Small Caps Robust in China

When small caps run, in comparison to large caps, thats a sign that too much liquidity is swishing in the system. Large caps are generally under the purview of institutional funds. In very much the same way, small caps have been robust in the US, and back home in Malaysia, the run in small caps have been more than generous over the past 18 months. Liquidity in private hands tend to move between property and stocks. In Malaysia and China, there has been a flattening out of the property markets, hence it is only natural that small caps are having their day in the sun. They can run for sometimetill something "major happens".

ChiNext Price Index (SZ399006) exchange-traded fund, which tracks the benchmarkgauge of the nation’s small-capitalization stocks, has delivered the highest risk-adjusted return among 23 Chinese ETFs during the past four years as a 67 percent gain compensated investors for bearing the highest volatility. The 50 smallest initial public offerings in that period have surged 151 percent on average, versus a loss of 22 percent for the largest deals, according to data compiled by Bloomberg. 

Small-cap stocks are outperforming because they dominate the services, technology and health-care industries, among the key parts of China’s $9 trillion economy that policy makers are counting on to drive growth as incomes rise. Larger companies from state-controlled Bank of China Ltd. to Jiangxi Copper Co. (600362) have fallen out of favor as Prime Minister Li Keqiang seeks to wean the country off government-led spending that fueled overcapacity and debt levels more than twice the size of economic output. 

“Investors prefer smaller stocks that are in sectors with strong structural themes,”Erwin Sanft, the head of China and Hong Kong equity research at Standard CharteredPlc, said by e-mail in Hong Kong on June 16. Smaller companies have “higher volatility so there’s the enticement for higher returns in a short timeframe.” 

IPO Wagers

China’s first IPOs in four months show investors are placing big wagers on smaller companies. Shandong Longda Meat Foodstuff Co., Wuxi Xuelang Environmental Technology Co. and Feitian Technologies Co. (300386), each valued at less than $510 million based on their IPO prices, were all oversubscribed by at least 120 times in online bidding. 

The three stocks jumped at least 32 percent as they started trading on the Shenzhen Stock Exchange today before the shares were suspended. 

Money managers in China have increased their holdings in smaller companies to 33.3 percent from 31.6 percent at the start of the year, while reducing large-caps to 24 percent from 24.4 percent, according to Hao Hong, the chief China strategist at Bocom International Holdings Co. IPOs of smaller companies are favored by individual investors, who account for 99 percent of trading accounts on the Shenzhen bourse and 80 percent for the Shanghai Stock Exchange, he said. 

“Small-cap IPOs serve as a lottery ticket for retail investors,” Hong wrote in an e-mail. 

Stock Valuations

Investors in the July 2010 IPO of Leshi Internet Information & Technology (Beijing) Co. (300104), a provider of online videos and maker of smart TVs, have gained about 1,100 percent through yesterday. Geron Co., a clothing material-maker, has surged 263 percent since its 241 million yuan ($39 million) trading debut on Jan. 28. Shaanxi Coal Industry Co., the nation’s biggest IPO this year, has gained just 3 percent after selling 4 billion yuan of shares five months ago. 
  
Small-cap shares are vulnerable to declines as investors shift money into IPOs betting on first-day gains. The ChiNext has dropped 13 percent from this year’s high on Feb. 17, versus a 5.2 percent retreat in the Shanghai Composite Index. (SHCOMP) 

Ten companies have started the share-listing process since June 10, with an average price-to-earnings ratio of 17.8, according to the China Securities Regulatory Commission. That’s a 69 percent discount versus the ChiNext’s multiple of 55.5, according to data compiled by Bloomberg. The securities watchdog’s chairman said in a May 19 statement that it plans to allow about 100 IPOs from June through the end of the year. 

Low Pricing

“New IPO shares will definitely jump in the first couple of days because of low pricing,” said Wang Weijun, a strategist at Zheshang Securities Co. in Shanghai. “But that will come at the cost of existing stocks, particularly small caps.” 
Chinese investors are willing to weather volatility in smaller companies for the prospect of outsized returns, Gerry Alfonso, a sales trader at Shenyin & Wanguo Securities Co., said June 16. 

The iShares FTSE A50 China Index ETF, which tracks the largest companies traded in China, posted a loss of 26 percent in the period. 

