I’m often asked what is it about following Hong Kong equities that I find so fascinating. I could reply that it is days like last Monday and Friday that keep the interest flowing. During the week investors had to digest: a HK$15 billion revenge attack against a badly handled announcement relating to the HS Index’s largest constituent, evidence of a major disintegration of the family run banking/property business model of Hong Kong companies, bad corporate governance, and the collapse of a market that accounted for 20% of traders’ business following unwanted snooping by the government’s corruption body. All these issues will raise risks for Hong Kong equities, keeping traders and commentators on their toes.
The Hang Seng index fell 586 points or 2.4% in wispy turnover last Monday, thus falling below the technically crucial 24,700 level. That in itself is not particularly outstanding. However, the index was ramped lower by a decision, announced over the weekend, which shocked the market into submitting to the 24,700 support line. The restructuring of China’s telecommunications industry (which consists of Chinas Mobile, Unicom, Telecom and Netcom) had been mooted and discussed for months, while the substance of the actual restructuring had been known for months as well. So, when the shuffle was announced there were few surprises. The mobile and fix-lined networks would be joined in various combinations.
However, someone in Beijing had forgotten to drop hints of a very important change: that the biggest player of the lot, China Mobile, would be required to share its dominant network with the others. This was a real bombshell. No one had predicted such a radical opening up of the market, because on one had been told. China Mobile, the largest mobile company in the world, fell 7% on Monday (losing HK$204 billion/US$26 billion in market value) on massive, record-high turnover/volume (HK$16 billion on 140 million shares). Half of the 586 point decline in the Hang Seng Index on the day was due to the pummeling of Mobile’s shares.
China Mobile is the largest constituent stock in the HS Index, with a weighting of 13%. Comparisons were immediately drawn with the demise of another giant telecom company that succumbed to market opening – Cable & Wireless – Hongkong Telecom. Could the same fate, illustrated in the table below, await China Mobile? Long term holders were not about to find out.
PCCW’s fall from grace – year-end market rank and value (HK$b)
Futures traders were horrified and were also in no mood to find out. Matters were made worse by the fact that the other protagonists (Unicom, Telecom and Netcom), two of which are HS Index constituents, remained suspended from trading. Why, no one knows. If they were suspended, then surely Mobile should have been too. If they were not suspended, it is likely their share prices would have risen and compensated somewhat for the decline in the Index caused by China Mobile’s losses. The important 24,700 level on the index could have been saved. Futures traders had been banking on China’s support, and were on the rampage when it didn’t appear.
Two groups of people had messed up here: first, the regulators in Beijing because they did not prepare the market about the Mobile news and, second the people at the Exchange for either not suspending Mobile, or resuming trade of the other telcos. Traders’ revenge was in the air and they planned their attack for the Friday auction.
Traders’ gripes were legitimate. It is mistakes like these that increase the risk premium/volatility of Hong Kong/China equities. I believe the China Mobile botch up, all but wiped out the increase in confidence generated by the stamp duty cut in China on April 23 and Beijing’s feeble attempts to halt the selling of stocks through fiat. From that point until last Monday, traders and investors had assumed that China’s leaders had taken a benevolent approach towards them. That view was blown apart by the handling of the changes at Mobile.
If overseas investors are puzzled and confused by the mixed signals coming from Beijing, they should be laughing their heads off at the SHK Properties scandal, which has turned even more bizarre. The 79-year old mother of Walter Kwok was elected Chairperson of the board of Hong Kong’s largest property developer last Tuesday – replacing Walter, who has been demoted to a mere non-executive director. He took a HK$5 million pay cut and a huge loss of face.
How is it possible for a 79-year old tai tai, with no working experience, to gain effective control a board of directors? It’s beyond me. According the statement which announced this flagrant abuse of majority shareholder power Madam Kwong has 40-years of experience looking at property sites, and this, somehow means she is qualified to be the chairman of the board. This, of course, is complete nonsense. This, soon-to-be-octogenarian, who can hardly walk, has no idea how to run a business having never been a director of a listed company before. Looking at building sites does not qualify her to run anything.
