Multi Sports, Xinquan - Post mortem

Red chips in Bursa. The first couple were hard to swallow, who will dare bring more in. Investment bankers were patting themselves before the listings, now they wondered if they are doing the right thing.

Why these shares almost immediately trade below IPO price:

a) the usual question, why choose to list in Malaysia, that in itself is a difficult question to answer, how to dispel the rumours that they are too small to list back home

b) the pricing will have to be fair relative to what other red chips are being priced in SGX, Xinquan was priced too high at IPO

Does that mean we should forget about bringing red chips over to list on Bursa? No, but we need to rethink our strategy.

1) Investors will be concerned that they have never seen the operations and that they may never get "good research coverage" or even corporate news analysis on the counter. The investment banker should be coming out with decent research reports for at least 2 years (updates on each quarterly results). Any red chip listing on the Bursa should have to pay RM100,000 a year to two other brokers research house to cover their stock for two years.

2) Bring in respected investors or institutions when applying for IPO - e.g. get EPF, LTAT or influential investors such as Quek or Kuok or other interesting outfits such as "private equity firms" or "respected long term asset management firms" to take substantial stakes pre-IPO. These shareholders should have a minimum holding period of not less than 12 months before they can sell.

If you don't implement these two measures, I can safely bet you that all upcoming red chips to be listed on the Bursa will drift below IPO price almost immediately upon listing, unless you manage to bring in those red chips that are sufficiently big enough (e.g. market cap more than RM1bn).

The final question mark is that there is still the sneaky suspicion that these smallish red chips may be packaged to list on Bursa or other overseas exchanges by "amalgamating a few smaller companies as one" - this lack of long term cohesion is a worry.

The other way confidence could return to these red chips is if these companies continue to show good results quarter after quarter for a substantial period, and/or these companies were to be "bought aggressively" by institutional investors or private equity firms with the intention of taking them private (because they traded so cheaply). Once these things happen, you will find investors regarding these smallish red chips with a different and improved mindset. You cannot blame investors for being cautious with so many unknowns.

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Shoe sole maker Multi Sports Holdings Ltd was the second China-based company to debut on Bursa Malaysia’s Main Market on Aug 19. The group, known in the industry as the provider of the Huoxing brand of shoe soles, prides itself on being the “one-stop shoe sole specialist” for China’s sports footwear industry as it is “vertically integrated” and is able to process raw materials to produce components needed as well as design and develop shoe soles.

The company operates in Jinjiang city in Fujian province, China’s sports shoe manufacturing capital and one of the world’s largest sports shoe manufacturing centres. In 2007, Jinjiang accounted for 20% of the world’s total sports shoe production. There are an estimated 3,000 shoe manufacturers in Jinjiang producing an estimated 700 million pairs of shoes per year, according to Multi Sports’ initial public offering (IPO) prospectus, citing the China Leather Industry Association. In 2008, Multi Sports Group had a 1% market share of China’s 2.1 billion pairs of rubber/plastic shoe soles production and 0.2% market share of the 10 billion pairs in the footwear soles sector in China, based on its output of 22 million pairs of sports shoe soles.

The group, one of the five largest shoe sole-makers in Jinjiang, currently has a 1,929-strong workforce, of whom 64% or 1,241 are skilled workers. The group has 300 customers, including Guohui, 361 degrees and Xdlong, manufacturers of well-known local sports shoe brands. Between 2005 and 2008, its annual production grew from about 4.9 million to 22.1 million pairs of shoe soles, with some 300 designs across four main product lines. Multi Sports’ production capacity is set to triple over the next two years as some RM30 million of the RM48.96 million gross proceeds from the IPO has been earmarked for the expansion of its production capacity within 24 months.

OSK Research, in a note dated Aug 7, says Jinjiang’s existing order book is three times its production capacity and reckons that the group’s earnings would see a compound annual growth rate (CAGR) of 18.3% over the next two years. In the past two years, the group registered a CAGR of 33.9%. OSK expects margins to improve on the back of higher production volume. “Compared to the first Chinese IPO, we are slightly more positive on Multi Sports premised on its current order book which is three times its current capacity; high cash conversion cycle; less competition (about 100 shoe sole producers versus over 3,000 shoe manufacturers in Jinjiang). Previously, we pegged Xingquan International Sports Holdings Ltd’s FY2010 PER at 5.4 times based on S-share companies listed in Singapore rather than Hong Kong or China-listed companies. We believe it is more realistic given its lower earnings base and market capitalisation. Using the same FY2010 PER valuation of 5.4 times FY2010 EPS, we derive a fair value of RM1.03, with an upside potential of 21.5%,” OSK says.

