Professional Documents
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Ticker:
404.HK
Market Cap:
HK$3.5 billion
Recent Price:
HK$0.62
Target Price:
HK$0.12
Expected Return:
-81%
Opinion:
Strong Sell
Disclaimer
Neither Anonymous Analytics nor its principles is a registered investment advisor or otherwise licensed in any
jurisdiction, and the opinions expressed herein should not be construed as investment advice. This report expresses our
opinions, which we have based upon publicly available facts and evidence collected and analyzed including our
understanding of representations made by the managements of the companies we analyze, all of which we set out in our
research reports to support our opinions, all of which we set out herein. We conducted basic research based on public
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is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable, and who are
not insiders or connected persons of the stock or company covered herein or who may otherwise owe any fiduciary duty
to the issuer. However, we do not represent that it is accurate or complete and should not be relied on as such, in
particular, Hsin Chong Group Holdings Ltd. (Hsin Chong or the Company) and insiders, agents, and legal
representatives of Hsin Chong and other entities mentioned herein may be in possession of material non-public
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Dont be stupid and invest in the public markets unless you are prepared to do your own homework and due diligence.
Executive Summary
We believe that Mr. Lin Zhuo Yan, the current non-Executive Chairman, is using Hsin Chong as his
personal dumping ground for problematic and non-revenue generating development properties at the
expense of minority shareholders. Since 2011, Hsin Chong has acquired a number of development
properties that were either owned by Mr. Lin or his wife, or can be directly linked to Mr. Lin.
This report will present the evidence including site visit photos and satellite images that lead us to
believe that two of the Companys biggest property acquisitions have languished for years while Hsin
Chong continues to mislead investors about the commercial viability of these properties. Each year, Hsin
Chong claims that monetization of these properties is just around the corner, but we can find no
evidence that this is true.
In one case, Hsin Chong spent ~HK$4 billion on the acquisition and construction of a property that sits
empty as one of Chinas notorious ghost towns in a location that Bloomberg calls Ground Zero of
Chinas Slowdown.
In another case, Hsin Chong spent HK$5.9 billion on a property that has been sitting idle for years,
having failed to attract international brands and commercial tenants.
Relative to Hsin Chongs HK$3.5 billion market cap, these acquisitions were substantial in scope.
Furthermore, both of these properties were acquired from vendors that included Mr. Lin and his wife, at
vastly inflated prices relative to their original purchase price. These acquisitions have burdened Hsin
Chong with significant share dilution and increased debt which we believe have led to a host of other
problems with the Company, including:
Based on Company disclosures, we estimate Hsin Chong will pay well over HK$700 million per
year in cash interest expenses alone. As of the most recent reporting period, the Company only
had HK$1.1 billion in cash on its balance sheet.
Hsin Chong has been both operating cash flow negative and investing cash flow negative in each
of 2013, 2014, 2015, and interim 2016.
In order to preserve funds, Hsin Chong has suspended its long-standing dividend.
Based on our research, we believe Hsin Chong is having serious problems monetizing its land bank.
Furthermore, we have serious concerns over the Companys substantial debt obligations.
Considering the evidence and the analysis presented in this report, we value Hsin Chong at HK$0.12 per
diluted share. With shares currently trading at HK$0.62, our valuation suggests a potential 81%
downside.
Introduction
Hsin Chong is a construction and property development company listed on the Hong Kong stock
exchange under the ticker 404.HK. For most of its 75+ year history, Hsin Chong was primarily a
construction company, with contracts focused in Hong Kong.
In 2011, Hsin Chong decided to expand into the property development business with its first major land
acquisition. A number of other substantial acquisitions have since followed, transforming Hsin Chong
from primarily a construction company to primarily a PRC-focused Property Development and
Investment (PDI) company. In fact, Hsin Chongs PDI business has so eclipsed its construction business
that we consider the latter almost immaterial to its current HK$3.5 billion market cap. For example, a
research report dated 26 January 2015 from Emperor Securities estimates that 93% of Hsin Chongs
market value is derived from its PDI business.1
Unfortunately, we believe Hsin Chong has misled investors about the commercial viability of its
properties. This report presents evidence that Hsin Chongs new non-Executive Chairman has enriched
himself and his associates by unloading problematic properties onto shareholders at vastly inflated
prices, while burdening the Company with share dilution and increased debt. Our research shows that
most of these properties have languished for years and failed to attract tenants.
Specifically, this report will focus on Tieling and Foshan, which are the Companys two largest property
acquisitions and account for nearly all of Hsin Chongs land bank:
Source: http://www.hkexnews.hk/listedco/listconews/SEHK/2016/0510/LTN20160510273.pdf
https://www.emperorcapital.com/filemanager/companyresearchreport/en/upload/135/0404%20Research%20Re
port%202015-01-26%20(English).pdf pg. 2
Tieling Property
The Tieling acquisition was originally sold to investors as a sustainable source of the Groups revenue
and profit over the next five to eight years.2 In reality, we believe this acquisition paved the road for
years of subsequent destruction of shareholder value at the hands of Mr. Lin and his associates.
