Haier Smart Home (690.D) – Discount Convergence – 56%+ Upside

Current Price: €1.85

Target Price: €2.9+

Upside: 56%+

Expiration Date: TBD

Press release

This idea was shared by DiSam.

 

This is an interesting arbitrage opportunity between two classes of shares of the same company listed in Germany and Honk Kong. Upside stands at +56% assuming partial narrowing of the spread and at +95% if the two classes of shares become exchangeable into each other and the spread gets eliminated. Strong short term catalysts for this to happen.

Haier Smart Homes, the Chinese home appliances manufacturer (one of the largest in the world, with $30bn in sales and $35bn market cap) has recently completed its listing on the Hong Kong stock exchange and now has 3 different listings. All three classes have equal economic value:

  • A shares (domestic, on Shanghai exchange) - trading at CNY35.1/share (eq. to €4.5/share). Not available to foreigners.
  • H shares traded in Hong Kong (6690.HK) - HK$33.8/share (eq. to €3.6/share)
  • D shares listed in Germany (690.D) - €1.85/share.

Share capital looks like this:

D shares consist of only 3% of the total share capital. And despite being economically equivalent they trade at 48% discount to the recently listed H shares. This offers an interesting opportunity to play on the narrowing of this discount as there are multiple reasons to believe that this will happen in the short term. Most importantly, the company has announced a large scale D share buyback (up to 57% of the free float). Eventually, I expect the gap between D/H shares at least to get in line with similar discounts of <20% of this type (e.g. BHP Group). At the current H share price this would be equivalent to €2.9+ per D share. Both share classes are very liquid and there is plenty of cheap borrow available on IB.

The only risks I could envisage for this arbitrage are potentially extended timeline and a potential increase in borrow fees. However, given the recently announced buyback (major catalyst) and liquidity as well as a far higher float of H shares, neither of the risks seems prominent.

 

Quick Background

It is quite common for a Chinese company to have 2 share classes - A shares (domestic) and H shares (HKEX). Domestic shares are not available to foreigners, so to appeal to a wider investor base, companies also list in HK. A and H shares are not exchangeable, while A shares almost always trade at a premium to H shares (due to China capital controls and somewhat limited investable universe of local stocks). However, unusually for a Chinese firm, instead of going for H listing, Haier Smart Home conducted an IPO in Germany in 2018. It seems like the offer wasn't really successful - originally it intended to sell 400m shares, however, the offer was made for only 300m. All shares were subscribed at €1.05/share, the lower part of the €1.00 - €1.50/share range, while around 50% of the buyers were Chinese companies. After the IPO, the price tanked over 20% and until recently used to trade under €1.00/share. Since then D shares remained relatively stranded, ignored by the analysts, and presumably unknown by the market in general. As a result, D shares have been trading at a significant discount to A shares (much wider than the Chinese average H/A share discount of 40%):

 

H Shares Listing

As mentioned in the section above, D shares used to be fairly forgotten by the market. However, the recent listing in HKEX is likely to fix that. The appearance of another, economically equivalent, targeted at foreign investors, potentially exchangeable (not yet, explained below) listing will (and to some extent already has) catalyze market's awareness of the Haier German listing. In fact, after the debut of Haier H shares, D shares have already shot up by 85%. In time, more and more investors should realize that they can buy the same company 2 times cheaper. Also, the count of H shares is 10x higher relative to the count of D shares (even bigger difference in terms of free float) - suggesting that a small percentage of H shareholders getting their eyes on the German listing might be enough to put sufficient buying pressure on the D shares and for the spread to start closing.

Some level of discount between H and D shares will likely prevail (till the time both classes will be made fully exchangeable). However, the discount among two equivalent share classes of this size (48%) is simply unprecedented and should not remain at the current level.

 

Large D Shares Buyback

This is the most important catalyst for the thesis. The company seems to have recognized the extreme size of the discount and now intends to capitalize on it itself. On the 31st of December, Haier announced a large scale open market buyback during the six upcoming months. To put it short, the parent company, Haier International, currently owns 57m (21%) of Haier's D shares and intends to increase its stake to €66m to €277m (including €57m already owned) of D shares:

HIC plans to increase its holdings of the Company's D-Shares through a combination of block trading and/or market trading as well with an accumulated amount herein no less than EUR66 million (including the shares purchased in the First Shareholding Increase) and the number of purchasing D-Shares no more than 2% of the then total issued share capital of the Company (including the shares increased in the First Shareholding Increase)

The maximum limit of the current buyback amount stands at 58% of the remaining D share float (excluding Parent's currently owned stake). If the buyback is carried out at this level I would expect the spread to close completely.

