Tag Archives : China


Hanergy and the Shanghai-Hong Kong Stock Connect 2

Disclosure: No position in 566 HK.

Northbound short selling has been allowed for six trading sessions on the Shanghai-Hong Kong Stock Connect (沪港通) and so far not a single A share has been sold short. It’s not yet possible at Interactive Brokers, so apparently other brokers are also still figuring out the settlement logistics.

Hong Kong-listed shares, on the other hand, remain fertile hunting ground for short sale candidates. But seller beware! The influence of Shanghai’s frothy, retail-driven stock market may be beginning to be felt. One line in a WSJ article about the recent unexplained and unjustifiable rise of Hanergy Thin Film (566 HK) caught my eye: “The company’s share price has nearly quadrupled, to HK$6.80 on Friday, since the trading link opened on November 17, making it the best-performing and most widely held stock in the program known as Shanghai-Hong Kong Stock Connect.” To what extent might retail interest have driven such a massive change in the valuation of a loss-making solar panel manufacturer whose accounting and relationship with its parent has long drawn scrutiny from shortsellers?

First, an anecdote

I am reminded of a conversation I had with my uncle in Shanghai earlier this year, a few days after the Shanghai Composite fell nearly 8% in one day. Not to pick on him, but my uncle is the quintessential retail daytrader. He and my aunt have long enjoyed telling family about their occasional speculative stock trades, but as the Chinese A-share market has heated up, they have become more serious about actively trading their savings. My 16-year-old cousin proudly told me about her first real-money three-bagger last fall, which she had picked at random. A sign of the times, perhaps?

Since I invest for a living, we were naturally very interested to hear one another’s perspectives on the stock market. It was fascinating to learn about the range of financial products and securities lending-related innovations available to retail accounts in the mainland, many of which are quite complex. But I must confess; the conversation suffered from more than the usual language barriers. It wasn’t just that I don’t recognize the Chinese name for, say, Bollinger bands (“布林线”) off the top of my head—we were speaking entirely different languages. I told him about the meeting we had had with NetDragon the day before and how I think the business trades well below asset value despite exciting growth prospects over the next 3-5 years. He responded by explaining how he only buys a stock when it has had at least 3 “red” days in a row, and that after a couple of “green” days it was time to sell. (In China, the color red is considered good luck, so the red/green negative/positive association the rest of the world uses is inverted—a small part of my motivation for choosing neutral blues for Cable Car’s logo! See the tickers in the photo below from January.)

View of stock tickers in the Shanghai financial district January 2015

View of stock tickers in the Shanghai financial district January 2015

To his credit, my uncle understands the dangers of trading on margin, unlike much of his competition, and he is quite thoughtful and careful about his position sizing. But like most of his fellow retail traders in China, he is not evaluating stocks on any sort of fundamental basis. He is a momentum trader and a speculator with a long bias, and he knows that eventually what goes up must come down.

Back to Hanergy

In my opinion, this sort of non-fundamental trading creates opportunities for fundamental investors with a longer time horizon. Conversely, it can also be a reason why mispricing persists in markets that remain dominated by retail investors. Estimates vary, but Shanghai trading is thought to still be at least 50% retail-driven, with Hong Kong around 30% according to INSEAD. In US markets, it is often clear when an illiquid, low-capitalization security has been pumped by uninformed retail speculators. There is typically a paper trail of newletters or cheerleading posts on message boards. When it comes to Hanergy, I may not be looking in the right places, but I haven’t seen the usual signs of a pump-and-dump in Chinese media.

It’s possible that interest may be arising through boiler room-style marketing by brokerage firms, but it seems at least plausible that the simple fact of the recent rise in the share price has created a momentum bubble that feeds on itself. My experience with Chinese retail investors is that they like to buy stocks that have gone up recently. On the surface, it seems improbable for a company with a US$36 billion market capitalization and meaningful float to be influenced by retail volume. However, retail interest—especially through the Stock Connect Program—has contributed a significant amount of the trading volume during the rise. Southbound trade in Hanergy has exceeded 25% of trading volume on some days, and it has represented net purchases (buy volume minus sell volume) every day except one since the beginning of February.

The chart below shows the percentage of total trading volume represented by estimated gross Stock Connect volumes as the price has increased.

Southbound Stock Connect volumes have represented 7-26% of daily Hanergy trading volume since February

Southbound Stock Connect volumes have represented 7-26% of daily Hanergy trading volume since February

For better or worse, I have been unable to secure a borrow on Hanergy, so this is more of an academic exercise for me. But it is fascinating to witness the formation of a valuation anomaly and speculate as to its cause.  Perhaps the bubble will continue as long as mainland retail money continues its net inflow into the stock.

