The company put out a press release related to the unusual activity in the stock.
UNUSUAL PRICE AND TRADING VOLUME MOVEMENTS
We have noted the recent decreases in the price of the shares and the significant trading volume involved of Huabao International Holdings Limited (the “Company”). Save as disclosed below, we are not aware of any reasons for such incidence.
We have been recently notified by Ms. CHU Lam Yiu, the controlling shareholder of the Company, of her entering into a derivative transaction on 14 October 2011 relating to a long position of a monetary value equivalent to 94,736,842 shares of the Company with a contract period starting from 14 October 2011 to 13 January 2013...
I have a simple question: what is the "derivative transaction" that Ms. CHU Lam Yiu entered into regarding over 94 million of her shares?
In my world all derivatives can be bifurcated into a series of forwards, put options and call options. (The bifurcation is alas not unique...)
Unless I am mistaken then she has either
(a) sold her shares using forwards in which case it is effectively a forward sale (she has just cashed out and used fancy language and derivatives to obscure this fact),
(b) sold the upside of her shares by selling call options or
(c) protected the downside of her shares by buying put options or
(d) some combination of the above.
All of those are bets against her shares in some form or other. Of course I can be mistaken, but it seems the CEO is betting against her own shares using derivatives.
I am also betting against her shares - so I have something in common with her.
But not much.
You see I am just a guy who reads public filings. She is the controller of the company and the world's youngest self-made female billionaire. She is a smart cookie too: took her company public via reverse takeover, sold a chunk of shares in 2008, and again in 2009 and again recently. She is, on some lists, the eighth richest woman in the world.
And she still seems to be betting against her shares. Mostly she sells at lower prices.
But whatever: I think we are entitled to know precisely the nature of the bet that the CEO has taken against her shares.
I am happy to disclose my bet: I am short. Ms. CHU Lam Yiu, it is your turn to disclose.
She is the second biggest insider-seller of any Chinese stock according to this list - having cashed out about half a billion US dollars this year.
I have now emailed with many people who have an interest in Huabao. Some visited the (recently purchased) reconstituted tobacco leaf plants - and they were moderately impressed. Some visited the flavors plant (the legacy business) and they found a few blue drums and a vat full of strange liquid but nothing redolent of a business then worth over USD3 billion. They ran a mile from the stock.
The most impressive website any of the people I communicate with has found is for their Peacock brand. They sell 572 products (far less than most retail shops) including "tomato sauce" and "cheese powder". Press "new products" and you get a one word answer: "no". A similar response is given for "food flavor". Isn't this meant to be a flavors company?
This compares as I noted in my previous blog post with maybe 100 thousand pages of text on the website of the major company in this industry (Givaudan).
It is unlikely you make 60 plus percent margins reselling flavored yogurt on an obscure Chinese website. I am not joking - see this link.
The only way that the margins - almost five fold the margins of Western competitors - are possible is by selling at an inflated price to the Chinese state owned tobacco companies. And indeed that is what the bull story is as many of my readers have pointed out.
I can neither confirm nor deny the existence of those sales. My only correspondents who have visited the factories responsible for those sales found a few blue drums. But there might be a large and complex factory behind that or there may be other sites so their word should not be taken as complete.
Moreover Price Waterhouse Coopers audited the accounts and they tell me the sales are real so I presume they are. Whatever: if real it is likely that one day the State Owned Enterprises will try to renegotiate the deal which seems unreasonably favorable to Huabao...
Maybe that is why Zhu Linyao is the "Queen of Cashout".
by selling at an inflated price to the Chinese state owned tobacco companies. And indeed that is what the bull story is as many of my readers have pointed out
Oh god help us, the old smart-dumb "oh yes, we know they're dodgy, but they're on our side, and despite never having met us, these people are going to use all their government contacts for our benefit". Did nobody learn anything at all from investing in Indonesia in the 90s, or am I just old?
Nemo Incognito said...
Look, he may be an insufferable barbaric kleptocrat but if you smoke cloves in Indonesia you are smoking his. - Asian Ibanker re Tommy Soeharto circa 1995
Looks like Huabao is done. Spoke to some folks at Kunming Ciagrette Co and this is news to them, so either they:
1) Didn't know about this and are going to stop it
2) May have been on the take but can't continue doing so now or
3) Huabao straight up does not exist.
October 17, 2011 9:08 PM
Anton de Stoc said...
I've been doing some thinking about different sorts of dumb, centering around Bre-X and some Australian rocks that have been innocently sitting in Western Sydney for 25 years.