In November 2011, Hsin Chong acquired 17 parcels of undeveloped land covering approximately 1.8
million square meters in Tieling, Liaoning Province.3 Total consideration paid for the acquisition was
HK$1.8 billion.4
Outrageously, the original vendors which included a related party had completed the acquisition of
the land only five months prior for a mere RMB439 million (HK$575 million).5 More on this later.
According to the 2011 annual report, Hsin Chong had ambitious plans for the land:
Hsin Chong even provided an image of what the 3 million square meter gross floor area Tieling project
would look like on completion for investors who lacked the imagination to picture such a grandiose plan:
http://www.hkexnews.hk/listedco/listconews/SEHK/2013/0425/LTN20130425507.pdf pg. 16
http://www.hkexnews.hk/listedco/listconews/SEHK/2012/0426/LTN20120426899.pdf pg. 11
4
http://www.hkexnews.hk/listedco/listconews/SEHK/2012/0426/LTN20120426899.pdf pg. 11
5
http://www.hkexnews.hk/listedco/listconews/SEHK/2011/0929/LTN20110929161.pdf pg. V-5
3
The Tieling development project, named La Viva, was Hsin Chongs maiden foray into the property
development business. Yet, after five years and billions of RMB spent on construction, the project has
consistently missed deadlines and currently sits empty as one of Chinas many notorious ghost towns.
Since the beginning, Hsin Chong has tried to sell shareholders the idea that monetization of the property
was just around the corner:
And so we come to today a development project that supposedly had tenancy agreements signed with
more than 20 anchor tenants four years ago, and a planned pre-sales campaign as far back as three
years ago, seems to have gone nowhere.
5
In fact, a recent site visit shows that the property is neither ready to be sold nor habitable. Worse still,
the entire project seems stalled and commercially unviable.
These curated pictures from the 2015 annual report show the exterior of the residential buildings, which
appear complete:
However, a site visit as recently as June 2016 shows incomplete construction work with overgrown grass
and litter and debris everywhere:
The 2015 annual report also shows the interior of the residential spaces as finished, presumably to
suggest that the properties are move-in ready:
However, the site visit found that no interior decoration work had been completed:
From this site visit its painfully clear that the residential projects are neither complete, nor under
construction. There were no construction workers, and no notable construction machinery (except for
idle cranes).
Everything simply looked abandoned.
The commercial side of the project was much of the same, with unfinished construction and debris
everywhere:
We have serious doubts any tenants or businesses want to move into this development given its current
state.
Even the water park considered the crown jewel of the Tieling development leaves a lot to be
desired. Here are pictures of the water park from the 2015 annual report:
In its 2016 interim report, Hsin Chong refers to this water park as one of the key components of the
unparalleled La Viva experience and claims that construction is coming along smoothly.6 However, an
Al Jazeera article dated 19 September 2016 and titled The End of the Chinese Dream? published this
picture of the inside of the water park:
The article notes that the water park was scheduled to open in the summer of 2015, but construction
has since stalled, calling it a victim of the economic slowdown. Coming along smoothly? We dont
think so.
http://www.hkexnews.hk/listedco/listconews/sehk/2016/0927/LTN20160927475.pdf pg. 15
10
As part of its anticipated opening, Hsin Chong even published a promotional article on its website dated
25 May 2015 titled La Viva Tieling to be Unveiled This Summer. The article goes as far as to boast that
lifeguards had already been hired for the local water park, as well as a number of frontline customer
service staff:
Source: http://www.hsinchong.com/en-us/Pages/what-new-details/214
Unfortunately, the development project never opened and local sources explained that the lifeguard
and staff that were recruited have since been let go.
11
Furthermore, we found what appears to be a complaint from a buyer to the Management Committee of
Tieling Fanhe New Area claiming that they paid a deposit of RMB5,000 to buy a residential unit in La Viva
Phase 1, but because of stalled construction wanted a refund. The deposit was subsequently returned:
Source: http://www.tlxc.gov.cn/dy/show.asp?id=9880
As evidenced from the site visit, the Tieling development sits unfinished and all construction has
stopped. According to industry sources, the unfinished construction is partly the result of payment
disputes with its contractor.
The original general contractor for the Tieling project was China Construction First Building (Group)
Corporation Ltd. (CCFBC). Due to payment disputes, CCFBC pulled out and successfully sued Hsin
Chongs relevant subsidiaries in 2014, although based on the information we could find, the Company is
appealing.