The Quek family, who is a major shareholder of Multi Sports Holdings Ltd, has sold off a chunk of its equity stake in the Chinese shoe sole-maker. According to filings to Bursa Malaysia last Friday, the Quek family, via its Cayman Islands incorporated vehicle GuoLine Group Management Co Ltd, had disposed of a 3.6% stake comprising 12.97 million shares in Multi Sports on Aug 24. The Quek family had held about 15% of the company before selling down the shares. It now owns about 11.4% stake or 41.03 million shares in Multi Sports. Multi Sports IPO: 85 sen Now: 52 sen

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Xinquan International Sports

307.33m shares
IPO: 1.71
High: July 15 2009 (1.81)
Now: 1.39

The current Executive Chairman, Mr. Wu Qingquan established Jinjiang Xingquan in 1995, jointly with his wife, Mdm Zhuang Hongji, and his brother, Mr. Wu Lianfa, to engage in the manufacture of shoes and shoe soles for local and international shoe manufacturers. In 2009, they acquired the entire share capital of Addnice Holdings for a purchase consideration of USD21.503mn which was satisfied entirely by the issuance of the Consideration Shares at an issue price of USD1 per Consideration Share. The products under the 'Addnice' brand are distributed across 20 provinces, municipalities and autonomous regions within the PRC. Products which the Company manufactures as OEM are also distributed outside the PRC by its OEM customers. As at the Latest Practicable Date, the Company has appointed 29 authorized-regional distributors and 43 direct retailers to distribute its 'Addnice' products. The Company's 'Addnice' products are sold via 954 'Addnice' specialty stores and 464 retail stores totaling 1,418 point of sales. An aggregate production capacity for sports and leisure shoe products and shoe sole products in Quanzhou amount to approximately 5.9 million and 14 millions pairs per annum, respectively.

For its financial year ended December 31 2008, Xingquan posted RM323.56mn revenue and RM65.76mn profit after tax.This company is established in Bermuda.

RM2.10, OMG, it went downhill amidst a good bull run for most equity markets. Underwriter CIMB Investment Bank Bhd recently activated and completed the price stabilisation mechanism, a first in the local market since it was introduced in early 2008, in relation to Xingquan’s listing. But even CIMB said enough is enough, we should only take so much losses. The price stabilisation mechanism, which is not uncommon in other markets, was aimed at assuring investors that a party was backing the stock in the initial stages of its listing.

The IPO price was RM1.71. In terms of the attractiveness of the stock at the fundamental level, its IPO price of RM1.71, the valuation of roughly five times forward price-to-earnings ratio (PE) did not compare well with similar stocks listed in Singapore. China-based athletic footwear stocks in Singapore include China Hongxing Sports Ltd at 7.3 times 2009 PE, China Sports International at 3.1 times PE and Hongguo International Holdings at 5.7 times PE. Plus Xingquan was much smaller, hence CIMB was suckered into pricing it at RM1.71 - not the company's fault.

p/s photos: Hanako Takigawa

Outlook For Ringgit For The Rest Of 2009

• Malaysia Ringgit (MYR) has appreciated 6% after hitting a low in early March taking the ytd losses to 1% as of May-end 2009
• March 3, 2009: MYR fell to the lowest level (3.725-3.735/USD) in 3 years due to weakening exports and foreign investment
• February 2009: To promote bilateral trade and investment for economic development, Malaysia's central bank and Chinese central bank established RMB40billion currency swap arrangement for 3 years
  
  Risks for ringgit in 2009:
• External balances: electronic and commodity exports are contracting at a sharp pace and the trend is likely to continue through 2010 with a sluggish recovery in 2010. Presently greater contraction in imports relative to exports is sustaining the trade and current account surpluses and forex reserves
• Easing capital flows: keeping interest rate on hold in April and May 2009 has helped reverse some of the past capital outflows. Rising bond issues at higher yields and sharia bond issues are a plus. But ratings downgrade due to increasing fiscal deficit can weigh on debt inflows. Impact on lower corporate earnings ad revival of risk aversion can weigh on stock market. A recession in 2009 and rising bond issues in U.S. (safer-haven) can be a negative. FDI is expected to fall over 50% y/y in 2009 due to decline in export manufacturing related capex
  
• Central Bank policy: In 2008, central bank was intervening in the FX market selling USD reserves to contain currency depreciation but in 2009 the central bank has been defending the exchange rate to support exports especially as reserves have also been declining. foreign exchange reserve stood at US$88bn as on 15 May, 2009 which is sufficient to finance 8.3 months and 3.8 times the short-term debt. Large forex reserves and external surpluses are a plus to deal with export contraction and any revival of capital outflows. Trend in USD and SGD will also be improtant determinants of movement in ringgit
  
• Since the central bank decided to keep key rate at 2%, USD/MYR is expected to be higher by the end of Q2 2009. But USD/MYR will be lower in H2 2009 as the economic situation is improving. But further stabilization in domestic and global economy is still necessary to guide USD/MYR around 3.45 by the end of 2009
• MYR continues to track the SGD and is expected to weaken against USD in mid-2009 due to anticipated resurgence in USD strength
  
• Declining forex reserves and depreciating SGD would put further pressure on ringgit
  
• Confidence of ringgit would be dampened due to increasing deficit on overall balance of payments, declining exports, outflow foreign capital, and expectation of further rate cut by central bank
• In 2009, ringgit would be weak against USD as the process of de-leveraging by international investors will continue to boost demand for USD
  

p/s photos: Hanako Takigawa

Dissecting The Economics Of Malaysia

The size of Malaysia’s export sector is huge at more than 100% of GDP. Hence its importance in driving domestic demand should not be exaggerated. The manufacturing industry is under severe assault due to the collapse in exports. Consequently, manufacturing employment has plunged by 10% from year ago and wages are also falling. In contrast, private consumption fell only 0.7% year over-year in the first quarter, and imports of consumer goods have been relatively resilient.

One reason could be that, even though exports are a significant part of the economy, manufacturing employment is relatively small – about 18% of total employment. By contrast, service sector accounts for close to 60% of total employment. Meanwhile, agriculture and plantation make up 9% of employment, and the construction sector 13%.

Resources/plantation exports such as palm oil, petroleum, natural gas and minerals account for about 30% of total Malaysian exports and the share is rising. China, being the past decade’s fastest growing economy with an seemingly insatiable appetite for resources, has naturally increased in bilateral trade with Malaysia. Trade between the two countries has increased four-fold since 2002.

Malaysia’s exposure to manufactured-goods exports to the G7 is still large, commodities and China are playing a more prominent role in terms of overall exports. The better outlook of these segments – compared with that of manufactured goods exports – will help pull the economy out of the slump.

Malaysia’s banking system is healthy and in a position to support a recovery in household spending. Remarkably, the lending rate of Malaysian banks has fallen to new lows in response to the central bank’s rate cuts and the authorities’ efforts to facilitate borrowers’ access to credit. There are already signs of stabilization in indicators of domestic demand. Housing approvals and loan disbursements for car purchases are bottoming.

Resources-related industries contribute over 50% of government revenues. Since late 2008, both palm oil and crude oil prices have rebounded strongly. Unless they collapse anew, exports of crude oil and palm oil, which accounts for 15% of total Malaysian exports, will boost both domestic income and government coffers and help plug the fiscal deficit.

The odds of recovery in domestic demand are notable, despite continued contraction in the export sector. The 1997-1998 Asian financial crisis was a watershed event for Malaysia’s banking industry. Although some post-crisis policy measures adopted by the Malaysian authorities – mostly notably capital controls – have long been a source of controversy and outright criticism, banking industry consolidation and much stricter supervision from the central bank have fortified the position of banks and largely insulated them from the current global
credit crisis.

Industry consolidation and continued enhancement in risk management have borne fruit in the form of enhanced returns on capital. Currently, the Malaysian banking sector is well capitalized, with a risk-weighted capital ratio of 14.2% as of March 2009. The private credit-to-GDP ratio has fallen since the Asian crisis, implying there has been no froth in bank lending over the past several years. Within the structure of banks’ loan portfolios, household loans account for 54% of all loans, while lending to the manufacturing sector is only 11%.

Malaysian banks are awash with liquidity as the country runs a large current account surplus (17.5% of GDP in 2008). The loan-to-deposit ratio in the banking system is 74%. Bank credit accounts for about 90% of gross financing to the private sector.

Still, Malaysia’s banking system is not without problems. Bankruptcies are rising sharply, access to credit has deteriorated markedly since the onset of the global credit crisis and banks remain somewhat wary of extending credit. The problems in Malaysia’s banking sector pale when compared with the difficulties in many other countries around the world. A relatively healthy banking system puts Malaysia in a better position to cope with economic challenges stemming from the synchronized global growth slump.