The statement made no mention of how long her appointment will last. It can’t be a long-term tenure. If she has been appointed as an honorary chairperson, then the company should say so and appoint a qualified person to run the business. Also, Walter, the former chairman, was ousted from the position because of questions about his mental health. If there is something wrong with his mental faculties, how can he be fit to be a non-executive director of the company? Do Chairmen require higher mental agility than ordinary directors? Are 57-year-old Walter’s mental skills less sharp than a 79-year olds’? These are significant contradictions, which, I suspect, Walter can use, from his inside position, when he attempts to regain the Chairmanship. This story has not ended here.
Here’s another quirky mystery. Why is it that two of the directors of SHK Properties, are also directors of the company’s biggest competitor, Henderson Land? I’m sure Messrs. Lee Shau Kee (who helped establish SHK) and Woo Po Shing are honorable men, but scheming minds might consider that the disruptions at SHK Properties may be of some benefit to Henderson Land. No one from SHK Properties sits on the Henderson board. Mr. Lee’s high profile public support for Madam Kwong and his lack of support for Walter suggests he and Mr. Woo are culpable of encouraging the dispute. None of the other directors of SHK have had anything to say about this supposedly “family dispute”.
Finally, I can’t help saying something about the introduction of the Stock Exchange’s new auction trading system – which was launched last Monday and grossly abused on Friday. The idea of the 10-minute extension to the trading day is to increase trading on the exchange and to better determine the closing price of stocks using a system whereby brokers place orders in an auction after the usual 4pm close. The closing price is then determined by the price with the highest number of bids.
Officials noted that the extension will result in an increase in trading, with HK$2 billion traded this way most days last week – until Friday’s HK$15 billion explosion. However, it is very likely that these bids were cannibalized from the normal trading session. The importance of the closing price has increased significantly since most equity linked products are priced daily using the closing price. While investors hope the equity linked product will not be knocked out (i.e. if the strike price of the contract is not hit), the investment banks that write these products are very keen to knock them out, so that the customer has to re-write the deal – thus increasing churn and therefore fees for the bank. As ibanks are the only players big enough to play and win the auction game, they have a distinct upper hand in determining closing prices in the auctions.
Defenders of the auction system point out that the previous method (taking the average of the last five trades) was also subject to manipulation. This is true, but, as far as I can tell, all the new method does is hand this advantage to the big brokers and their proprietary trading desks. Evidence of their ability to distort closing prices was blatantly shown last Friday, when HK$15 billion of trades (20% of the total day’s trading) were determined by auction. The auctions weren’t aimed at the futures close, with the HS Index only adjusting by 30 points. Rather, traders targeted thinly traded stocks such as CLP, which surged 10% to a record high during the auction period, and Wheelock, with both recording a doubling of their turnover “after hours”.
As for the increase in business through the Exchange, the HK$54 billion traded last Tuesday was the lowest non-holiday impacted daily turnover since August 14 2007, when the index was trading at 22,000. In other words, turnover has slumped 12% on an adjusted basis. That’s what happens in bear markets, activity slows down, increasing the ability of traders to distort the market – whether they have revenge on their minds or not. However, the discovery by the ICAC of price fixing in the previously booming covered warrant market (supposedly by Calyon) has exaggerated the slowdown in turnover, and impacted the relative performance of HKEx (388.HK) as the chart below shows:
Warrant turnover as % of total (%) vs HKEx relative share price performance
Lower turnover will also increase volatility – making watching Hong Kong equities as riveting as ever. I can also say that this is true of corporate Hong Kong/China, where the demise of monopolies and family-run public companies seems to be gathering pace. I’ll discuss the sale of Wing Lung Bank by the Wu family and why 3x book value is not expensive next week.