No Stories

“Large caps lack volatility and are difficult to move, like big elephants,” Oliver Rui, a professor of finance and accounting at China Europe International Business School in Shanghai, said by phone on June 24. “Large caps represent the traditional parts of the economy that don’t have any stories. They are not exciting.” 

China’s state-owned companies, which have benefited from cheap credit and monopoly positions for years, face a less comfortable future after Communist Party leaders pledged in November to give market forces a bigger role in the economy. The central bank said in January it supports the development of technology companies and will allow the formation of smaller lenders to support the businesses. 

Investors will keep pouring money into smaller companies as “the growth driver is more favorable,” Kelvin Wong, a Hong Kong-based analyst at Bank Julius Baer & Co., which has about $287 billion under management, said by phone. “There are more catalysts.”

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Interesting Oil & Gas RTO in Ideal Jacobs

Not all oil & gas RTO are equal, we know of the huge surge in Barakah, and the moderate gains in PDZ. Barakah had a fantastic run because of the people behind the company coming in and the new projects which they won. PDZ was slower because the buyer was not as "strongly connected" and the fact that there is still a huge number of outstanding shares of PDZ out in the open.PDZ new owner bought a controlling stake but has yet to announce any asset injection, hence the flattish performance.

So where does the Ideal Jacobs RTO rate?

HEADS OF AGREEMENT IN RELATION TO THE PROPOSED 

REVERSE TAKE-OVER OF IJACOBS BY CEKAP TECHNICAL 

SERVICES SDN BHD (“CTSSB”) AND MECIP GLOBAL 

ENGINEERS SDN BHD (“MECIP”)

The proposal is to acquire Cekap Technical Services and Mecip Global Engineers via an issuance of new Ideal Jacobs shares @ 25 sen. Fair enough. For this deal, we already know which company/asset will be injected, hence easier to survey their prospects.
  

The vendors of CTSSB are Md Nazir Bin Md Kassim and Sofiyan Bin Yahya. The vendors of MECIP are Ahmad Nazari Bin Ashari, Mohd Nor Bin Abd Basar, AliShastry @ Haslan Bin Husain.

What is positive is also a management buyout of the existing operations of Ideal Jacobs by its current owners (Andrew Jacobs and Ben Meng), which is to say Ideal Jacobs will be a "clean company", and if you examine their balance sheet, its pretty clean already. This allows for the RTO asset to be valued accordingly without any baggage or legacy issues.

 

Formed in 1994, Cekap Technical Services Sdn Bhd has established a niche as a provider of integrated technical services especially in project management and integrated project services including project management, project support, safety consultancy, environment consultancy, G&G services, ICT and integrated operations. The company has an excellent safety record of zero LTI since it began operations. Currently the company has more than 400 staff across its operations. The company has successfully served all the oil & gas operators and major players in Malaysia and has established a track record in the region, including Brunei and Philippines. The company has also expanded into the Middle East, especially UAE and Iraq, and Far East in Korea and Japan. The company has offices in Kuala Lumpur, Kerteh, Pasir Gudang, Dubai and Brunei.

 So how much more can we assess the RTO if we do not know the valuation of the two companies? Thats a fair question since its only a Heads of Agreement but we can easily spot the key driver of the deal in one of the vendor, Sofiyan bin Yahya. He is a BSD in oil & gas if you are in Malaysia's oil & gas industry.

 

President (April 2008 – April 2014), Malaysian Oil & Gas Services Council

The Malaysian Oil & Gas Services Council or MOGSC is the most proactive non-profit organisation or NGO representing the interests of the service providers in the Malaysian oil & gas industry. Key missions are to promote Malaysia as the regional hub for oil & gas services, and showcase the capabilities of the Malaysian oil & gas services sector. MOGSC collaborates with all the industry stakeholders. MOGSC has working groups and task force committees addressing various industry interests and issues, and regional chapters to promote local players in the specific active regions.

Back to Cekap, it is licensed by Petronas (L-295213-P). Some of the key projects they have completed:

- Malampaya debottlenecking project (Philippines)

- Petronas' Integrated Operations Collaboration Center

- Central Luconia rejuvenation project (Sarawak)

Barring any nasty surprises in terms of valuation, the prospects for this RTO is pretty good. You are only as good as the driver behind the vehicle, in particular when you are talking about doing well in the oil & gas industry in Malaysia. Hence this deal is closer to Barakah in terms of attractiveness than say PDZ.

