One interesting way to play China

Over the last couple of weeks, the Chinese markets have been under severe pressure. They may have recovered some lost ground recently, but the outlook remains cloudy.

Now you might remember that nearly a year ago, I singled out one company as the ‘bellwether stock for China’.

The stock is, of course, China Cinda Asset Management (1359 HK), the largest state-controlled asset management company in terms of assets, revenue, net profit and market share. With 31 branches nationwide, the company’s business is in buying up distressed assets, repackaging them, and flogging them at a higher price.

In 2014, distressed assets contributed over 60% of China Cinda’s total revenues. The company also has investments in non-distressed assets.

Prior to the initial public offering (IPO) in December 2013, prominent Western financial institutions, including banks, sovereign wealth funds and hedge funds, took strategic stakes in the company. These include Norwegian central bank Norges Bank (the oil fund), hedge funds such as Farallon Capital Management, Oak Tree Capital Group, and Och-Ziff Capital.

I thought that if they remained invested after Cinda’s lock-up period expired in December 2014, it would be a sign that the ‘smart money’ was bullish about making money in China.

As far as I can tell, they have kept their stakes. However, the yield on their investment has been paltry.

The stock is down 10% since I featured it, and up a mere 6% since flotation. Most tellingly, it dipped below the IPO price during the market turmoil.

I think the inadequate performance can be attributed to four factors.

Four problems facing China Cinda

1. Chinese government intervening in the market

There are some 1,400-plus stocks suspended in China, equivalent to 49% of total listings. The government has suspended IPOs and other share sales while also asking the banks to roll over loans backed by shares. Short-sellers have been called names, had their margins squeezed, and negative stockmarket comments have been discouraged.

2. Foreign banks have been trimming their holdings

On 24 June, Standard Chartered Bank began offloading shares worth up to $215m. A few months earlier, UBS trimmed its holdings in the stock by offloading 400 million shares.

3. A new share issuance has been planned

On 29 June, the Ministry of Finance (MoF), the largest shareholder (67.8%) in China Cinda, gave a mandate to issue additional H-shares within the next 12 months. The amount is said to not exceed 20% of the outstanding H-shares, or 6% of the total shares, by the end of May. This will result in dilution for existing shareholders. However, after the few days of sell-off, the MoF clarified in a statement that it would not reduce its stake during “abnormal fluctuations in the stock market”.

4. More competitors are coming into the market

On 6 July, China Huarong Asset Management Co, China’s largest distressed-loan buyer by assets, filed a preliminary prospectus on the Hong Kong Stock Exchange for an IPO which could raise $2bn-$3bn. Interestingly, last year the company roped in eight strategic investors including Goldman Sachs, Warburg Pincus, CICC, Khazanah Nasional (Malaysian sovereign fund), China Life Group, Citic Securities International, Cofco Corp (Chinese state-owned food company) and Fosun International.

Overall, I question the rationale of investing in distressed asset management companies operating in a command economy.

For comparison, the investment case was easier after the Asian financial crisis of 1997-98. Thailand and South Korea allowed assets to be re-priced lower, paving the way for distressed asset buyers to buy cheaply and sell (more) expensively.

However, there are alternative ways to play a bearish China outlook. One attractive route is through a pawnbroker.

Three pawnbrokers that might be worth looking at

Back in January, I told you that my investment banker friend had started a pawnbroking business.

I mentioned three stocks: Oi Wah Pawnshop Credit Holdings, Maxi-Cash Financial Services Corp and Srisawad Power Public Company. Since I mentioned them, Oi Wah and Srisawad have risen 47% and 27% respectively. Maxi-Cash, meanwhile, has fallen 22%.

While not directly focused on China, I believe Oi Wah Pawnshop (1319 HK), which operates 12 pawnshops, a pawn loan service and mortgage loan service centre, looks interesting.

In the second quarter of 2015, Oi Wah reported revenue and net profit of about HK$146.5m and HK$80.1m – an increase on 52.9% and 95.0% respectively.

According to Bloomberg, there are two research houses covering the stock, pegging the fair value to HK$3.50 – equivalent to a 63% upside.

I have no idea whether that is feasible. However, it seems that some believe that it could work. For instance, Value Partners, a 20-year veteran value investor in Greater China, has recently accumulated a 6.3% stake. An opportunity to keep an eye on, anyway.