Like Father Like Son, Macau Style

If you ever see Macau casino heir Lawrence Ho give a speech, right away you notice he embodies the spirit of the “next generation” in much the same way that Richard Li contrasts with the patriarch Li Ka-shing. Compared to father Stanley Ho, Lawrence’s profile is young and international. When he gives speaks before investors and business clubs, which he does often and well, the junior Ho peppers his text with fashionable business terms like “creativity” “productivity” “maximizing shareholder returns” and the ever-popular, “good corporate governance.”

Nonetheless, Lawrence Ho is clearly not above engaging in the sort of business practices that give Hong Kong’s stock market its cowboy reputation. During the territory’s Internet bubble in 2000-01, the sons, offshoots and associates of all the big local power players quickly threw together tech companies and listed on Hong Kong’s then newly created Growth Enterprise Market. Lawrence Ho joined the crowd, raising HK$50 million for an online trading services company called iAsia.com, whose shares flew as high as HK$8.40 before falling to earth when the bubble burst.

These days the shares trade at just above HK$1, and the company has been transformed into a brokerage house called VC Brokerage. Besides doing a lot of business for companies owned by the Ho family, VC brokerage is one of those plucky little finance houses that lends more than 20 percent of its asset base to punters taking bets on hot IPOs.

VC Brokerage can also be quite creative about making the odd buck here and there. One example came in March last year, when the firm underwrote a “rights” issue for a company called Heng Tai Consumables.

For the unversed, a rights issue lets existing shareholders pitch in extra money at a discounted price. Some observers say this is a much more civilized way to raise money than selling stakes to new shareholders at a discount – who wants new people to get in cheaper than you did?. (Investor activists and market observers such as David Webb in Hong Kong and the South China Morning Post’s Jake van der Kamp are what you would call “pro” rights issue.)

However sometimes companies can use the rights issues obnoxiously. For instance, they may try to raise a big amount of money this way, and not all investors will have the dosh to participate. This gives the controlling shareholders the opportunity to increase their stake in the company on the cheap. Interpreted more harshly: it’s a way to rip off minorities.

A rights issue last March by Hong Kong-listed Heng Tai Consumables had another special twist. It let its broker on the deal, VC Brokerage, buy up all the rights shares which other shareholders rejected.

In other words, it let an outside party – Lawrence Ho & Co. – buy into the company at a 47 percent discount to the market price. (The Hong Kong Stock Exchange’s Disclosure of Interests section says Ho owns 21 percent of Heng Tai – which would indicate he bought the controlling stake at such a discount. Heng Tai’s corporate announcement said VC Brokerage owns just 1.6 percent of their company, probably just another example of how confusing and error-prone the Exchange’s disclosure section is.)

Not all rights issues give the broker the chance to buy up untaken shares on the cheap. Why Heng Tai treated shareholders like this is a mystery. They had just raised HK$200 million in a placement the previous summer and money is easy to come by these days. This is a liquidity-fed bull market. Banks are biting off their arms to loan money; hedge funds are circling with deals.

VC has continued to do lots of business with Heng Tai – earlier this week it closed a very similar slap-in-face rights issue for Daqing Oil, in which Heng Tai is the biggest shareholder. This time VC purchased 10 percent of the existing share capital, or 3 percent of the new, enlarged ownership at the steeply discounted “rights” price issue.

Daqing had been through this is the past. Only about two years ago the Hong Kong-listed brokerage Kingsway Financial took a majority stake in the firm after it underwrote an unpopular rights issue, thus taking up the shares themselves. One odd footnote: Kingsway recently had lots of management changes after the death last year of one of the families that control the brokerage. A long-time executive director, Patrick Sun, retired only days after a new board was announced the previous spring. And guess where Mr Sun landed? VC Brokerage.

The International Angle

A company that sold huge blocks of its shares at steep discounts to third parties might reasonably be shunned by the big, well-known, international fund managers. Think again. More than a dozen international fund managers hold Heng Tai and Daqing, including JPMorgan, HSBC, Fidelity, Julius Baer and Value Partners. And the group has at least one very enthusiastic cheerleader in bulge-bracket broker Merrill Lynch.

Just before last March’s rights issue, funds had piled into Heng Tai. Its core business is strong and it is much cheaper than other China retail plays. The rights issue acted as a reminder as to why it is much cheaper: the shares fell from $1.43 per share before the rights issue to a low of HK$0.56 last September.

During this time management tried to vote through a ridiculously expansive stock option plan, but that was vetoed by international investors. Nevertheless, Merrill Lynch rallied around the company once again. In August it upgraded the company to a “buy”, saying the “current price reflects the corporate governance risks”.

Fund managers piled back in as the shares took off, hitting a high of HK$1.37 – until the Daqing rights issue in December once again reminded investors that this company treats is shares – and its shareholders – like dirt. Today Heng Tai’s shares trade at HK$0.77.

It is a mystery why firms act like this. By treating investors better, Heng Tai could raise a lot more money at better prices, and be valued much higher on the market. It’s underlying business is strong, after all.

So what’s the moral of this story?

Mr Ho, for all his talk of “corporate governance,” runs a brokerage that is happy to help its corporate clients shoot themselves in the foot, as long as they get a good commission for helping out.

And international investors and investment banks, with all their talk of “corporate governance,” are never going to see change if they keep stupidly buying companies that regularly engage in bad behavior.