X & P/B 3.5X, perhaps a tad too high, implied goodwill was perhaps too generous.
Having collected most of my Sincere shares at SGD 1 and less, I was happy to accept the offer and the PM shares.
But, that was when complacency set in and oversight took over.
I did not pour over the B/S of PM like you did. Sitting on profit, I only did a qualitative type assessment of the PM biz. The rich Chinese had an insatiable appetite for luxury watches and were key buyers in HK and Sg. PM had just taken over a watch movement manufacturing company (rivaling Seiko) and seemed overly ambitious. The expansion in China seemed overly rapid and risky since Chinese were buying overseas and NOT in China (due to sales tax and authenticity problems).However, my conclusion was that Sincere and TLW must have done due diligence before coming on board and that they will be there to iron out the kinks.
Sincere, IMHO, was a reasonably well run biz, reasonable FCF, backed by dividends with a shrewd niche marketing and incremental targeted expansion strategy.
2) By Aug 2008, PM was suspended by HKEx, by Sept 2008, liquidators were appointed.
Apparently, PM 2 majority owners had pledged their shares and the syndicated loans fell thru when the rumors about this spread and it was were later substantiated that 30% of A1 shares was pledged. The shorts brought the share price from HKD 9+ (HKD14+ at time of takeover of Sincere) to HKD 1.50 (May 2008) . Carlyle took a look and rejected.
Rumors were also rife that Egana & PM was related and suffering similar problems. PM B/Ss was rubbished. With the accounts & B/Ss rubbished, PM was a gone case, the banks were pulling out of loans and leaving in a hurry.
3) To cut the long story short, PM was delisted. Sincere Watch operations were ringfenced and TLW eventually partnered LVMH to re-boot Sincere. Chow Tai Fook bought the HK & Chinese retail & distribution operations.

With Hind sight

I guess for an investor you can go visit the operations, kick tyres, visit the watch making operations, check out their retail outlets etc.
But if the accounts are fake and that pertinent facts like pledging of shares not disclosed -- what can you do?
From the proposal on the SGX to delist in Apr 2008 to the collapse in prices in May 2008, the speed of PM fall was just too fast for any investor to react. The rumor mill and the media simply took over.....

[d.o.g.]

I guess for an investor you can go visit the operations, kick tyres, visit the watch making operations, check out their retail outlets etc.
But if the accounts are fake and that pertinent facts like pledging of shares not disclosed -- what can you do?

In the case of Peace Mark it was not necessary to know that the accounts were fake, nor that the majority owners had pledged their shares. The official published accounts were already highly suspicious as I pointed out.

A really smart crook is unlikely to be caught. Luckily, most crooks are not in this category, so they leave clues:

the financial statements (too good/bad to be true);
share placements (frequent, large discounts);
convertible bond issuance (despite holding lots of cash) etc.

An investor cannot hope to avoid ALL the crooks. But most of them can be avoided by doing due diligence.

[Qiaofeng]

As regards, VP.....
IMHO, VP post-IPO is a different animal from VP pre-IPO.
VP post-IPO was prepared to do things like shorting which IMHO, is not strictly "value" investing.
Also, I do not think that U can take a fresh MBA grad, green behind the ears, give him a template and make him a good assessor of bizs, management and risks.

Advantage Investing sounds like "I win" and "You lose" kind of investment.
Buffett style is "Win -Win".
The way CCH explained, I don't think he just buy based on discount to intrinsic value and on investment moats; since he is wary of being hustled. In fact, I think if one side negotiates with the other with an edge in info or knowledge, the weaker side will feel ill at ease and suspicious -- not conducive, IMHO to trust building.

While I agree with CCH point about diversifying to reduce risks, I am NOT quite sure what he is doing at VP, is of the Buffett kind.

He is doing "value investing with chinese characteristics"

---

I guess for an investor you can go visit the operations, kick tyres, visit the watch making operations, check out their retail outlets etc.
But if the accounts are fake and that pertinent facts like pledging of shares not disclosed -- what can you do?

