Photographer: David Paul Morris/Bloomberg

Keeping the Faith (Even After a 99% Wipeout) for Shareholders

  • Repeat rights issuers under scrutiny as bourse link expands
  • China’s concerns highlight scope for regulatory friction

No one can fault the managers of Eminence Enterprise Ltd. for lacking chutzpah.

After saddling investors with a 99.99 percent loss since 2011, the Hong Kong-listed property firm is asking shareholders to plow fresh capital into the business for the eighth time in five years. Eminence plans to raise at least HK$478.2 million ($61.7 million) in a rights offering next month, twice as much as its current market value.

It’s a scenario that often ends badly for Hong Kong investors, who stumped up more than $16 billion for rights offerings by the city’s smaller companies over the past five years, only to watch the median stock drop 36 percent in a rising market. Now, as China gives its citizens greater access to Hong Kong small-caps through a new cross-border exchange link, the city’s repeat rights issuers are coming under increased scrutiny.

Chinese authorities have warned investors to be wary of such companies, even as offerings like the one proposed by Eminence remain legal in the former British colony. Beijing’s concerns highlight the potential for friction as the exchange link blurs the lines between a high-touch regulatory regime in China and the more laissez faire system in Hong Kong.

“Individual investors from the mainland get burned when they blindly apply their small-cap knowledge to Hong Kong stocks,” said Dai Ming, a money manager at Hengsheng Asset Management Co. in Shanghai. “The mainland regulator sees small investors as the market foundation and offers them meticulous parenting. As Hong Kong seeks to boost trading by luring mainland investors, it must step up protection.”

Rights issues, in which a company offers new shares to existing stockholders, are used by firms around the world to raise capital for any number of reasons, including paying off debt and funding expansion. While Hong Kong requires companies to disclose details of planned and completed offerings, critics of the city’s regulations say unsophisticated investors are vulnerable to firms who use repeated issuance to keep loss-making businesses afloat.

Eminence’s proposed rights offering is subject to approval from independent shareholders, according to an exchange filing last month. The company, which also has a money-lending business, plans to use the funds for property investments and working capital, saying most of its HK$376 million of cash and cash equivalents at the end of October has been earmarked for other purposes.

The firm has no comment, according to Betty So, who identified herself as assistant company secretary for Easyknit Group, to whom calls to Eminence were transferred. The two businesses have offices and some top managers in common, and Easyknit, also a property firm, is listed as a substantial shareholder of Eminence in the latter’s latest annual report.

Read more: A QuickTake Q&A on the Shenzhen-Hong Kong exchange link.

Eminence recorded net losses in seven of the past 10 years, including a loss of HK$69.3 million in the fiscal year ended March that the company attributed to declines in the fair value of investment properties in Hong Kong, exchange filings and data compiled by Bloomberg show. Shares have tumbled more than 80 percent in each of the past four years, a period when the Hang Seng Index rose 19 percent.

Eminence is hardly unique. More than 290 companies in Hong Kong with market values below $1 billion have conducted rights offerings since December 2011, raising about six times more than their counterparts in China. The Hong Kong firms reported net losses totaling more than $5 billion during the period, versus a combined profit of about $2.5 billion for rights issuers in China, data compiled by Bloomberg show.

Faced with a rights issue, individual investors can buy more stock, betting the new funds will spur growth; hold tight and watch their shareholding get diluted; unload their stake; or, in some cases, sell the rights to other investors.

Sun Xiongjin, a 39-year-old resident of Wuhan in central China, decided to hold tight two years ago after China Environmental Energy Investment Ltd. -- a Hong Kong-listed firm whose ventures have included recycling, Internet services and diamond trading -- announced a rights issue at an 82 percent discount to the stock’s market price, the company’s second offering since 2011.

Sun’s HK$220,000 investment lost 90 percent of its value after the deeply discounted rights offer, while shareholders who subscribed to the rights lost more than 80 percent over two years. China Environmental reported net losses totaling about HK$1.6 billion in the three years through March, which it attributed to factors including goodwill impairments on its Internet and recycling businesses.

Shenzhen Warning

“I felt terrible,” Sun said in a phone interview. “I learned a lesson and now always check a company’s history of rights.”

China Environmental didn’t respond to questions from Bloomberg News delivered to the company’s Hong Kong office. The firm’s website lists no phone number or e-mail address. Shares fell 3.8 percent on Wednesday, while Eminence declined 1.4 percent.

China’s regulations on rights issues are stricter in some respects than those in Hong Kong. Chinese offerings require approval from the nation’s securities regulator and two-thirds of the votes in shareholder meetings, while Hong Kong rights issues don’t need stockholders to sign off if new shares amount to less than 50 percent of the firm’s existing equity.

Shenzhen’s exchange is adding warnings about Hong Kong rights issues to a risk-disclosure statement for traders who use the new link. The offerings have also been highlighted by state-run Chinese media as a potential danger for investors.

‘Cowboy Exchange’

For those who do their homework, Hong Kong offers all the information needed to avoid companies with a history of rights offerings that end poorly for shareholders.

“I can be angry about it, but that’s the marketplace here,” said John White, a Hong Kong-based managing director at Heitman LLC, a global real estate investment firm whose holdings include publicly-traded property shares.

The city operates a disclosure-based regulatory regime instead of trying to weed out bad actors ahead of time, Charles Li, the chief executive officer of Hong Kong Exchanges & Clearing Ltd., wrote in a blog post in September. The bourse’s rules offer protections for small investors, including the need for independent stockholder approval on large rights offerings, an exchange spokeswoman said in response to questions from Bloomberg News. Hong Kong’s Securities & Futures Commission didn’t reply to requests for comment.

For David Webb, a shareholder activist and former board member of Hong Kong’s exchange, the city needs to do more to protect its reputation as a major financial hub.

“We are starting to look like the cowboy exchange to China, while they are starting to look like the grown-up and a better regulated market,” Webb said.

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