A number of court orders describe the lawsuit:
http://www.court.gov.cn/wenshu/xiangqing-5998.html
http://courtapp.chinacourt.org/wenshu/xiangqing-6011.html
http://courtapp.chinacourt.org/wenshu/xiangqing-5997.html
http://courtapp.chinacourt.org/wenshu/xiangqing-4504.html
According to a former engineer of China Railway International Group (CRIG), in 2014 Hsin Chong hired
CRIG to replace CCFBC as the general contractor. However, in 2015 construction was suspended once
more and CRIG pulled out.
12
We find these payment disputes and prolonged halts surreal. In 2013 and 2014 alone, HK$2 billion in
cash was paid out for properties under development according to the Companys 2014 cash flow
statement. We attribute these payments to the Tieling project since it was the only development
property owned by Hsin Chong at the time:
2014 Cash Flow Statement
For all the money and time spent, its baffling that this project is simply sitting there, incomplete and
neglected, while the Company disingenuously continues to assure shareholders that operational
commencement is imminent. How does Hsin Chong plan to attract tenants to a property that looks like
it was the set for an episode of The Walking Dead?
(Artists impression legal counsel advised us to put this disclaimer so there would be no misunderstanding that
the picture has been altered and the undead are in fact not roaming Tieling. Seriously.)
13
However, Tieling New Town has failed to attract businesses or residents, and proved to be a colossal
failure of state planning. In a 2013 article, the Wall Street Journal described Tieling New Town as
virtually a ghost town where:
Clean waterways weave among deserted residential and government buildings.
Housing blocks that won recognition from the United Nations for providing good
affordable homes are almost empty. The businesses that were supposed to create local
employment haven't materialized. Without jobs, there is little incentive for anybody to
move here.
In a 2015 follow-up article, the Wall Street Journal described Tieling New Town as having some signs of
life, but still largely empty:
However, the busy areas were concentrated around the places where rural residents,
moved off their land to make way for the city, had been relocated. The waves of new
migrants the ones who can afford the rows and rows of high rise apartments that still
seem largely empty had yet to materialize. Even more residential developments had
been added since the Wall Street Journal last visited.
14
The problem with Hsin Chongs La Viva project is that it isnt even located in Tieling New Town, but
rather on the outskirts. How desirable can a development possibly be when it faces the double whammy
of essentially being the suburbs of a virtual ghost town?
Not very, as evidenced by the pre-sales campaign.
According to one local expert, there are a number of contributing factors to La Vivas failure, including:
Unbelievably, the failed pre-sales campaign and these other critical issues have not stopped Hsin Chong
from continuously assuring investors that monetization is imminent. Recently, Hsin Chong claims in its
2015 annual report that:
The residential sales launch will be tied with the phased opening of the retail outlets
and water park in the second half of 2016.7
It further states that:
It is expected that our flagship La Viva projects in Tieling, Liaoning will roll out, and
will begin contributing revenue to the Group in 2016.8
These rosy statements are utter nonsense. Whatever window of opportunity Hsin Chong had to
commercialize the Tieling property seems to have disappeared as the local economy collapsed. A recent
Bloomberg article dated June 2016 calls Tieling Ground Zero of Chinas Slowdown and describes
Tieling as:
...the worst-performing city in the worst-performing province. Ads offering work visas
abroad are peppered across hoardings, and billboards offer loans for people in "urgent
need." Shuttered car-parts factories flank the highway to the high-speed train station. In
the center, a closed wedding-photograph studio has a notice in the window that reads:
Owner is going overseas. Shop for sale.
Investors need to look no further than Detroit and other industrial cities to see how difficult it is to turn
around failed rustbelt economies. We have serious doubts that shareholders will be able to extract any
meaningful value from the Tieling property and fully expect Hsin Chong to continue its questionable
tradition of pushing out the sales launch date into perpetuity.
7
8
http://www.hkexnews.hk/listedco/listconews/SEHK/2016/0510/LTN20160510273.pdf pg. 26
http://www.hkexnews.hk/listedco/listconews/SEHK/2016/0510/LTN20160510273.pdf pg. 3
15
10
16
Mr. Wilfred Wong Ying Wai (35.55% ownership): At the time of the acquisition, Mr. Wong was
the Executive Deputy Chairman of Hsin Chong. He would later be promoted to the CEO of Hsin
Chong before eventually resigning in 2015. His position likely gave him significant influence in
pushing through the Tieling acquisition. As part-owner of the property, he stood to gain
personally from the transaction.
Ms. Ma Kwing, Pony (35.55% ownership): At the time of the acquisition, Ms. Ma was
considered an independent third party. She was/is the wife of Mr. Lin who was at the time
mostly an unknown figure to shareholders, but would go on to become the non-Executive
Chairman of Hsin Chong in 2015.
Beijing Capital Co. (28.9% ownership): an SOE (state-owned enterprise) listed on the Shanghai
Exchange, and a subsidiary of Beijing Capital Group.
