China

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. 

In this briefing:

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

1. 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.

2. 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. 

3. 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).

4. 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. 

5. 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.

In this briefing:

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

1. 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.

2. 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.                      

3. 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.

4. 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.

5. 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.

In this briefing:

1. Healius (HLS AU): Bid Rejection Provides Option Value
2. Ten Years On – Asia Outperforms Advanced Economies
3. Futu Holdings IPO Preview: Running Out of Steam
4. Asian Credit Monitor: 2019 Portfolio Strategy, US Rate Trajectory, China Reform Pause
5. Weekly Oil Views: Crude Remains at the Mercy of Fickle Financial Markets

1. 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.”

2. 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.

3. 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%).

4. 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.

5. 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.  

In this briefing:

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

1. 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.

2. 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.

3. 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.

4. 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). 

5. 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. Weimob IPO Valuation: Optically Cheap
2. Tencent: A Brief Statistical Review of Game Approvals
3. Weimob IPO Quick Take – Less SaaS, More Ads -> Lower Valuation

1. Weimob IPO Valuation: Optically Cheap

Weimob.com (1260480D CH) is a combination of a SaaS software and an adtech (targeted marketing) business which has started book building to raise gross proceeds of $108-135 million. According to press reports, Weimob is being viewed favourably by investors as it is being offered at a “cheap” valuation of 18-23x 2019 P/E.

2. Tencent: A Brief Statistical Review of Game Approvals

Paused for eight months, China’s authority resumed the domestic game approval in December. The first batch of 80 games was approved recently.

Since the last round of game application approval, the stock price of Tencent Holdings (700 HK) has fallen by 26%. Stock price reacted positively to the recent progress of game approval. 

In this insight, we try to assess the significance of recent progress with a statistical approach.

3. Weimob IPO Quick Take – Less SaaS, More Ads -> Lower Valuation

Weimob.com (1260480D CH),  a Tencent Holdings (700 HK) and GIC investee company, plans to raise up to US$135m in its Hong Kong IPO.

I’ve covered most aspects of the deal in my earlier insight, Weimob Pre-IPO – Can Be Steamrolled by Tencent, Anytime, where I spoke about the over-reliance on Tencent, high attrition rates and acquisition costs for SMBs, and the increasing contribution of its ads business.

In this insight, I’ll provide an update from the latest filings, comment on valuations and run the deal through our IPO framework.

In this briefing:

1. Discover HK Connect: Mainlanders Were Buying Pharma and Property Managers in December

1. Discover HK Connect: Mainlanders Were Buying Pharma and Property Managers in December

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 this briefing:

1. Chinese Telcos: 5G Launches in 2019. Buy the 5G Beneficiary (China Tower).
2. Are Chip Oligopolies Real?
3. Global Banks: Some New Year Pointers
4. Extraordinary Fiscal and Monetary Policies Have Disrupted the Global Economy
5. China Tower: More Details on Non Telco Growth Suggest Further Upside to Share Price

1. 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. 

2. 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.

3. 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.

4. 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*. 

5. 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

In this briefing:

1. New Oriental (EDU): Educator License Not A Concern
2. Would a Sale of Founder’s Holdco NXC Corp Trigger a Tender Offer for Nexon (3659 JP)?
3. USD Peaking with the Economic and Political Cycle
4. A Golden Future?
5. Uranium – About to Enter Its Own Nuclear Winter

1. 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.

2. 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.

3. 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.

4. 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. 

5. 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.