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No Crying Over Huishan's Spilt Milk

Don't blame the market for this debacle, and spare a cheer for small investors.
As of 9:20 PM EDT
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If there's one thing more extraordinary than the 85 percent slump in China Huishan Dairy Holdings Co. shares last Friday, it's the 0.4 percent decline in the stock over the previous three months.

Investors minded to take a bearish view of Huishan would have found plenty of fodder -- figuratively and literally 1 -- in the Dec. 16 report from short-seller Muddy Waters Research, which concluded the company was "worth close to zero." (Huishan said allegations in the report were groundless and contained misrepresentations.) Despite this, Huishan's Hong Kong-listed shares modestly outperformed those of China's second-largest milk producer, China Mengniu Dairy Co., from that date, right up until the moment they lost $4.1 billion in 90 minutes.

If Something Can't Go On Forever

Shares in Huishan Dairy did nothing, and kept doing nothing, and then plummeted

Source: Bloomberg

Note: Rebased. March 28, 2016=100

A lack of trading activity doesn't explain the eerie calm in Huishan's shares. Although about 71 percent of Huishan is owned by Champ Harvest Ltd., a vehicle that chairman and founder Yang Kai uses to control the business, it's not lacked for liquidity.

About HK$2.95 billion ($380 million) in stock changed hands between Dec. 16 and March 23, compared with the HK$8.11 billion turnover in Mengniu. Average bid-ask spreads were about 0.37 percent of the mid-price, in line with blue chips such as nuclear generator CGN Power Co., hotel operator Shangri-La Asia Ltd., and gold producer Zijin Mining Group Co. That near-straight line on the chart above isn't a result of no one buying or selling Huishan stock. It's a result of someone always being willing to buy around the HK$2.90 mark.

There's feverish speculation in Hong Kong about the identity of that weirdly consistent buyer or buyers. Company filings show that Champ Harvest bought about 45 million shares after Muddy Waters' report in December, but that's only a tiny fraction of the stock that's changed hands since then.

One possible explanation would be if people connected to the company spent three months buying stock on the market to prop up the share price, before finally running out of cash. 2

There certainly is plenty of cash around. PingAn Bank Co. announced Tuesday that it had accepted 3.43 billion shares of Huishan as collateral for a HK$2.14 billion loan to Champ Harvest. Huishan also announced Tuesday that another 6 billion of its shares were pledged as collateral for loans to Champ Harvest and other Yang-controlled companies, or deposited in Champ Harvest's brokerage accounts to secure margin finance.

Huishan Dairy itself had 9.78 billion yuan in cash and equivalents at the end of September. Ge Kun, who managed the company's relationships with principal bankers as well as its internal treasury and cash operations, wrote to Yang last week saying she would "take a leave of absence and does not want to be contacted at this time," according to Tuesday's statement.

Freedom Is Relative

Companies where free-floating shares make up less than half the total account for 45% of the capitalization on the Hong Kong exchange

Source: Bloomberg

It's tempting to view this sort of activity as an innate problem with the Hong Kong stock market, which is unusually dominated by insider-controlled companies. Businesses in which less than 50 percent of the stock floats freely make up 45 percent of the capitalization on the territory's exchange, compared with around 4 percent in London and New York.

Tempting, but wrong. While Hong Kong's market has its wild corners, local investors aren't dupes and its more illiquid stocks aren't necessarily badly run. The median return on equity of companies where less than one-fifth of the stock floats freely is 9 percent, barely worse than the 9.4 percent at companies where more than four-fifths is traded. 3  Returns are the best in the 60 percent-to-80 percent free float range, but not by much.

She's Lost Control

Return on equity in the least-liquid quintile of Hong Kong stocks isn't much worse than in the most-liquid, and dividends are better

Source: Bloomberg

Note: Shows only the 274 companies with at least $1 billion in revenue.

Look at dividends and the real attractions of those illiquid stocks start to show up. The median dividend yield in the zero-to-20 percent range is 3.5 percent, well ahead of the 2.32 percent in the most-liquid quintile. That stands to reason: Companies that are treated as the personal piggy banks of controlling shareholders are likely to pay a decent income to those shareholders, and minorities get to hitch a ride.

There's good reason to worry about the activity that led to Huishan's slump, but it's not a reason to blame the Hong Kong market. Indeed, a whole lot of investors since the publication of the Muddy Waters report managed to offload stock at around HK$2.90 that's now worth about HK$0.42. That's not great for whoever's been buying -- but for the territory's mom and pop investors who sold out, it's a perversely good result.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. A large part of Muddy Waters' argument focuses on contesting the company's claims to be self-sufficient in alfalfa to feed its cattle.

  2. A call to Wendy Chan, an external spokeswoman for the company at Wonderful Sky Financial Group, wasn't answered. An e-mail to her wasn't immediately returned.

  3. We've excluded companies with revenue below $1 billion to save the large number of startups muddying the picture.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net

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