Mr. Wongs involvement and benefit from the Tieling deal is straightforward: he owned 35.5% of the
property. He was also the Executive Deputy Chairman of Hsin Chong at the time. Selling Tieling to Hsin
Chong netted him a substantial return.
As a key executive of Hsin Chong at all relevant times, Mr. Wong had a fiduciary duty to the Company
and its shareholders. If the Tieling property was indeed such a great deal, Mr. Wong should have
directed Hsin Chong to buy the land at the original price, instead of collaborating with associates to buy
the land only to flip it to shareholders for personal gain.
Mr. Wong also appears to have been a close business associate of Ms. Ma and her husband, Mr. Lin. This
is evident from the fact that Mr. Wong and Ms. Ma jointly owned Summit View Holdings, as per the
above organizational chart. At the time of the Tieling acquisition, Ms. Ma and Mr. Lin were considered
independent parties. However, as we will see throughout this report, Mr. Lin would go on to be involved
in a number of highly questionable deals with Hsin Chong and ultimately take over as its non-Executive
Chairman.
In fact, we believe Mr. Lin was a key figure behind the Tieling deal 11,12 and subsequent other
acquisitions. He will appear numerous times throughout this report and his role will become more
apparent.
11
12
http://outletcn.com/news/project_xq.aspx?news_id=12425
http://news.winshang.com/html/012/1409-3.html
17
Foshan Property
With all its outstanding issues, we would have expected Hsin Chong to focus on salvaging the Tieling
project before setting its sights on new development properties. Yet, in January 2015, Hsin Chong
completed another major acquisition this time of semi-developed land in Foshan City, Guangdong at a
consideration of HK$5.9 billion.13
The story of the Foshan property follows the same narrative as the Tieling property, including inflated
assets and missed deadlines. Furthermore, this property was bought directly from Mr. Lin at substantial
personal gain to him.
Without a stinging sense of irony, Hsin Chang justifies the Foshan acquisition as being:
relatively similar to the Groups [Tieling] La Viva project, such that the Group can draw
on relevant development and commercialization experience from its [Tieling] La Viva
project for further planning and development of the Property, and can create possible
brand synergy in the development and management of large scale composite property
development projects in the future.14
LOL whatever.
Even with its short ownership history, commercialization plans for the Foshan property are already
being pushed out:
2014 annual report: Phase 1 will be rolled out within the next 2 years and the existing retail outlet mall
is intended to start the operation toward the end of 2015.
2015 annual report: The residential sales launch will be tied with the phase opening of the retail
outlets in the second half of 2016.
2016 interim report: The residential sales will be launched after the phased opening of the retail
outlets at the end of 2016.
Based on a recent site visit, we have serious doubts that these statements have any merit.
When Hsin Chong acquired the Foshan property, one of the plots was already semi-developed with an
existing retail complex, 25 blocks of low-density residential properties, and a clubhouse.15 These
buildings comprise the Phase 1 rollout.16
Yet the glossy pictures Hsin Chong presents in its annual report belie the true state of these constructs.
13
18
Here are pictures from the 2015 annual report showing the landscaped residential units looking ready
for primetime:
However, a site visit shows the buildings in a neglected state with overgrown grass, unpaved roads, and
unfinished construction:
19
The interiors of the residential buildings look like an even bigger pit of despair, with weed overgrowth
creeping into the property:
20
Turning to the retail side, here is a picture from the 2015 annual report which shows the Disney-esque
faade of the retail outlet:
The bad news is that the retail complex has been completed since 2013 and yet is still not operational. A
recent site visit showed that no brands had entered the outlet yet. In fact, our team could find no sales
or business development office anywhere on the Foshan property. There were only security guards and
cleaners working the grounds. In casual conversation with two of them, neither knew when the retail
complex would open or when the residential houses would start to sell.
21
Stalled Project
Through industry sources we learned that the entire Foshan project has been stalled for years.
According to these sources, major construction started in 2009 and came to a halt in 2013 (save for the
construction of an enclosure wall). Several reasons were given as to why the project has stalled,
including:
When the government sold the parcels of land originally, it did so at very favorable prices in
exchange for a requirement that the commercial center have tenants before the residential
buildings launch pre-sales. This requirement adds to the financial pressures of the project.
There have been difficulties in attracting tier-1 international brands.
The project is in a remote area ~50km from the city center of Foshan and ~60km away from the
city center of Guangzhou.
According to Baidu Maps, there are at least four other outlet stores within ~20km from the city
centers of Foshan and Guangzhou, including the recently opened Florentia Village:
Using satellite images from Google Earth, we can confirm that the project has stalled since at least 2013
and no notable work has been performed on the Phase 1 area since Hsin Chong acquired the property.