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Need to Get to "No Par Value" Regime

I was very excited for the entire market when news filtered out that SC/Bursa was close to adopting the no par value regime. However, till now, there has not been a date set, no more rumblings of changes or amendments to corporate laws which are needed to push through the changes. What is holding them back? I do not see any LOGICAL reason for staying on par value regime. It boggles the mind.

What is par value, it is the minimum paid up per share when you are considering to liston Bursa. Bursa is about the last of the active developed/emerging markets to adopt no par value. What kind of finance/investing masterplan we have if we do not include this as a top priority?



There are two main reasons:

1) What is even more galling is the ACE market, which is supposed to be encouraging growth companies, but there is still the par value regime which locks out many applicants. Why do you think so many smaller growth companies have been going to AIMS and Taiwan to list their companies, while you can count the number of new ACE companies listed over the last 12 months on one hand. Let me tell you that the very poor performance of the last few listed ACE companies is probably due to the paid up capital issue - these are companies, by hook or crook boost up their paid up with bricks and mortars but no solid business, so you end with small manufacturing plants and unconvincing old school products. 

The very basis of encouraging growth companies is GROWTH PROSPECTS, THE SUSTAINABILITY & LEVERAGE/SCALABILITY of the business model, and NOT par value. It is very important because as current rules stands, even Facebook could not have listed 5 years back on ACE because their paid up was too low. Even when Facebook listed recently, their par value (which still exists, but there are no rules as to how low you can go) was something like 0.0006 cents per share, and IPO price was nearly $30.00.

When you hold to the current regime, any company considering to list on ACE must at least have a minimum of RM7m - RM10m, even that will considered as low to our regulators. We all should be aware that in the evolution of business model, invested capital is a poor judge and poor guide for evaluating any company. 

If you are making a few million ringgit, with a scalable business model, why do you need to have RM10m in paid up? The new economy would indicate emphatically that the internet, new business processes/delivery of services and new marketing platforms (MLMs, network marketing, franchising) are playing critical roles in new business models. Most of these require a LOT LESS INVESTED CAPITAL, but what they do provide is more VALUE ADD SERVICES and PRODUCTS delivered in a smarter and more creative way.

The longer Bursa/SC stays inactive with the par value regime, the more we are pushing away great smaller companies. As it stands in ACE, with a minimum of RM7m-RM10m "unwritten rule" as paid up, YOU ARE ENCOURAGING THE ENTIRE ECONOMY TO STAY WITH SUNSET INDUSTRIES, YOU ARE ENCOURAGING COMPANIES TO STAY OLD SCHOOL IN THINKING, YOU ARE STRONGLY DISCOURAGING INNOVATION - all that has a strong trickle down effect, how do you think private equity investors or angel investors will feel, they will further shy away from innovative companies and rather fund companies with bricks and mortar assets or in manufacturing. The cycle is devastating, when early seed funders do not get good exit options, smaller companies get little or no funding.

If a company is making RM2m-3m profit early in its life with a paid up of less than RM500,000 ... why stop them from listing on ACE? These are the very companies you need to encourage and foster. When they can do that with minimal capital, it show their business model is SCALABLE ... which is to say if you provide further capital by allowing them to tap the ACE market, say another RM5m-10m, they have a good chance to churn out 3x, 4x, maybe more profits.

And you know smaller companies will always find funding very difficult in their early days, banks... fergedaboudit, with minimal exit options, angel investors and private equity would be hesitant as well.

Let me give you a real example, a company that makes RM3m a year with a paid up of RM500,000 in its 3rd year of existence. No way can they list on ACE. They have to put in another RM7m-10m cash into the company as the minimum par value is 10 sen. So, if you have RM10m PUC, you can have 100m shares listed, and then issue another 25m shares to the public to raise funds.