In the case of Peace Mark it was not necessary to know that the accounts were fake, nor that the majority owners had pledged their shares. The official published accounts were already highly suspicious as I pointed out.

A really smart crook is unlikely to be caught. Luckily, most crooks are not in this category, so they leave clues:

the financial statements (too good/bad to be true);
share placements (frequent, large discounts);
convertible bond issuance (despite holding lots of cash) etc.

An investor cannot hope to avoid ALL the crooks. But most of them can be avoided by doing due diligence.

They may not have fooled d.o.g.
But, they fooled many banks, investors, Sincere, auditors etc.....

[Qiaofeng]

In the case of Peace Mark it was not necessary to know that the accounts were fake, nor that the majority owners had pledged their shares.

The official published accounts were already highly suspicious as I pointed out. An investor cannot hope to avoid ALL the crooks. But most of them can be avoided by doing due diligence.

My 1c Gibberish on the events

The banks, the auditors, the investors (VP included) must have done their due diligence on PM’s B/Ss, just as you did. Even if they had suspicions, it would only remain as hunches and suspicions. It is not possible to connect the dots looking forwards; it is only possible to connect the dots looking backwards. Hindsight is 20/ 20.
Originally, PM had intended to keep Sincere listed with approx. 50% stake. IMHO, PM unraveled becos PM decided to go for a delisting of Sincere and upped the ante to a complete takeover. In doing so, it had to go to a consortium to get a syndicated loan. The rumor on the collateral pledge and the association with Eganagoldfeil made the banks wary at a time when banks were looking in the eye of the GFC storm. Credit should be given to Stan chart, whom it appears was the first to pull out of the consortium of banks when they smelled something fishy. Subject to a different set of prevailing opinions & circumstances at that time; it is possible that PM management could have pulled the whole thing off if the banks had been willing and the Webb Report; which totally destroyed PM credibility thru its analysis of PM’s accounting record, was not published. The triggers that mattered were the undisclosed pledging of the shares and the similarities with Eganagoldfeil pointed out by the shorts.

[d.o.g.]

The banks, the auditors, the investors (VP included) must have done their due diligence on PM’s B/Ss, just as you did. Even if they had suspicions, it would only remain as hunches and suspicions. It is not possible to connect the dots looking forwards; it is only possible to connect the dots looking backwards. Hindsight is 20/ 20.

It is true that hindsight is 20/20. But all this while I have relied on the official accounts up to FY2006-2007, which were already available during the pending take over of Sincere. The Sincere deal was ongoing at the time the interim report for 2007-2008 was published.

While it may have been impossible to predict in advance that Peace Mark would blow up, anyone who compiled a spreadsheet tracking the cash flow and share count should have been very concerned by the fact that the share count increased 6x from 2000 to 2007, and that per-share book value actually declined from 2000 to 2007.

Any company doing such huge share issuance is either in deep trouble or undergoing a fundamental change e.g. reverse takeover. During the same period free cash flow was positive in only 3 of the 7 years, inventory days increased from 63 to 180, asset turnover days went from 300 to >500 etc. So the business was fundamentally changing in character.

The Tay family got a big cash payout in addition to the Peace Mark scrip. As founders, their low per-share cost meant that the cash component alone represented a huge profit. The PM scrip was merely a bonus, so it was easy to agree to the deal.

I don't know about the Webb report, but David Webb posted an article on his website titled "Peace Mark's warning signals" on 16 Sep 2008 (admittedly also after the blowup), where he dissected the Peace Mark accounts and pointed out the related party loans, unusual share incentive scheme, share options for non-employees, fishy auditors, relationship with Egana etc. Again, these were all disclosed in the past annual reports going back as far as 1995, for everyone to see. As to whether anyone read them, well, there is a saying that "there are none so blind as those who will not see."

And regarding Stanchart being the first to pull the loans, it should be noted that Stanchart was the investment bank that brought Peace Mark public to begin with in 1993...