22
Here is a satellite image of the Phase 1 area dated 10 October 2013 as a starting reference point. At this
point, the property was owned by the vendor:
Club house
Retail complex
Residents
Here is a satellite image one year later, dated 11 October 2014, around the time that Hsin Chong
announced the acquisition and approximately 2.5 months before the deal was closed. There appears to
have been no further work done on the area by the vendor in all this time:
Club house
Retail complex
Residents
23
And here is the most recently available satellite image dated 1 October 2015. By this point, Hsin Chong
had had ownership of the property for 9 months, yet the area looks exactly the same, save for
overgrown weeds around the residential properties:
Club house
Retail complex
Residents
Given its static state, it seems clear from these pictures that the previous owners of the property saw
little merit in the development. It also seems clear that Hsin Chong has put little effort into further
developing the project since the acquisition, and has either been unwilling or unable to monetize the
project.
So, why spend shareholder money on such a substantial acquisition in the first place and who stood to
benefit from this deal?
24
Each piece of land was held by a Wholly Foreign-Owned Enterprise (WFOE) of the same number. So
for example, Land 1 was held by WFOE 1, Land 2 was held by WFOE 2, etc, etc.
Of these, Land 1 is the only one to have been at least partly developed and is the site of the residential
properties, the outlet mall and the club house. There was no construction on Lands 2-5.18
Originally, Lands 1-4 were 50%, 60%, 60%, and 60% owned by Beijing Capital Land through WFOE 1-4,
respectively. Beijing Capital Land is a HK-listed entity (2868.HK) controlled by Beijing Capital Group.
Meanwhile, the remaining stakes of WFOE 1-4 were owned by a BVI holding company named Rich
Century. Rich Century also wholly-owned Land 5 through WFOE 5. In turn, Rich Century was 100%
owned by our favorite property-flipper, Mr. Lin.
In April 2013, Beijing Capital Land sold its stakes in WFOE 1-4 to Rich Century, giving Rich Century 100%
ownership of WFOE 1-5, and by extension, the entire Foshan property.19
17
25
We can see from Beijing Capital Lands annual report disclosures that it sold its stakes in WFOE 1-4 for
RMB$521 million (HK$651 million):
Beijing Capital 2013 Annual Report Disclosures
Conservatively pro-rating the disposal price by 50% implies that WFOE 1-4 were valued at HK$1.3 billion.
In addition, the Foshan acquisition circular states that WFOE 5 had net assets of HK$220 million as at 30
June 2014.20 Combined, that gives us a value of ~HK$1.5 billion for the entirety of WFOEs 1-5. Yet, that is
a far cry from the HK$5.9 billion that Hsin Chong paid for the WFOEs.
Indeed, we can see from satellite images that no major construction had been undertaken on the
property from the time shortly after Mr. Lin acquired the outstanding stake from Beijing Capital Land in
2013 and when he flipped the property to Hsin Chong in 2015 to justify this glaring HK$4.4 billion value
gap.
It just seems that Mr. Lin made out like a bandit acting as a middle-man on this transaction, while Hsin
Chong and its shareholders paid a grossly inflated price for a property that has seen de minimis progress
over the years and whose original SOE owner seemed eager to dispose of.
20
26
Notably, Hsin Chong discloses in its 2015 annual report that the Foshan acquisition includes deferred tax
liabilities of HK$6.1 billion:
However, the Foshan property has never generated revenue. Therefore, we suspect that the deferred
tax liability is, at least in part, the result of a write-up in the values of the assets pre-acquisition. We
suspect that this nonsensical write-up was conceived to make an otherwise terrible deal more palatable
to Hsin Chongs shareholders.
As a side note, while the Foshan deal ultimately closed in 2015, Mr. Lin had entered a Memorandum of
Understanding with Hsin Chong to sell the property as early as 2013 only months after he had
acquired the outstanding stake from Beijing Capital Land. Furthermore, Mr. Lin had the gall to initially
ask for as much as HK$10.6 billion for the Foshan property21 before the deal finalized for HK$5.9 billion.
Curiously, a week after the 2013 Memorandum of Understanding was signed concerning the possible
acquisition of Foshan, Mr. Mak Kwai Wing an independent director and head of the audit committee
resigned. Hsin Chong did not have a replacement ready to fill the vacancy which suggests to us that this
resignation was abrupt. In announcing his resignation, Mr. Mak explained that he would like to focus his
time more on his own profession.
However, at the time of his resignation, Mr. Mak was also an independent director, chairman of the
investment committee, member of the audit committee, member of the remuneration committee and
member of the nomination committee of Tianjin Development Holdings (0882.HK) positions that he
holds to this day. Apparently Mr. Mak lacked the same urgency to resign from these positions as he did
from Hsin Chong. We wonder why.
