Thursday, October 20, 2011

Huabao: derivative transactions and disclosure

Huabao - a fragrances and flavors company and the subject of attention on this blog - has suffered a rapid stock-price decline lately.

The company put out a press release related to the unusual activity in the stock.

To quote:

UNUSUAL PRICE AND TRADING VOLUME MOVEMENTS 
We have noted the recent decreases in the price of the shares and the significant trading volume involved of Huabao International Holdings Limited (the “Company”). Save as disclosed below, we are not aware of any reasons for such incidence. 
We have been recently notified by Ms. CHU Lam Yiu, the controlling shareholder of the Company,  of her entering into a derivative transaction on 14 October 2011 relating to a long position of a monetary value equivalent to 94,736,842 shares of the Company with a contract period starting from 14 October 2011 to 13 January 2013...
I have a simple question: what is the "derivative transaction" that Ms. CHU Lam Yiu entered into regarding over 94 million of her shares?

In my world all derivatives can be bifurcated into a series of forwards, put options and call options. (The bifurcation is alas not unique...)

Unless I am mistaken then she has either

(a) sold her shares using forwards in which case it is effectively a forward sale (she has just cashed out and used fancy language and derivatives to obscure this fact),

(b) sold the upside of her shares by selling call options or

(c) protected the downside of her shares by buying put options or

(d) some combination of the above.

All of those are bets against her shares in some form or other. Of course I can be mistaken, but it seems the CEO is betting against her own shares using derivatives.

I am also betting against her shares - so I have something in common with her.

But not much.

You see I am just a guy who reads public filings. She is the controller of the company and the world's youngest self-made female billionaire. She is a smart cookie too: took her company public via reverse takeover, sold a chunk of shares in 2008, and again in 2009 and again recently. She is, on some lists, the eighth richest woman in the world.

And she still seems to be betting against her shares. Mostly she sells at lower prices.

But whatever: I think we are entitled to know precisely the nature of the bet that the CEO has taken against her shares.

I am happy to disclose my bet: I am short. Ms. CHU Lam Yiu, it is your turn to disclose.




John

22 comments:

Tom said...

13 January 2013 is not an exchange-traded option expiry date. I wonder who the counterparty is.

Jacob said...

While the press release doesn't exactly inspire confidence, it's not completely clear to me that "derivative transaction...relating to a long position" necessarily means an offsetting transaction. Couldn't it mean for example that she purchased call options outright? Or sold puts? Seems improbable but the language is not as clear as you suggest!

Anonymous said...

That's a very unclear statement, but doesn't it read as if she'd bought instead of sold via the derivatives market? Or maybe it reads "all your base are belong to us."

ptuomov

Anonymous said...

Would it be too surprising if the counterparty of the trade is Huabao itself?

Nemo Incognito said...

Tom - looks like its a large American non-cephalopod bank.

Eaststopper said...

Maybe it is an OTC equity swap?

Andrew said...

http://www.china.org.cn/business/2011-10/14/content_23626245.htm

Anonymous said...

Clearly the derivative involves an exposure to the stock price that is short, not long, as it is being used to explain a massive sudden *drop* in the stock price - ie, whoever is the counterparty had to hedge the derivative by selling, not buying. Very interesting, and the failure to provide details is super dodgy.

The stock has tanked a long way already but I suspect that a substantial part of this company's supposed business doesn't actually exist! I spoke to a fund manager today and mentioned this to him, and it turns out that he actually met with Huabao around 3 years ago and asked to inspect their factories, and he said that there was simply nothing there, nothing going on - they gave some kind of sketchy excuse about the factories just happening to not be running at the time of his visit.

I can't wait to see how much further this stock drops.

Anonymous said...

I wonder if you can actually cut down on a huge chunk of your own work, John, and just short en masse stocks that company's own management is selling (straight or via derivatives).
They normally have that work done for'ya when they execute that :)))

Regards,
Dmitry.

Anonymous said...

J, your implicit assumption is that she is has initiated an effectively short/hedged position, which is understandable given the not so unambiguous wording used in the filing.

This might help:
Nomura Comment: We believe that the chairwoman's long position is positive for the shares. Based on our conversations with
management, Ms Chu chose to take a long position via derivative transactions rather than buy shares directly because it could
leave the chairwoman more flexibility to take a positive position on Huabao's shares in the next 15 months. According to
regulations, the controlling shareholder cannot increase their stake by more than 2% in one year otherwise it would trigger a
general offer. Note that the chairwoman already increased her stake by 0.7% in Sep 2011. However, through the derivative
transaction, any shares of Huabao she buys won't be under her name. Based on the terms of the derivative, Ms Chu can buy
3% of outstanding shares in the 15 months. If based on today's closing price, she would use at least HKD414mn.
We believe that this means the chairwoman remains positive with regards to the company's fundamentals.

cogitator

Frozen in the North said...

If she things the company is in trouble, wants to retain control, then a monetization is the best bet; a nice little forward sale, allowing here to keep notional ownership but reducing her capital commitment. Bet you a fiver that she's done with several countparts...

Crafty

Anonymous said...

What is the best way to search for chinese frauds on the HKEx? For US listed chinese companies, there is a good stock screener http://www.fixyou.co.uk/index.php.

Is there anything like this for hong kong?

Anonymous said...

Why not short the tobacco SOE as well?

I've never actually heard of a fund shorting a listed SOE, does this happen? Or is there an assumption that they have infinity cash?

Anonymous said...

"In my world all derivatives can be bifurcated into a series of forwards, put options and call options. (The bifurcation is alas not unique...)"

Isn't that a "trifurcation"? Sorry...couldn't resist

Richard said...

I have to agree with the last contributor. The price action is a clear indicator of direction. The only question is whether the transaction is a put option or a short forward. Given the size of the price movement, I suspect that the deltas are rapidly converging and (assuming that the put was bought "at the money") there is now effectively little difference between the two.

The puzzle for me is the identity of the cowboy who would stand on the other side of such a transaction. They are probably not very happy at the moment.

Finster said...

Cash settled call options taking control of large chunks of shares to short squeeze you the Porsche/VW way.

Or maybe she went into a derivative transaction regarding you with a triad.

Just kidding. If she is a smart cookie, she will have bought protection on her book through put options.

Anonymous said...

Are you committing a crime or have any moral hazard right now?
You said something about a company with very weak evidence while you are at the same time short selling that stock??? Please explain !!!!!

Anonymous said...

John do you have any opinion on MUCH smaller fragrances company, which has recently branched into flavors as well, Ecogreen Fine Chemicals (2341.HK)? I have always wondered about the enormous claimed returns on capital and bizarre capital allocation. Don't know if it's good/bad/ugly.

-Tex

Pete D said...

My God I laugh at the retards thinking she might be taking long exposure. The move in the underlying stock makes that very clear, and besides, what sort of semi-sensible executive ever INCREASES their exposure to the company that employs them voluntarily. Very few.

Anonymous said...

any development on Chaoda Modern?

Anonymous said...

Check out what Bridgewater has to say about hedge funds and their relative worth - http://bit.ly/qY57JX

Mark T said...

Just read on FT Alphaville, Anonymous Analytics just published a pretty comprehensive destruction job of the queen of cash out...along with a pledge to release the encryption code should any of its people be threatened by the 'real' people behind the pump and dump

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