Quick review of Chinese Tech Stock selloff – what does Mr. Market know that you don’t

Chinese tech names are hit hard in the past few months. As holders of a handful of them, I’m curious to know what Mr. Market knows about them that I don’t.

Starting with Tencent, game monetization approval is indefinitely halted, corporate structure is shaking up. Maybe that’s why it lost 38% of its value in past 180 days. How about JD? Founder CEO Richard Liu got into this sexual assault scandal. That must be why it lost 48%% of its market value. YY? Oh, that must be because the new type of short video, e.g. Douyin/Tik Tok gaining traction leading to it’s 43%% market valuation evaporation. BABA? Jack Ma retiring must lead to 34% market value drop.

Well, if they are plausible, what about BIDU, WB, NTES, MOMO, SINA, CTRP & GDS who all happened to lose 30-50% from their recent high? Are there plausible fundamental reasons to explain each of them incurring so similar negative returns? I’m sure financial journalist could help find them if they want to. However, it looks to me such synchronized movements could hardly be explained well by idiosyncratic risks. I just want to see how much these movements are synchronized (correlated), thus can be attributed to market as a whole, rather than for each specific name.

I’m a R person, and below I try to do some simple statistic summary. I also attached my R scripts in markdown file for whomever is familiar with R and may want to play around with it.

Download R Markdown Notes: Link

  • Here is how daily close price looks in past 180 trading days:20181017_1_StockCharts
  • Here is the performance and max drawdown in same period

20181017_tbl_perf

  • here is the correlation matrix & its visualization

20181017_tbl_cormat20181017_2_CorMat

All these large blue dots indicate highly correlated daily price movement between these names, as well between single names and CQQQ (a Chinese tech ETF).

  • