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Web-only Exclusives
November 30, 2000

From Our Correspondent: Hirohito and the War
A conversation with biographer Herbert Bix

From Our Correspondent: A Rough Road Ahead
Bad news for the Philippines - and some others

From Our Correspondent: Making Enemies
Indonesia needs friends. So why is it picking fights?

Asiaweek Time Asia Now Asiaweek story

The China Connection

Take care to pick red chips that offer value

By Matthew Fletcher


IN HONG KONG, AS in China, connections count. And if you don't have guanxi, you can buy it -- in the form of China-connected stocks. Lots of investors do. Consider GITIC Enterprises, a construction materials and property company. When it went public in Hong Kong, demand for the stock was over 800 times the supply. Investors eagerly plunked down $13 billion for the new shares, an amount equivalent to a fifth of the territory's foreign reserves. GITIC's main attraction: it is indirectly controlled by the investment arm of the Guangdong provincial government, one of China's wealthiest.

It's not just GITIC. Mainland-backed Hong Kong holding companies, or "red chips," have outperformed the Hang Seng index by 40% over the last six months, says Peter So of Schroder Securities. In comparison, Chinese firms with a secondary listing in the territory ("H" shares) have trailed in the market's affections.

Why the euphoria? Because people are counting on red-chip companies to continue acquiring choice China assets, from theme parks to tollroads, at attractive prices from their mainland parents. The handover is another factor. The influence that red chips wield with mainland organizations, investors reckon, will become even more valuable after June 30, when the territory reverts to China.

But some fear that mainland authorities will try to dampen the buying frenzy. Beijing may want to tighten up on red-chip placements, to prevent state assets from being sold too cheaply. Talks between Chinese and Hong Kong regulators in recent months temporarily cooled investors' enthusiasm for the counters. "The door is increasingly going to be monitored and guarded by the regulators," says Lisa Chow, a fund manager for Guinness Flight Asia in Hong Kong.

That prospect has already prompted some red chip bosses to speed up acquisitions to catch the market while it's hot, says Charles de Trench of UBS Securities in Hong Kong. "In order to avoid any uncertainty, they have pushed through with placements," he says. But when earnings come through, warns de Trench, "there's room for disappointment."

Are red-hot prices due for a correction? "There's not much value in many red chips," says de Trench. Though he concedes there are a few long-term buys (his favorite: Beijing Founder, the software development arm of Beijing University), he finds many red chips overvalued. "But if you're a speculator looking for high-risk stocks, there are some opportunities," he adds. De Trench prefers "H" shares and "B" shares (China-listed stocks that foreigners can buy): "They still offer upside."

But most analysts believe that red-chip exposure to China's burgeoning economy makes them worth their current prices. "There is plenty of momentum left," says Anthony Mei of DBS Securities. He thinks prices may continue to rise for another year after the handover.

Still, with red chips generally trading at twice the 1997 price-earnings ratios of Hong Kong blue chips, stock-pickers should be selective. "There are a number of mini-red chips riding on liquidity without a clear corporate strategy or plans for asset acquisitions," warns Chung Man Wing, a fund manager at HSBC Asset Management. "But at the end of the day, the winners will be those with good parent support and a strong management that can not only inject assets but run companies."

Don't buy simply on the expectation of further asset injections, agrees Chow, as the acquisitions may turn out to be duds. "It's a high-risk strategy," she says, "You have to look for value." That means sound core businesses. And, ideally, either a ministry-level parent or backing from a strong provincial government. One stock that fits the bill, says Chow, is Beijing Enterprises Holdings. The investment vehicle of the Beijing municipal government, which includes infrastructure and tourism interests, is expected to list on the Hong Kong bourse later this month.

Schroders' So likes China Resources Enterprise. It is involved in cold storage, container terminals and brewing. Property makes up over 40% of its earnings. CRE's listed Beijing real estate unit gives it prime exposure to the China market. It is also participating in a residential development on Hong Kong's Tsing Yi island.

"Earnings from its residential projects will be strong," says So. "It can then utilize these to invest in other projects that will bring additional cash flow." Agrees Mei: "The quality of CRE's earnings is good." So adds that by using its cash flow rather than issuing extra shares to acquire new assets, there is no earnings dilution for existing stockholders. Another advantage: its parent is China's Ministry of Foreign Trade and Economic Cooperation.

So also likes CITIC Pacific and China Merchant Hai Hong. CITIC Pacific's share price fell in recent months as many investors turned away from the counter, considering it too Hong Kong-focused. But the stock has picked up since. So praises the company's strong management under CEO Larry Yung, the son of Chinese Vice President Rong Yiren, and its solid core infrastructure operations. The analyst forecasts good earnings growth: "Any asset injections will be a bonus."

Plans by its parent to add several tollroads to China Merchant Hai Hong's portfolio will transform it from an industrial and shipping company to an infrastructure play. That should help its share price. Says So: "After the acqusitions, it will have a lower risk profile that promises higher growth. That's a bonus for investors."

Another favorite of the Schroders analyst is COSCO Pacific. The fourth-largest container-leasing company in the world, it also operates container terminals in Hong Kong and China. "Earnings are stable and the stock offers attractive value," says So. "It has a core business that you can understand and that will stay around," agrees UBS Securities' de Trench, though he expects the company's share price to consolidate at current levels.

DBS Securities' Anthony Mei recommends red chips linked to Guangdong. He likes Guangzhou Investment, a key landowner in the provincial capital. It also has cement and paper businesses that should benefit from an economic pick-up in the southern region. Mei favors Guangdong Investment, an arm of the provincial government. He expects it to spin off some of its mature assets, including a malt and brewery business, later this year.

But stay clear of GITIC Enterprises, warns Mei. The stock price has fallen since its debut. Still, at a 1997 P/E multiple of 28, "it's too expensive to get into," he says. "People think this is another investment arm for Guangdong." But the provincial government owns only 57% of GITIC. "I don't think they'll inject large assets because the beneficiaries will be other shareholders." With June 30 looming, that may not deter many in Hong Kong.

All money values in U.S. dollars except share prices, which are in Hong Kong dollars. Sources: Asiaweek Research, Datastream, First Call/World Equities


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