The government’s recent move to scrap the long-standing Bumiputera ownership requirement for 27 service sectors and to increase foreign ownership of its commercial banks (from 49% to 70%) could help unlock growth potential by encouraging investment and boosting productivity within domestically-oriented segments. This, along with other reforms within the public sector aimed at reducing red tape, corruption, government intervention and overall inefficiency, could unleash positive forces that will produce stronger growth in domestic segments of the economy.

Malaysia small caps offer a better outlook profile than many other emerging markets. They will benefit most from potential political and economic reforms. Besides, small-cap valuations are decent on both an absolute basis and relative to the emerging market small-cap universe. The currency’s outlook is bullish versus the U.S. dollar. The country has huge external surpluses and the ringgit will benefit from the U.S. dollar’s decline. Relative to other Asian currencies, the rating the outlook for the ringgit as neutral as the central bank is unlikely to allow for much appreciation due to export sector concerns. As for currency valuation, the currency is cheap versus the greenback but is fairly valued versus the Singapore dollar.


p/s photos: Hanako Takigawa

Roubini's 10 Risks To Global Economy Growth Prospects (Part 1)

Nouriel Roubini: This week, I will discuss why the recovery will be sub-par and below trends for a few years once it does occur, and why there is even the risk of a double-dip W-shaped recession.

The crucial issue facing us is not whether the global economy will bottom out in the third or fourth quarter of this year, or in the first quarter of next year. It's whether the global growth recovery, once the bottom is reached, will be robust or weak over the medium term--say 2010-11. As I argued last week, one cannot rule out a sharp snapback of GDP for a couple of quarters, as the inventory cycle and the massive policy boost lead to a short-term growth revival. My analysis, however, suggests that there are many yellow weeds that may lead to a weak global growth recovery over 2010-11.

The current consensus among "green shoot" optimists sees U.S. economic growth going back in 2010 to a rate that is close to the 2.75% potential growth rate, and returning to potential by 2011. Many optimists go even further, arguing that the snapback of demand and production after the depressed levels of the current recession will lead growth to be well above trend (3.5% to 4%) for a couple of years, as most previous U.S. recessions have been followed by a period of above-trend growth once the recovery gets going. Yet a detailed analysis suggests that growth will remain well below potential for at least two years--if not longer--as the severe vulnerabilities and excesses of the last decade will take years to resolve. Let us examine 10 factors that will cause below-potential economic growth over the medium term even after this recession is over.

First, an incorrect interpretation of the causes of this crisis has led to a policy response that doesn't resolve the fundamental causes. The right way to think of this crisis is of its being caused by: excessive over-borrowing and overspending by households; excessive and risky borrowing and lending by financial institutions; and excessive leverage of the corporate sector in a global economy where housing, asset and credit bubbles got out of hand and eventually went bust. So this is a crisis of debt, credit and solvency, not just illiquidity. The alternative interpretation is that this is a crisis of confidence--an animal-spirit-driven, self-fulfilling recession--that has led to a collapse of liquidity (as counterparties don't trust one another) and of aggregate demand (as concerned households and firms cut consumption and investment in ways that can turn a regular business-cycle recession into a near-depression).

Note that even those who believe that this is a crisis of over-leverage and overspending agree that aggressive monetary and fiscal easing is necessary to prevent a severe recession triggered by such excesses from turning into a near-depression. But while such easing is necessary to prevent the global economy from falling off a cliff into the depression abyss, the ability of these over-leveraged economies to resume lending, borrowing, spending, investment and growth depends on the resolution of the excesses that caused the crisis in the first place.

Yet true de-leveraging by households, corporate firms and financial institutions has not even started, as private losses and debts are being socialized and put on the balance sheet of governments. The lack of true de-leveraging--or appropriate debt restructuring--will lead to a corrosive debt deflation and limit the ability of households to spend, of firms to invest, and of banks and other financial institutions to lend. In other words, if this is a crisis of credit and solvency rather than just illiquidity and confidence, much more is needed than easy money and massive fiscal stimulus to resume high economic growth. Worse, the socialization of private losses creates--down the line--another dangerous debt and solvency problem, this time for the sovereign, with risks of a more severe financial crisis once a refinancing crisis occurs and/or the ability of the sovereign to borrow more is curtailed.

The right way to resolve a problem of excessive debt relative to equity capital is to reduce such debt and convert it into equity. Corporate debt and the financial sector's unsecured liabilities should be converted into equity. Even household debt can be converted into equity by reducing the principal value of mortgages and providing an equity upside to the mortgage creditor in the form of a warrant.