At the lowest limit, €9m of incremental buybacks, Parent would purchase only about 2% of the outstanding D shares. However, there are several arguments indicating that the buyback will be far larger than €9m. First of all, the economic incentive is very sound. Current buyback is actually the exact same Shareholding Increase Plan that the company announced in September'19, when the Parent has acquired the first €57m stake in D shares. However, apparently, it has been delayed until now by the matters related to HKEX listing. The Sept'19 announcement states that the Parent has acquired the stake in a private transaction from another shareholder, but doesn't mention the price. Assuming it was done around the market price of that time, the purchase was settled at a 48% discount to A shares (vs 59% currently). A substantially larger current discount provides an even greater financial incentive for Haier to buy as many D shares as possible, especially when due to the existence equivalent and accessible by foreign investors H shares and the reasons explained above, the company can't afford to wait any longer (the discount should only narrow in the future).

Another interesting twist is that Haier has not allowed H/D shares to be exchangeable at the moment, despite such option being possible from the regulatory perspective. The proxy for H share listing (see page F-291) clearly stated that there is a regulatory process available to exchange H/D. However, in the later documents the company has decided not to allow the conversion:

Our H Shares cannot be converted or exchanged into D Shares or A Shares, and they are not fungible with D Shares or A Shares.

I don't think Haier would've blocked the conversion option (seemingly temporarily, but that is only my personal guess) if they weren't getting ready to capitalize heavily on this arbitrage opportunity themselves.

 

Class D shareholders

  • Haier International - 21.08%.
  • Silk Road (20.3%) - participated in the IPO.
  • Industrial and Commercial Bank of China  (9.7%).
  • China Investment Corporation  (8.9%).
  • Shougang Holding (8.8%).
  • Rechi Precision (7%) - participated in the IPO.

Concurrent with H shares listing, D share price has jumped up significantly and for the first time broke over the IPO price ( €1.05/share). So far the daily volume of D shares has increased 10x. 34% of the free float is owned by the original IPO investors and a further 34% by other major shareholders who have also acquired their stakes under €1/share. With shares currently 80% above the cost basis of major shareholders (vs €1.85 currently), some might be taking profits - this would help to explain why the spread is still so wide despite a drastic jump in trading volume.

 

H shares might be slightly overvalued

It's possible that with the initial excitement of the recent listing, H shares are a bit overvalued. This could be judged from Haier's A/H share premium standing at lower levels than the average premiums of other Chinese dual listings in Shanghai and HongKong. This might drive the price of H shares lower in this way also benefitting the hedged D/H shares arbitrage.

    • The current premium of Haier's A shares over the H shares is 25%, compared to the average (Chinese A/H Premium index) of 38% (used to stand significantly over 40% since mid-2020 until recently).
    • A/H premium of close peer Hisense Home Appliances also stands at 38%.
Published on: January 13, 2021  •  Published by:
Category: Delisting  •  Other

27 COMMENTS

  1. charlies_almanac

    Excellent find and write up. HTSC LI (Huatai) similar situation June2019 where they were listed in Hong Kong and China and then listed in London Internation, and those shares became directly fungible with the A shares after a few months and the spread promptly went to zero. Importantly, in this case, that means that the European listing actually trades in line with the A shares, which is a huge premium to the H shares (70% premium, or in the terms you were using, the H shares trade at a 42% discount to the A/London shares)

    1. charlies_almanac

      Sorry, to be clear the London shares being fungible with the A shares was due to the london shanghai stock connect program. I do not think that is possible here as the european listing is in germany.

  2. ijw

    Sorry Im a bit confused here, I did some math and it appears H shares trade at a premium to A shares?

    So here is my math, please tell me where I got it wrong (if i did):

    A share implied market cap = 6.3bn x 33.85 RMB x (100/70) = 305bn RMB implied market cap

    H share implied market cap = 2.45bn x 39.6 RMB x (100/27) = 359bn RMB implied market cap

    D share implied market cap = 271m x 14.7 RMB x (100/3) = 132bn RMB implied market cap

    I converted HKD to RMB at conversion rate of 1.2 and EUR to RMB at a conversion rate of 7.8

    This implies a premium for the H shares? And a much bigger discount of D shares of 57% to A shares and 63% to H shares?

    1. dt

      Your calculations are incorrect:
      A – 33.85RMB = 4.32eur
      H – 33.05HKD = 3.52eur
      D – 1.85eur

      1. ijw

        Oh yes I messed the HK-RMB conversion, my bad.

        So then it looks like this:

        A share implied market cap = 6.3bn x 33.85 x (100/70) = 305bn RMB implied market cap

        H share implied market cap = 2.45bn x 33.05 x 0.83 x (100/27) = 250bn RMB implied market cap

        D share implied market cap = 271m x 1.88 x 7.8 x (100/3) = 134bn RMB implied market cap

        Estimated 2021 earnings are 10.6 bn RMB. So it appears the D shares are valued at roughly 13x estimated 2021 earnings. Which does not seem bad for a growth stock like this.