 


The raw daily data below is from FactSet and the HKEX Daily Top 10 Southbound securities, available for trading sessions beginning February 2, 2015. *Estimated from February monthly figure.

Date Buy
(HKD m)
Sell
(HKD m)
Net
(HKD m)
VWAP
(HKD)
Est. Stock Connect Volume
(m shrs)
Total Volume
(m shrs)
Stock Connect %
2-Feb 13 6 7 $3.61 5 95 5.6%
3-Feb 18 12 6 3.64 8 80 10.1%
4-Feb 19 13 7 3.77 9 116 7.4%
5-Feb 67 21 47 4.09 22 187 11.5%
6-Feb 39 18 21 4.20 14 127 10.6%
9-Feb 34 23 11 4.22 13 79 16.9%
10-Feb 46 21 24 4.31 16 91 17.3%
11-Feb 102 25 77 4.51 28 167 16.9%
12-Feb 75 7 67 4.47 18 116 15.8%
13-Feb 55 8 47 4.53 14 104 13.3%
*17/18-Feb *10 *18 (8) 4.35 7 73 9.0%
25-Feb 58 7 51 4.48 15 60 24.4%
26-Feb 25 9 16 4.52 8 63 12.1%
27-Feb 48 7 42 4.51 12 64 19.0%
2-Mar 123 7 117 4.69 28 107 25.9%
3-Mar 138 37 101 5.10 34 178 19.2%
4-Mar 239 64 175 5.92 51 414 12.3%
5-Mar 491 337 154 7.58 109 583 18.7%
6-Mar 250 182 68 6.84 63 322 19.6%
9-Mar 154  66 87 6.65 33 152 21.7%
Total 2,005 887 1,118 $5.50  506 3,180 15.9%

 

 


New year updates 1

Disclosure: Long 777 HK, long ISIG, long MOMENT 4.69% 2022, short MOMENT 11.5% 2016, short EXAS, no position in GCVRZ, 

Happy new year! My apologies for the long hiatus from blogging. It’s been a busy couple months of holiday travel and a solid finish to 2014 thanks to the performance of several long positions in December. I’m looking forward to making a fuller report in a forthcoming quarterly letter. In the meantime, I felt some quick updates on ideas that have been discussed on the blog and elsewhere were overdue.


China trip and NetDragon (777 HK)

I will be visiting Hong Kong and parts of mainland China later this month. If I have any readers there and you would like to say hello, please drop me a line. If you are a fundamental investor with interest in joining any management meetings, I have a few opportunities for that as well.

The NetDragon thesis is largely unchanged following Q3 results, which were poorly received as expense growth for the education business ramps in advance of revenue generation. NetDragon now has more than half its R&D staff working on online education initiatives. Meanwhile, the core gaming franchise remains strong and has a potential new hit that has already recorded 240,000 PCU. The company repurchased 2.8% of shares outstanding in December.

 

Public commentary on Insignia Systems (ISIG)

ISIG remains a significant position for Cable Car despite an unusual activist situation in the marketplace. Given recent events, Cable Car has adopted a policy of not discussing the investment thesis publicly. However, I remain open to speaking one-on-one with other investors. If you are a shareholder and would like to discuss the company, please contact me directly.

 

Momentive Performance Materials reorganization

I was wrong about both the legal outcome and the potential downside for the 1.5 Lien notes, at least from a mark-to-market perspective. The plan of reorganization went effective in October and the former 1.5 Lien notes (now 4.69% second lien senior secured replacement notes) traded down to the low 80s context. At last trade, the replacement notes yielded 8.3% to maturity, much wider than other similarly capitalized industrial credits. I also failed to fully account for the impact of legal fees on the post-petition accrued interest, which remains in escrow pending a partial settlement (expected to be approximately 70% of billed fees, the same as the first lien notes). There is a further fee reserve against this amount to cover pending appeals. With the intercreditor action between the secured noteholders dismissed except for one narrow class of claims, cash recoveries under the plan as implemented are uncertain and appear limited.

That being said, I continue to find the risk/reward attractive, and arguably more so today. From a purely relative value standpoint, the replacement notes seem to be considerably cheaper than they should be. Interest rate risk and concern over high yield in general could negatively impact market values, but the notes are over-secured and the recapitalized Momentive is much more conservatively levered. Unfortunately, the ratings agencies are unlikely to rate the replacement notes unless someone pays them to do so, which may limit the number of natural buyers. The new notes should otherwise be investment grade. As mentioned before, comparable high yield issuers such as Berry Plastics have notes of similar coupon, duration and position in the capital structure that trade above par, despite what appears on the surface to be a worse financial position. I’m hard pressed to think of a good fundamental reason why second lien MOMENT notes should trade 300 bps wider than second lien BERRY notes, but perhaps there are technical reasons Berry is not comparable or greater concerns about Momentive’s underlying business than I have observed.