Second, in current-account deficit countries (i.e., where the country spent more than its income), consumers need to cut spending and save more: shopped-out, savings-less and debt-burdened consumers have been hit by a wealth shock (falling home prices and stock markets), rising debt-servicing ratios and falling incomes and employment. These deficit countries include not only the U.S., but also the U.K., Ireland, Iceland, Spain, many emerging European economies, Australia and New Zealand.

In these economies, the retrenchment of consumption and buildup in savings to reduce debt, restore net worth and resume robust spending will take several years. In the U.S., consumption averaged 65% of GDP (and household savings averaged 11% of disposable income) for a long time before the latest decade-long housing bubble and consumption binge.

At the peak of the bubble, consumption had risen from 65% to 72% of GDP, and the savings rate plunged to zero and even negative for a few quarters. Currently, consumption has fallen from 72% to 70% of GDP and saving has increased from near zero to about 5% of disposable income. Even if one were--heroically--to assume that consumption will not revert to the long-term average, a fall from 70% to, say, 67% is likely and necessary, while the savings rate goes toward double digits.

But how can households reduce debt ratios that have increased from 65% of disposable income in the early 1990s to 100% in 2000 and 135% today? And the debt ratio risks rising even further as price deflation leads to debt deflation (a rise in the real value of nominal debts). One solution might be to save a lot to reduce debt and rebuild net worth, but the "paradox of thrift" scuttles this. If households sharply cut spending and save more, the recession becomes a near-depression and the ensuing fall in income further increases the debt-to-income ratio. The only remaining solution is debt default and debt reduction.

Third, the financial system (specifically, traditional commercial banks) is severely damaged, and the credit crunch will thus not ease very fast. Most of the shadow banking system is either gone or in severe difficulty. The equivalent of a bank run has hit most of the highly leveraged institutions of this system: 300 non-bank mortgage lenders are bust; the system of conduits and structured investment vehicles is gone; two major broker-dealers are gone, one merged with another bank and the last two converted into bank holding companies; money-market funds cannot even cover their costs, as interest rates are zero and now under the umbrella of a government guarantee; half of all hedge funds may close shop in the next couple of years; even private equity will experience a serious refinancing crisis once "covenant lite" clauses and payment-in-kind toggles run their course; finance companies and insurance companies are also in trouble and need government support and recapitalization. Securitization is a shadow of its recent peaks and the attempt to revive it--TALF--has been a mixed bag.

After $12 trillion of liquidity support, guarantees, insurance and recapitalization, most of the U.S. financial system is under effective government control. And the financial sector damage is not limited to the U.S.: Most major U.K. banks--with the exceptions of HSBC and Barclays -are under effective government control. The IMF estimates massive losses on loans and securities of other European banks, given their exposure to both domestic borrowers and emerging Europe, a region on the verge of a broader financial crisis. According to the IMF, even Japanese and other Asian banks are not immune to significant losses on loans and securities.

Over time, financial institutions in the U.S. and around the world will clean up their balance sheet. But systemic banking crises are not resolved in a few months: They usually last several years and are associated with a persistent credit crunch. Given that a lot of economic activity is financed with debt/credit, this crunch will inflict persistent damage and restrict the ability of households and corporate firms to borrow, consume, spend and invest.

Fourth, a large part of the corporate sector is also under severe financial stress, and its ability to increase production, employment and capital spending will be restricted by poor profitability driven by slow revenue growth, deflationary pressures and rising corporate defaults. While most U.S. corporations are less leveraged than they were in 2000-01, the corporate sector has a large fat tail--similar to that of the household sector--that is severely indebted.

Firms that in the past would have been able to roll over their loans, bonds and debts coming to maturity now face a liquidity crisis that may lead them into costly debt restructuring. Some firms that would have gone into Chapter 11 debt restructuring will end up in socially costly liquidation (Chapter 7) because of the lack of financing. This process of corporate debt restructuring or outright liquidation may take years.

But the main constraint to a recovery in the corporate sector will be a weak recovery of corporate profitability. If the global economy grows at sub-par rates in 2010-11, corporate revenues will grow slower than otherwise; and if deflationary pressures remain across the world--given the glut of supply relative to aggregate demand--pricing power of firms will be limited and profit margins will be further squeezed. The ability to control costs and restore earnings by slashing employment will reach a limit, and excessive employment contraction has negative macro effects: Fewer jobs means less income, less consumption, less corporate revenue and lower profits and earnings.

p/s photos: Hanako Takigawa