        And discount is 56% and 46% for A and H shares? So why is upside only 28% if discount closes completely to H shares? It appears upside is about 87% to H shares?

      2. dt

        Thanks for spotting. This is typo on our side – we indicated upside based on change of the discount (from the current 48% to 20%) rather than the actual upside % for the share price change.

        Upside stands at 56% if the discount between H and D shares narrows to 20%. It raises to 95% if the spread between D and H shares closes fully.

        Now also corrected in the write-up.

  3. DavidW

    I’ve owned this for a couple months now and I really like the idea.

    But them buying back shares and canceling conversion can be considered a negative as well. If they intend on buying back a lot of D-shares why would they ever allow conversion? And if they don’t mind taking years to do the buyback so to not push up the price too much this discount would never really be closed at all.

    Other than that I do have a large position and positive things could happen with seemingly limited downside.

    1. Ilja

      D shares were IPO’ed only at the end of October’18, so there’s not much data before 2019. But initially, it was just over 30% and then quickly increased to nearly 50%.

  4. EvP

    What are the reasons the company doesn’t open the conversion between HK and EU?

    If it is possible then the company is buying the “cheap” shares and trying to benefit off some of the shareholders, which is a very bad sign.

    If it is not possible then the buyback will decrease liquidity a lot and without a clear catalyst it can trade at 20-40 percent discount for years (look at bmw, grf, psh in Europe).

    Otherwise I like the idea, think the discount can easily tighten by 10-15 percent.

  5. ijw

    So what is Haier international doing with the D-shares? They cannot cancel them and own around 20% of D-shares now, soon possibly 30%.

    Various other influential Chinese State actors will own another 50% or so. So really the minority shareholder base is much smaller than the 271m. You would think the 50% of State actors will not sell at a discount and will use their influence to close the discount once the impatient minority share holders have been largely skinned? Which is only about a quarter of the 271m shares outstanding.

    So my guess is that they slowly buyback the remaining 25%, and once that is largely done and there is no more liquidity and the discount is smaller, they will convert all the D-shares and cash in?

    So really the additional pressure here is that our incentives are aligned with what are likely some pretty influential shareholders. Of course the main risk would be that they pressure Haier International to buy all their shares in a private transaction at a much smaller discount. That seems a bit unlikely though.

    1. ijw

      He is a bit over the top though, I remember Beximco having a very wide spread as well at times. If you cannot convert the shares, the spread can stay very wide for quite a while. This one has nice potential catalysts though.

      1
    1. snowball

      If Haier’s dividend payout ratio converges to those of its peers (Midea, Gree), 690D will be a cash cow (double digit dividend yield in 2-3 years, if stock price remains the same and earnings growth tracks consensus), and we can even consider an unhedged long position.
      However, Haier has a long history of low payout policy, and I don’t see any catalyst for change.

      1. ijw

        Dividend payout seems in line with the other two? It is only slightly lower? Im seeing a 4.5-5% FW expected yield, not counting buybacks. It seems the real upside is in getting margins in line with the other 2 peers.

        Also the article mentions buybacks, but it isn’t really a buyback? Haier group corporation is doing the purchases, and they are a major shareholder of Haier Smart home. Not a subsidiary. So then I wonder, who owns Haier Group corporation? Is this a management holding company? It would explain the lack of actual buybacks of D shares. Since that would close the discount. And the D shares are set up this way to increase Haier group corp’s stake on the cheap.

        But then Haier group corp only purchased about 1m D shares, and said they had completed their purchase at the end of January this year:

        https://smart-home.haier.com/en/dggg/P020210201329801380582.pdf?appdesc=L2021002_Announcement%20on%20Implementation%20Results%20of%20Purchase%20Plan%20of%20D-Shares%20by%20Haier%20International%20Co.%20Ltd.%20(%E2%80%9CHIC%E2%80%9D)

        So maybe they are waiting for a dividend to start buying more shares?

      2. snowball

        Midea is trading at much higher P/E multiple, which translates into a low dividend yield despite a higher payout ratio.

        Both Gree’s management and Hillhouse (its private equity sponsor) are highly levered, and thus we can expect very high payout ratio going forward, as they depend on the dividends to pay loan interests.

        1
      3. ijw

        No I meant average payout % of net income is similar for all three over the past 5-10 years. Although forward expected payout looks higher for the other two.