In a no par value regime, the company can capitalise their profits and bring it up to say RM3m in PUC, and issue 100m shares with a par value of 0.3 sen a share. You price IPO shares no on par value, you price based on earnings potential,  ...historical and forward. Say for the same company making RM3m a year, you may even attribute a 15x PER as growth is paramount for sustainable growth companies = a market cap of RM45m, or an IPO price per share @ 45 sen. (If you force these companies to put in RM10m cash to get listed on ACE, what is the point ... if they have RM10m, they need not tap ACE for funds).

When you move to a no par value regime, you will be able to greenlight more exciting companies with scalable and creative business platforms - isn't that the very aim of ACE, isn't that the best way to encourage entrepreneurs, innovation, maintaining competitiveness and assimilation into the new economy?

Bursa/SC/EPU/Finance Ministry ... please consider how the current regime is holding us back. We were early adopters of the new economy, of the internet, of the MSC ... all great thrusts ... and yet we have an archaic system holding a large bulk of entrepreneurs back. Something needs to change and very quickly too.



2) Do you realise how many listed companies on Bursa are trading below their par value? We only have just over a thousand listed companies and I can safely say that there are between 250-400 companies, my estimates based on a brief perusal of a couple of sectors.

What happens when you trade below your par value? You get there usually because of accumulated losses over the years. Say your par value is RM1.00 and your share is RM0.70 sen now, there is no way you can issue new shares below par value to raise funds or to use new shares to buy some other businesses.

In a no par value regime, par value doe not count, the value of your shares is the last traded price. Hence even when you are at RM0.70, you can issue new shares around RM0.70 to existing shareholders (rights issue) to raise funds for new ventures, or you can issue new shares at around RM0.70 to take over some business which you thing will add value to your current platform or help to reinvent/recharge your business model.

In the current regime, these companies no longer have those options. Plus, for 99% of them, they would probably have MAXED out their available banking facilities as well ALREADY. So what is left for them to do?

With limited options, and a deteriorating business model, no access to funds, you can do zilch. Hence for many of them, they resort to speculative price "management" or what some of us refer to as rampings by syndicates, to bring forth some "profits" for themselves or stakeholders - I mean, they have to try to make money somehow.

They cannot even consider a RTO by a profitable and bigger company. In the cited example, no company will want to take new shares issued at RM1.00 for a company with a market price of RM0.70. Hence the only way left is to do a capital reduction. That is a fair path since the company has not been doing well, and shareholders are supposed to benefit and be punished alongside with company's fortunes. However, many are not taking up that option because they can very well make good pocket money by appointing syndicates to ramp up their shares once or twice a year. By limiting the options to these companies, Bursa/SC are indirectly condoning/encouraging these speculative share ramoings. (Especially when there IS ALREADY a viable, prove, global best practice that the authorities can adopt IMMEDIATELY ... ist not that their hands are tied or there are no options for Bursa/SC to take).

When the no par value regime is enacted, you will also energise the market enormously, which will have tremendous trickle down benefits. These companies below par value will be more active in scouring for good companies to buy to reinvent their business models (to help them get out of the slump). They could also do rights issues, and maybe even sweeten them with free warrants (which they could not do in a current regime).

The end result is they need not turn to syndicates to ramp their shares to make money, they can turn their attention to more genuine plans. It will reinvigorate investors as well as they can see some light at the end of the tunnel. Its like a patient with a terminal disease slowing rotting away, suddenly turning into a patient with new drug cures possibility.

Change it already ...

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Oldtown: Large funds are for easy to be understood companies

Usually large funds may seem to be going after difficult companies - in actual fact, they are not. Fidelity made large investments into Jobstreet only to reduce its holdings upon announcement of the sale to Seek.com. Just announced, Oldtown is invested by Franklin, a fund managed under Franklin Templeton (one of the largest funds in US).

Oldtown may seem to be complex but in actual fact it is a very easy to be understood company. It is one of the better performing IPOs of recent times and for a company to reach its current size in a short period of time, it is no easy feat. Recently, Oldtown has experienced a stagnation in revenue and income but over the long run I suspect it will be able to adjust itself. Oldtown is no doubt the type of company which I like - still.

Because South East Asia is one of the few pockets of growth for many foreign companies, typically companies such as Oldtown would be an attractive target for them. Over the last few years, companies like Heineken over its purchase of Asia Pacific Breweries, insurance companies in looking for targets in South East Asia, it would not be a surprise if over time some of these brand names are acquired at a high PE premium.

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