21
http://www.hkexnews.hk/listedco/listconews/SEHK/2014/1104/LTN20141104005.pdf pg. 18
27
Asset
Consideration
Notes
31-Mar-15
Tai'an property
HK$1 billion
29-Apr-15
Guangzhou property
HK$0.5 billion
Under refurbishment
14-Sep-15
Tianjin property
HK$0.9 billion
Undeveloped land
HK$2.4 billion
Source: 2015 annual report
Unbelievably, we found that all these acquisitions can be linked to Mr. Lin:
Taian property: Mr. Lin met the Taian local government in March 2012 to discuss the project.24
He even gave a speech at the cornerstone laying ceremony that year.25
Tianjin property: One of the shareholders in this property is Tianjin Century Group. Mr. Lin and
his wife appeared as guarantors on behalf of Tianjin Century Group in 2014.27
22
28
This is like playing the game Six Degrees of Kevin Bacon except instead of six degrees its just one
degree, and instead of Kevin Bacon its Mr. Lin.
Given the outcome of the Tieling and Foshan acquisitions, we are skeptical that these Lin-connected
projects will fare any better. In fact, it just seems that Mr. Lin is using Hsin Chong as his personal
dumping ground for problematic and non-revenue generating development properties. Despite their
recent acquisitions, there are already reported issues with these properties.
For example, this article dated 10 August 2015 states that phase 1 of the Taian property, which was
originally expected to be completed and begin a soft opening in 2014, is still incomplete. The reporter
also notes that construction had stopped for six months at the time of visit. There were only a few
security guards on site.
Meanwhile, this AFP article dated 20 May 2015 notes that the area where Hsin Chongs Tianjin property
is located is considered a ghost town where:
more than three years after construction began, all but one of the buildings planned for
the development in the northern Chinese port city of Tianjin appear unfinished, alongside
vacant spaces where others should stand.
In acquiring Tieling, Foshan, and all these other Lin-connected properties, Hsin Chong paid consideration
of at least HK$11 billion in cash and stock. 28 That is 3x the Companys current HK$3.5 billion market cap.
These expenditures were financed through a series of debt and equity offers that substantially
expanded Hsin Chongs balance sheet and extensively diluted minority shareholders. In 2010, Hsin
Chong had 673 million diluted shares outstanding. That was the year before the Company entered the
PDI business with its acquisition of Tieling. By the end of the 2015, there was 11 billion diluted shares
outstanding, representing a massive 15x increase:
Change in Ownership
(in thousands of shares)
2010
2015
673,174
10,843,359
4,757,122
44%
By acting as vendors to Hsin Chong in various property deals, Mr. Lin, Ms. Ma, and Mr. Wong amassed
underlying interest in 44% of the diluted shares of the Company by the end of 2015. In fact, in May
2015, Mr. Lin was appointed as a non-Executive Director of Hsing Chong, and then one month later was
appointed as its non-Executive Chairman29 which we believe effectively gave Mr. Lin reign of the
Company at the expense of minority shareholders. Thats not a bad outcome for a guy who was paid as
28
HK$5.9 billion for Foshan acquisition, HK$1.8 billion for Tieling acquisition, HK$1 billion for New Time Plaza, and
HK$2.4 billion for the three other acquisitions in 2015.
29
http://www.hkexnews.hk/listedco/listconews/SEHK/2016/0510/LTN20160510273.pdf pg. 41
29
a consultant and sold dubious assets to the Company while massively diluting shareholders in the
process.
If Hsin Chong was an individual, it would be a victim of Stockholm syndrome. But the abuse doesnt end
there. Outrageously, Hsin Chong has put deposits down on even more properties!
At year-end 2014, an earnest deposit of HK$130 million was paid in respect of a potential acquisition of
a property project in the PRC.30
Likewise, at year-end 2015, an earnest deposit of HK$200 million was paid in respect of a potential
acquisition of a property project in the PRC.31
We cannot fathom why Hsin Chong is putting earnest deposits down on more acquisitions when it
already has such a large portfolio of undeveloped properties that it has repeatedly failed to monetize.
Notably, between 2010 and mid-2016, prepayment and deposits to third-parties ballooned on Hsin
Chongs balance sheet and currently represent ~1/3 of its market cap:
Prepayments and Deposits to Third Parties
(In HK$ 000s)
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
2010
2011
2012
2013
2014
2015
2016 H1
We do not know what happened in 2016 H1 to swell the deposits so dramatically as there are no
accompanying notes to the financial statements. However, we find this growth incredibly suspicious
considering it sheer magnitude. We would not be surprised if there were even more earnest deposits
paid out for asinine land acquisitions.
30
31
30
Cash Burn
Nearly all of Hsin Chongs land bank is either in need of refurbishment or simply
undeveloped/incomplete. The question of commercial viability aside, we wonder how the Company will
be able to complete these projects given the additional capital requirements. Hsin Chong had
approximately HK$1.1 billion32 in cash at the end of June 2016, but we believe the Company is burning
through it at an unsustainable rate.