  6. WH

    It could be that we get a catalyst soon. The Annual General Meeting tomorrow is expected to approve a buyback program for the D-shares. Management’s rationale is as follows (page 132):

    REASONS FOR THE REPURCHASE OF D SHARES
    The Directors believe that the flexibility offered by the repurchase mandate would be beneficial to the Company and the Shareholders as a whole. At any time in the future when the Shares are trading at a discount to their underlying value, the ability of the Company to repurchase the Shares will be beneficial to the Shareholders who retain their investment in the Company as their proportionate interest in the assets of the Company would increase in proportion to the number of Shares repurchased by the Company from time to time and thereby resulting in an increase in net asset value and/or earnings per Share. Such repurchases will only be made when the Directors believe that such repurchases will benefit the Company and the Shareholders as a whole.

    https://www1.hkexnews.hk/listedco/listconews/sehk/2021/0603/2021060300682.pdf

    2
    1. dt

      Shareholders have approved open market buybacks for up to 10% of D and up to 10% of H shares. This is definitely positive and the buybacks should act as a catalyst for pushing D shares upwards. On the other hand, management’s commitment to shareholders seems questionable as they sought authorization to buyback equal % amounts of H and D shares even though D shares constitute 10x smaller part of the capital and trade at nearly 50% discount to H shares. The buyback size is also much lower than the upper range of the previous announcement in Dec’20 – out of which only a minimal amount of D shares was acquired in the open market.

      https://www1.hkexnews.hk/listedco/listconews/sehk/2021/0627/2021062700035.pdf

      Aside from that, another interesting point is that there are rumors that the stock exchange on which D shares are listed could potentially face liquidation due to some financial struggles. This could also act as a catalyst as Haier might be forced either to buyback all of D shares or exchange them into H shares. However, there is also a possibility D shares get simply delisted and shareholders get stuck with untradeable securities for God knows how long (think EMGCQ). The situation is still in a rumor stage only.

      https://www.boersen-zeitung.de/meinung-analyse/ceinex-droht-die-abwicklung-c6d91750-c55e-11eb-8a84-11b6edcee059?read=true

      1. ijw

        Another article here (google translate works well):

        https://verus.li/irrationalitaet-des-mr-market/

        From article:

        “second addendum on June 8th, 2021:A reader drew my attention to the fact that Ceinex (https://www.ceinex.com/), ie the stock market segment in which Haier’s D-shares (as the only security so far) are traded, is facing an austerity course. Since it has not yet been possible to win over several companies for this segment, this segment could also be dissolved in the foreseeable future. In any case, the Börsenzeitung speculated that this would probably be the beginning of the liquidation of the stock market segment. If that happens, then Haier would have to actively tackle a solution to the D-share issue. One option would then be to convert to H shares. A few weeks ago, however, the IR officer told me that Haier would like to maintain access to the European stock market. But of course it only makes sense if the D shares do not have a significant discount to Hong Kong. In any case, during the conversation I had the clear impression that Haier did not want this discount. It remains exciting.”

        I think the smaller amount of buybacks on D shares makes sense as it is quite illiquid. H shares have roughly 70x trading volume despite only having 9x more shares outstanding. I also don’t think it is likely they will throw the large institutional holders of D shares under the bus like that? They probably have some influence here.

  7. Pedro

    Thanks for the very interesting idea. From what I have seen the shares were priced at a 50% discount straight at the German IPO – any idea why that was the case? Thanks

    1. ijw

      Looking at the other large holders, it seems they are all Chinese state companies, and one supplier and Haier International which is a management holding company? So probably it was set up to reward insiders and keep political allies happy. Which makes me think this whole thing will be resolved at some point and discount will be closed. But you can’t do it right away because then it looks too much like a bribe or robbery of other shareholder classes. So probably it will happen somewhere by the end of 2022 or so. That is why I also think it is unlikely this will just be unlisted. And the unwinding of the German exchange this is listed on might provide a nice excuse to do so.

      2
  8. dt

    We are removing Haier from active ideas with 20% in 9 months. The chances of the company buying back the cheapest D shares listing and closing the gap between with China and Honk Kong listings did not really materialize. In 9 months since we posted this, the spread between H and D shares narrowed only slightly and recent actions by the company seem to be opposite from what D shareholders were expecting.

    1. snowball

      Haier’s Chinese peer Midea has announced that it’s going to squeeze-out and delist Frankfurt-listed KUKA (which it already owns >95%), quoting lack of needs to tap the capital market as its rationale.

      “Board decided that a public listing is no longer required for KUKA, because KUKA already ceased to obtain refinancing through the capital market following the takeover by Midea in 2016. ”

      https://www.kuka.com/en-de/company/press/news/2021/11/ad-hoc-kuka-and-midea

      1. Vincent

        Any idea what the squeezing out price will be? it was not announced. Midea tendered for KUKA at EURO115/share in 2016, which is over 50% over current price. Price rose only a few percent since this announcement. Could be an interesting situation.

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