Its easy to be smart-dumb.
Its harder to be smart-dumb about stuff you actually know about.
Food additives and perfumes are some pretty specific organic chemistry, and frankly virtually no-one knows about how hard or what the margins are.
As organic chemistry is hard, smart-dumb is what I'd bet on.
October 18, 2011 1:55 AM
@ Bronte Capital,
Agree with your assessment of Huabao, but there may be much bigger short opportunities in the "recovering" U.S. money center banks who are announcing bodacious earnings increases such as Wells and Citi due to "deposit and loan" increases.
The problem isn't just with the non-performing loan portfolios -- it's how they generate revenues on a retail level -- through a variety of scams. These scams involve trying to get the consumer to open needless bank accounts in an effort to get deposits. There isn't much differentiation as you might imagine for a commoditized business so if that doesn't work, the personal bankers, managers and down to the tellers are forced to open accounts for each other. This scam involves opening and closing accounts in succession so they can book "deposit growth." What happens when these retail branch people run out of "friends and family"? They get fired and the scam starts afresh.
Debit cards are also a considerable scam.
Don't believe me? Spend some time talking with retail branch operations and you'll get an interesting look.
October 18, 2011 2:15 AM
I kind of not get the Half-Priced Hoo... oops, sorry slipped, Price-Waterhouse-coopers story. "They say the sales are real" as in "as usual, they claim to have no way of verifying that"?
I mean, I can understand getting fooled by a novel fraud, but by now it looks like the "inside guy in a bank who provides cursory confirmation about money on the accounts over the phone" trick is in the book, no? Their public audits should have "methodology" section where one can see if they at least try to avoid being fooled by stuff like this...
P.S. And guess I'm old too, or maybe just too Russian :) People truly keep trying to win (http://en.wikipedia.org/wiki/Shell_game) even seein it for what it is! Like that persistent urban legend that fraudsters would let "win first try" "in order to lure one deeper into the game", which people of seemingly sane mind use as a reason to make "just one bet", haha.
October 18, 2011 1:01 PM
I think you don't understand what this or any other tobacco flavourings company actually does. As tobacco grows, its flavour alters according to the location in which it is grown, the amount of rain or sun it recieves each year and general climatic conditions, etc, just like apples or any other foodstuff. It then takes approx 2 years to dry, changing flvour all the time. What Huabao do is maintain a library, if you like, of the exact chemical composition of each brand's identity flvour and they then test each batch of tobacco and adjust the flavourings accordingly to bring it back to the brand flavour. The amounts of chemical used for this are teeny, hence minimal asset base - it's all in the knowledge. They have diversified into RTL recently as the Chinese tobacco market has consolidated, so there's not much growth in their taditional market any longer. That is why they are trying to break into the food flavourings too, but it is essentially the same model - keep a detailed chemical inventory of a brand's signature taste and replicate it to keep the taste consistent. There are lots and lots of reasons not to like this stock, but the ones you have highlighted here are not some of them.
October 20, 2011 3:31 AM
13 January 2013 is not an exchange-traded option expiry date. I wonder who the counterparty is.
October 20, 2011 9:30 AM
While the press release doesn't exactly inspire confidence, it's not completely clear to me that "derivative transaction...relating to a long position" necessarily means an offsetting transaction. Couldn't it mean for example that she purchased call options outright? Or sold puts? Seems improbable but the language is not as clear as you suggest!
October 20, 2011 10:27 AM
That's a very unclear statement, but doesn't it read as if she'd bought instead of sold via the derivatives market? Or maybe it reads "all your base are belong to us."
October 20, 2011 12:47 PM
Would it be too surprising if the counterparty of the trade is Huabao itself?
October 20, 2011 2:07 PM
Nemo Incognito said...
Tom - looks like its a large American non-cephalopod bank.
October 20, 2011 4:01 PM
Maybe it is an OTC equity swap?
October 20, 2011 5:01 PM
Clearly the derivative involves an exposure to the stock price that is short, not long, as it is being used to explain a massive sudden *drop* in the stock price - ie, whoever is the counterparty had to hedge the derivative by selling, not buying. Very interesting, and the failure to provide details is super dodgy.
The stock has tanked a long way already but I suspect that a substantial part of this company's supposed business doesn't actually exist! I spoke to a fund manager today and mentioned this to him, and it turns out that he actually met with Huabao around 3 years ago and asked to inspect their factories, and he said that there was simply nothing there, nothing going on - they gave some kind of sketchy excuse about the factories just happening to not be running at the time of his visit.
I can't wait to see how much further this stock drops.