In each of 2013, 2014, 2015 and interim 2016 Hsin Chong has been operating and investing cash flow
negative. In fact, HK$8.8 billion exited the Company through CFO and CFI in the last four and a half fiscal
years, with nearly 2/3 of that occurring in the last 18 months alone:
Cash Flow Analysis
2012
CFO
CFI
Total
2013
2014
2015
2016 H1
Total
523,774
(1,274,515)
(989,418)
(681,657)
(1,357,325)
(3,779,141)
(119,518)
(1,244,514)
(39,372)
(3,181,048)
(410,959)
(4,995,411)
404,256
(2,519,029)
(1,028,790)
(3,862,705)
(1,768,284)
(8,774,552)
More concerning is that interest expenses are on the rise given the Companys large debt obligations.
According to its 2016 interim results, Hsin Chong paid cash interest of HK$352 million in the six months
to June 2016 most of which was capitalized:
On an annual basis, this means that Hsin Chong is paying HK$704 million in cash interest. Actually, this
figure is likely understated because in January 2016 the Company issued US$150 million in senior notes
bearing 8.5% interest. Due to the timing, these additional interest payments would not be reflected in
the above cash flow statement.
32
http://www.hkexnews.hk/listedco/listconews/SEHK/2016/0825/LTN20160825057.pdf pg. 20
31
Hsin Chongs cash concerns are evident in the fact that it scraped its long-standing dividend payout for
year-end 2015 and instead proposed issuing bonus shares to shareholders.
Furthermore, Hsin Chong seems to acknowledge these issues more directly in its 2016 interim results:
One absurd novel strategy Hsin Chong is now exploring to generate cash and monetize assets is by
repositioning parts of the Tieling and Foshan properties as homes and facilities for the elderly:
32
Here are some aerial pictures of the abandoned retirement home project in Jinzhou:
Source:http://www.aljazeera.com/programmes/101east/2016/09/china-economy160913081105227.html
The failure of this project is not very surprising. If theres anything we know about old people its that
they love 5PM early bird dinners and warm climates. Liaoning is one of the coldest provinces in China.
Building retirement homes in a province where winter temperatures can drop to -11C is a terrible idea.
We believe this new attempt at repositioning its property portfolio is a tacit admission by Hsin Chong
that it is having serious problems monetizing its land bank.
33
Valuation
We value Hsin Chong as the sum of its PDI book value and the P/E of its construction business.
Book Value
Taking its balance sheet as stated, Hsin Chong has a book value of HK$1.25 per diluted share. With
shares currently trading at HK$0.62 per diluted share, this represents a 50% discount which is consistent
with many similar-sized HK-listed property development companies.
However, given everything presented in this report, we dont put much weight in the stated value of the
Hsin Chongs property holdings. Accordingly, we apply a 60% haircut to Companys PDI assets and take
into account the full dilution of shares:
Hsin Chong Balance Sheet 30 June 2016
(in HK$ millions)
As Stated
Haircut
Adjusted
1,076
0%
1,076
3,287
10%
2,985
2,478
0%
2,478
17,419
60%
6,968
24,260
13,480
588
0%
588
11,155
60%
4,462
Intangible assets
113
0%
113
986
100%
505
0%
505
Investment properties
13,347
Total Assets
37,607
5,668
19,148
5,761
0%
5,761
Short-term borrowings
6,391
0%
6,391
312
0%
312
12,463
12,464
Long-term borrowings
3,898
0%
3,898
Deferred tax
6,358
100%
10,263
3,898
Total Liabilities
22,726
16,362
Non-controlling interests
659
Total Equity
659
2,127
11,409
11,409
1.25
0.19
Diluted shares*
34
0%
14,222
In addition, the Foshan acquisition circular states that WFOE 5 had total assets of HK$702 million.35 This
gives us a combined asset value of $HK3.7 billion for WFOEs 1-5.
34
http://www.bloomberg.com/news/articles/2016-07-11/ground-zero-of-china-s-slowdown-leaves-locals-lookingfor-exit
35
http://www.hkexnews.hk/listedco/listconews/SEHK/2014/1104/LTN20141104005.pdf pg. IIF 4
35
However, when Hsin Chong acquired the assets two years later from Mr. Lin, it capitalized HK$15.2
billion worth of property on its balance sheet HK$2.7 billion as investment properties and HK$12.5
billion as properties under development:
Hsin Chong 2015 Annual Report Disclosures
This is 4x the value of the same property in the span of ~2 years. Recall from the satellite images that no
major work had been carried out on the site from shortly after the time Beijing Capital Land disposed of
the property and when Hsin Chong acquired it from Mr. Lin. Reverting to the original disposal value
assumes a ~75% discount. Accordingly, we believe our 60% discount more than fair.
Considering that Foshan and Tieling represent the vast majority of Hsin Chongs land bank, and
considering that all of the other acquisitions share links to Mr. Lin, we are comfortable applying our 60%
discount to the entirety of Hsin Chongs PDI assets.
