Buy M for madness till the music stops

FROM THE PEOPLE that brought you the red chip, H share and Snoopy doll crazes, comes Hong Kong’s latest mania: Macau concept stocks, already dubbed M shares. Prices of what were originally mainly penny stocks have recorded extraordinary gains as Hong Kong’s punters, blindly following the smarter and nimbler hedge fund and inside money, have piled into the latest craze to sweep the territory.

Exploiting Macau’s recent explosive economic growth, Hong Kong’s fast-footed businessmen have wasted no time in dusting off their moribund shell companies and reintroducing them to an eager public as the latest way to invest in China’s tiny gambling enclave.

In the past few months, barely a day has passed without an announcement from an obscure listed company in Hong Kong of a deal associated with an investment in Macau, however tenuous.

Investments in cruise ships, gambling lending syndicates, minority stakes in casinos and residential property developments have all helped companies with such diverse core businesses as electrical products, media, consumer goods and even floating restaurants boost their flagging share prices. The trick has even proved handy in resuscitating several defunct dotcom companies.

Fabrice Jacob, managing director of fund manager MYM Capital, is convinced that a crazy speculative bubble has developed. “They’re all Mickey Mouse,” he says of the M shares. “It’s collective madness. Just like the dotcoms and the red chips in ’97. People are losing sight of what’s reasonable and what’s not.”

A classic bubble

That might be so, but the gambit has proved a lucrative one thus far for the promoters behind the newest game in town. According to Hong Kong’s Securities and Futures Commission, which has tried to monitor the comings and goings of 19 Macau “concept” stocks, their share prices rose an average of 200% and their aggregate daily turnover value was up 5.8 times between September and November. The SFC calculates that 12 of the 19 companies lost money in their latest financial year. Alan Linning, the SFC’s executive director, is concerned. “It’s a classic bubble,” he says. “It’s the latest horse to chase at Happy Valley [Hong Kong’s race course].”

Linning is exasperated about how little he can do to try to protect the Hong Kong public from its own folly. “All we can do as a regulator is to warn people,” he says. “We’re frustrated: most of these stocks have been around for some time, so it’s not a gate-keeping issue. It’s fair to say there’s been some unusual movements [in share prices] – we’re looking into that, but it takes time to create the evidential trail.”

He is not exaggerating when he speaks of untoward volatility in the prices of some of the Macau concept stocks. Log onto the Hong Kong Stock Exchange website and search each stock for recent notices and either side of the announcement of any Macau deal is peppered with statements about unusual share price movements.

“You’ve got to be very careful,” says one local dealer about trading the M stocks. “The whipsaws are huge.”

That has not deterred professional investors, as dealers will freely admit. “We’re definitely involved,” says one. “We’ve got clients jumping in and out of them. Some have gone up five or 10 times. In some of the stocks, you’ve got some serious hedge funds involved, especially in some of the more established ones”.

Brook McConnell, who runs South Ocean Management, a Greater China smaller companies fund in Hong Kong, has also joined the party, albeit in a more sedate manner.

“A friend of mine put me onto it,”‘ he says. “I went over to Macau to take a look. I couldn’t believe it. The casinos were all filled with mainlanders [mainland Chinese tourists], five deep at the tables all trying to put down a bet. I bought CNAC, which owns Dragonair and Air Macau. It was the only way I could find a bet on Macau. Despite the oil prices, the stock’s gone up. It was a very conservative, defensive play.”

McConnell admits that if he ran more speculative money, he would have been tempted to place riskier bets. “I haven’t made any bets really,” he says. “I don’t trust a lot of the guys over there. If I had a hedge fund, though, I’d probably have made five or eight bets by now. I’ve been in these crazes before: they can take the stocks to the moon.”

As with so many instances of investment mania, there is a kernel of substance to the Macau madness. Macau’s economy, tiny though it is, has grown extremely strongly of late, especially in the past year. According to government statistics, Macau’s GDP grew almost 17% in 2003 over the previous year and GDP per capita grew 15%.

Fuelling these impressive figures are two key factors. First, the decision of the Macau government in 2001 to grant new gaming licences to two US consortia, which introduced much-needed competition into gambling, which was previously dominated by a single corporation. The move has also sparked a construction boom as new casinos and themed hotels are erected in an effort to turn Macau into Asia’s Las Vegas.

Secondly, the decision of the government of the People’s Republic to ease travel restrictions for mainland tourists to Macau has increased the demand for gambling venues at just the right time. Visitor arrivals to Macau in the first three quarters of 2004 were up 45% over the equivalent period in 2003. Some 87% of those arrivals were from Hong Kong and mainland China.

Leaving Las Vegas behind

The local government’s own bet on its gaming industry seems to be paying off therefore. Macau is already second in the world in gaming revenues behind Las Vegas and many observers expect the enclave to go to number one this year.

All this explains why Macau is currently a good place to invest, at least from a macro perspective. What is less certain, however, is whether many of the Macau concept stocks will ever turn out to be anything more than just concepts or whether there is genuine value to uncover.