Furthermore, the terms of the replacement notes remain open to appellate review. At current levels, that certainly seems like a free call option. The Momentive bankruptcy raised some important questions regarding the proper determination of a market rate of interest for secured creditors. Both the coupon of the replacement notes and the original make-whole claims are the subject of an appeal currently before the district court. From a naïve, non-technical standpoint, the market outcome of the legal process to date—that senior secured creditors could recover anything less than par value while junior creditors received significant recoveries—is unusual enough to lead me to believe the appeals process has potential. From a legal standpoint, it is quite a bit more difficult to handicap the odds of success on appeal, but noteholders remain highly motivated to pursue the case. There remains an outside chance at a full recovery including the make-whole payment, which could result in nearly 50% returns from current trading levels. More likely in my view is an upward adjustment to the coupon on the replacement notes. Even if the court upholds Judge Drain’s reliance on Chapter 13 precedent for his basic methodology, in my opinion the small incremental increase to the interest rate already made at the end of the confirmation process belies the objectivity of the process. The chosen 4.69% coupon is essentially arbitrary and clearly did not reflect the full market value of the notes.

I expect the appeal to survive a motion to dismiss on equitable mootness grounds, since it would be relatively straightforward to adjust the coupon. I expect the senior unsecured notes, which I am still short, to fail to clear that hurdle.

 

Exact Sciences (EXAS) and Cologuard reimbursement

Despite my public comment, CMS retained its original crosswalk to codes 81275, 81315, and 82274 in its 2015 payment determination for code G0464. The ultimate payment rate was the subject of some drama over the past few weeks, as the rates document was initially published on December 19 with a lower reimbursement level before being retracted. The reimbursement rate in the document was approximately 74% of the crosswalked values, an adjustment that normally only applies to tests prior to 2001. This was corrected, but several localities in the revised document have significantly lower payment rates than the National Limitation Amount (NLA), which is itself slightly lower than the sum of the three crosswalked codes. For example, reimbursement in Jurisdiction K, which contains populous states such as New York, is 45% lower than the NLA. Medicare reimbursement is based on the lower of the amount billed, the NLA, or the local payment amount. Some market commentators and even Exact’s own press release seem to imply that the NLA is the only reimbursement amount for all Medicare patients, which is not the case. It is a maximum.

Expect a further post discussing this in more detail. I am still looking into the reasons for the lower local reimbursement amounts, and Cable Car has a pending FOIA request for the other public comments on the CLFS in order to respond to potential justifications for a higher reimbursement level. I still intend to submit a reconsideration request, which could potentially impact the 2016 reimbursement level.

As a reminder, Cable Car is short EXAS primarily on the basis of lower-than-expected uptake. I believe setting a lower reimbursement rate is a public health imperative that could actually encourage wider screening.

 

Lemtrada approval and GCVRZ

Sure enough, not long after discussing why I was unwilling to bet on Lemtrada approval, GCVRZ had one big day after the drug was approved. It didn’t quite triple, and it now trades about 50% above the price the day before approval. I stand by the reasoning in the post and increasingly suspect I may have dodged a bullet. The price reflects considerable uncertainty over the timing and success of the US launch. My post did not address in detail the risk that Lemtrada has a slow launch in the US. However, there is a distinct chance that Lemtrada fails to achieve the $400 million first-year sales milestone even with contribution from the US. Due to the number of alternative MS treatments on the market, Lemtrada’s status as a last-line therapy emphasized on the label, and the time required for physician acceptance, US sales might not be sufficient for the milestone in the first year even if the drug is ultimately a blockbuster. In the absence of US data so far, the picture of the pace of sales from Europe does not look encouraging.

Although bound by the terms of the CVR not to deliberately interfere with sales, Sanofi’s incentives are at odds with CVR holders as well. The company could conceivably justify a slower launch, focusing on building physician relationships over meeting near-term sales goals in order to maximize the long-term value of the product. That they might avoid a ten-figure payment to CVR holders would be a nice bonus. If the $2 milestone appears more likely once sales data begin to come in, I would expect Sanofi to buy back CVRs or conduct another tender offer. Unless and until they do so with the benefit of internal sales data, I view the likelihood of GCVRZ paying more than zero to be low.


Thank you for following along last year. I look forward to many interesting investment opportunities and conversations with you in 2015.