The Spectacular 176% Surge of a Debt-Laden Apparel Maker's Stock

  • Codes Combine rocketed 500% after news of FTSE index addition
  • Korea Exchange prompted to introduce rule to prevent repeat

One of South Korea’s best-performing equities this month is a debt-ridden, cash-strapped clothing company that has less than 1 percent of its shares available to trade, creating a situation so volatile the country’s stock market brought in a rule designed to prevent a repeat.

Codes Combine Co.’s share price has risen 176 percent in March, gaining more than 500 percent at one point. The moves have been so pronounced that it was briefly the second largest public company in the small-cap Kosdaq index by market value. Such has been the shock in the country that on March 22 Korea Exchange said that from now on it will suspend trading in any company that has less than 2 percent of its outstanding shares on the Kosdaq market.

The dramatic moves came after an announcement on March 2 that Codes Combine, a company that only has 0.7 percent of its shares available to trade, would be added to the FTSE Global Small Cap Index. That meant an influx of foreign investors reacting to FTSE’s move and trying to buy a hard-to-get stock. The subsequent price moves, in which the stock moved the daily limit of 30 percent on about a half dozen occasions, highlight what happens when there’s a lack of liquidity in a security.

“This is a very rare case,” Park Seung Bae, director-general at the Kosdaq Market department of Korea Exchange, said by phone. “This case happened because the company’s shares were mostly locked up as part of a court receivership, but the demand for buying such a small amount of floating shares surged.”

Codes Combine’s shares started to post double-digit growth on March 3, the day after FTSE said it would add the company to its index on March 18. The London-based institution didn’t reveal the weighting of the company on the index. On March 7, Codes Combine issued a statement saying it had "no crucial information enough to affect the market," in response to Korea Exchange seeking an answer for the surge.

Foreign investors have bought a net 3.4 billion won ($2.9 million) worth of shares between March 2 and March 15 when the stock reached its one-year high, according to data compiled by Bloomberg. As of Monday’s close the stock had gained 176 percent compared to the benchmark Kosdaq’s 3.8 percent rise. Codes Combine on Tuesday again rose the daily limit of 30 percent, while the Kosdaq climbed 1.5 percent.

"All our indexes are based on data from public sources, and we welcome any moves by regulators and exchanges that further increase transparency," an FTSE Russell spokesman said in an e-mailed statement. FTSE’s screening method includes looking at a stock’s liquidity twice a year and also takes into account daily volume and free-float adjusted shares, using publicly available information, according to the company’s Web site. Codes Combine didn’t post an English-language filing on the lock-up, which is not mandatory in Korea.

Four straight years of operating losses at Codes Combine saw Korea Exchange lock up 99.3 percent of its 37 million shares in December. Half the locked-up shares will be released in June with the rest coming back on the market in August. To lower its debt-to-equity ratio, it has gone through a capital reduction program and issued more shares.

Codes Combine was started in 2002 by a couple selling clothes at Korea’s outdoor market Dongdaemun in Seoul. It was once hailed as the country’s domestic answer to retailers such as Zara. In 2012 its annual revenue was 200 billion won. It also faced its first operating loss that year amid ownership conflicts between the couple, tax audits and issues from expanding too fast, Kim Jun Ho, a manager in charge of investor relations at the company, said in a phone interview on March 24.

No one can prove that FTSE’s adding of the company to one of its indexes has affected the buyers’ decisions, according to Gilbert Choi, analyst at NH Investment & Securities.

“It could be one of standard strategies of hedge fund managers who are targeting distressed companies with their financial statements cleared through capital reduction,” Choi said by phone. “In a normal case, no one invests on a company doing capital reduction as it means the company is bankrupt. This case is just a black swan.”

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