Favourite with many punters are the listed vehicles of Macau gambling magnate Stanley Ho: Shun Tak Holdings and Melco International Development. While Shun Tak certainly has a pedigree of successful investment in Macau, Melco is famous thus far for owning and operating two floating Chinese restaurants of questionable culinary merit in Hong Kong. Both companies have announced deals related to new Macau initiatives, and Melco has even announced an Asia Pacific gaming joint venture with Australian investor Kerry Packer. There has also been talk of a spin-off of the joint venture on Nasdaq this year. “Not only do you have NAV backing,” says a trader in Hong Kong of Ho’s companies, “but on some of the casinos, they’re getting their payback in one or two years.”

Upside from M shares is not limited to Mr Ho’s companies it seems. “Macau Success may be one to look at,” says a local broker. “They’ve got a travel agency and a gambling ship already, but the real blue sky is in the private holding company, which owns four of the top five VIP private gaming rooms in Macau. The feeling is that these will get pushed into the listed company.”

Macau Success is controlled by Sunny Yeung, son of Hong Kong property and entertainment magnate Albert Yeung, whose own listed vehicle, Emperor (China Concept) Investments, has also been busy buying its very own gambling ship, Golden Princess, from Yeung’s private trust. Macau Success, meanwhile, has announced that it will invest up to HK$1.2 billion (US$154 million) for a 24.5% interest in a company that will develop a theme park, including a hotel, shopping arcade and casino.

There’s no word as yet from Macau Success, however, about those all-important VIP rooms. The numbers behind them, claims one insider, are staggering.

“The average VIP room makes US$40 million profit net per annum,” he says. “It’s huge.” The same source claims that the four VIP rooms owned by the parent company of Macau Success generate gross monthly revenues of US$640 million, with net annual profits of about US$70 million.

With numbers like that, maybe there’s brass amid the muck after all. The average Hong Kong punter’s chance of getting to share in such riches is another issue altogether. There are serious impediments to injecting such assets into a listed company in Hong Kong, as one broker explains. “If they inject the VIP rooms into Macau Success at, say, 12 times [earnings], that’ll mean US$840 million,” he says. “Current market cap is only US$250 million. And why would Sunny Yeung inject them at anything other than top dollar?”

There might be other less obvious reasons dissuading the owners of some VIP rooms from letting their valuable assets into the spotlight of a Hong Kong listing. “A lot of these VIP rooms are not 100% owned by the companies,” says the broker. “There’s some others in there as well. This is really the sharp end of the stick. Do they really want a lot of this out in the open?”

Massive minority questions

One company that has been compelled to address the issue of minority interests in its Macau investments is Massive Resources International Corporation (Massive Resources), currently a manufacturer of electrical equipment and a provider of electrical engineering and contracting services, securities trading and investment in China.

Eager to turn itself into an M share, Massive Resources announced in November 2004 that it would acquire a 70% interest in EC Link, a company whose sole asset is a 5% interest in another company, Golden Gain, that in turn holds an 80% interest in Golden Times Club. According to Massive Resources, Golden Times Club is a syndicate with “no legal personality” that has a contract to operate certain gaming and betting related services, including lending to customers in the casino of the Grandview Hotel, Macau.

Curiously, Golden Gain has an “oral agreement” with the other, unidentified members of the Golden Times Club to share 80% of the profit and losses of the syndicate’s activities in the casino. These unidentified members are described in the announcement from Massive simply as “other business partners”. There is no disclosure as to the identity of the holders of the 95% of Golden Gain that Massive will not control after the acquisition. It’s extremely complex and, with a price tag of HK$35 million a trifle expensive for a business established in April 2004.

It might well be, then, that Macau’s most lucrative gaming assets will stay in private hands, leaving the listed stocks with the froth of peripheral, related investments. That would suggest that the really smart money is being made either by those holding gaming interests in private companies or those promoters peddling M stocks.

Market participants agree that the Macau bubble can only end up exploding nastily. Despite this, many professionals are not yet calling the end of the ramp. “I wouldn’t short anything yet,” says South Ocean’s McConnell. “It’s too dangerous. There could be a short squeeze down the road. But this thing’s getting way overblown and when it blows, it’s going to get ugly.”

Despite years investing and dealing in Hong Kong, McConnell remains bemused by the behaviour of local punters. “Hong Kong people are crazy,” he says, “I’ve tried to figure out why they behave like this. The really good stock operators are waiting for the amahs [female domestic servants] and the taxi drivers to pile money into this. Then they’ll cover their short and take it all the way down to where it started.”

It’s a pretty gloomy outlook, it seems, for the average Hong Kong investor. The SFC’s Linning is certain about what is to come and offers little comfort for any investors that get burnt.

“Some of it may be real,” he says, “but like most bubbles, for every gold find, there’s 10 claims. If the music stops and you’re left without a seat, don’t come crying to us. It’s a mug’s game.”