Furthermore, we are also giving a 10% discount to Hsin Chongs prepayment account because at least
HK$200 million of this amount is earnest deposits on more land acquisitions, which we have no reason
to believe will perform any better than all the other non-revenue generating properties the Company
has acquired.
And finally, we are also nulling Hsin Chongs tax indemnification assets and its deferred tax liabilities,
because in practical terms we do not believe these assets/liabilities will be realized as they are
associated with the write-up of the properties. We note that this adjustment benefits the Company
significantly since its tax liabilities far outweigh its tax assets.
Based on all of the above, we value Hsin Chongs PDI assets at an adjusted book value per diluted share
of HK$0.19.
36
Earnings Value
While the majority of this report has focused on its PDI business, Hsin Chong also has a construction
business. In fact, Hsin Chong has historically been known as a construction company, which we believe is
a credible business with a notable presence in Hong Kong. Unfortunately, we do not believe the
construction business is profitable enough to support Hsin Chongs current valuation.
Over the last three years, a large part of Hsin Chongs reported profitability was the result of valuation
gains and gains on bargain purchases. For example, in 2015, the Companys reported HK$2.3 billion in
gains of bargain purchase represented almost all of its HK$2.6 billion in pre-tax profits. Likewise, in the
first half of 2016, fair value gains of HK$459 million represented nearly all of its HK$475 million in pretax profits.
This shouldnt be entirely surprising because as we presented on page 31, Hsin Chong has been
operating cash flow negative in each of 2013, 2014, 2015, and interim 2016. To get a more accurate
picture of the construction business recurring earnings potential, we have adjusted Hsin Chongs TTM
income statement by stripping out the PDI business as presented below:
Hsin Chong Normalized Income Statement TTM
(in HK$ 000s, except per share figures)
Revenue
TTM
Less PDI
Adjusted
12,992,839
74,645
12,918,194
Cost of Sales
-12,356,209
-58,838
-12,297,371
Gross profit
636,630
15,807
620,823
103,988
117,975
-13,987
299,341
299,341
562,675
562,435
240
-22,393
3,059
-25,452
-517,786
-88,627
-429,159
-10,987
-1
-10,986
6,237
2,132
4,105
Interest expenses
-120,817
-26,022
-94,795
936,888
886,099
50,789
-154,587
-146,206
-8,380
782,301
739,893
42,409
0.0037
Construction multiple
12x
0.04
Applying a generous construction industry multiple of 12x to Hsin Chongs TTM adjusted earnings
implies a value of HK$0.04 per diluted share for the construction business.
37
Summing the construction business value (HK$0.04) and PDI book value (HK$0.19) would, in theory,
value Hsin Chong at HK$0.23 per diluted share.
In theory.
Unfortunately, there is often a distance between the theoretical valuation of a security and the practical
application of investment logic which rarely fit neatly into an Excel spreadsheet. In reality, we believe
shares of Hsin Chong are mostly worthless from the perspective of minority shareholders. Consider that:
In order to preserve funds, Hsin Chong has suspended its dividends and shareholders are no
longer receiving any cash flow from this investment.
Based on Company disclosures, we estimate Hsin Chong will pay well over HK$700 million per
year in interest expenses alone. Most of this interest expense is capitalized and doesnt flow
through the income statement. However, in cash terms, it seems that all the profit generated
from the construction business will not be able to fully pay this interest expense. We note that
Hsin Chong has consistently been operating cash flow negative in each of 2013, 2014, 2015 and
interim 2016.
Management expects to meet Hsin Chongs financial requirements by a combination new equity
shares, debt securities, and bank borrowings so look forward to more dilution.
The Company has shown very little ability or desire to actually monetize the properties it has
acquired from Mr. Lin and his associates. Even if the Company had the desire, we dont imagine
many potential buyers sitting in their office thinking my portfolio needs more ghost towns.
Given the fact pattern, including the earnest deposits for more land acquisitions in the PRC, it
appears that Hsin Chongs new raison d'etre is simply to act as a dumping ground for Mr. Lin.
The large ownership interest of Mr. Lin and his associates, as well as his entrenchment as nonExecutive Chairman give Mr. Lin substantial reign over Hsin Chong, which makes a push for
corrective action by minority shareholders incredibly difficult.
In the end, its questionable what, if any potential value minority shareholders are getting when they
buy into shares of Hsin Chong. In order to better capture these critical issues, we believe a discount of
50% is appropriate in valuing Hsin Chong from a minority shareholder perspective:
(in HK$)
Property book value
0.19
0.04
Theoretical value
0.23
-50%
0.12
Accordingly, we value Hsin Chong at HK$0.12 per diluted share. With shares currently trading at
HK$0.62, our valuation suggests a potential 81% downside.
39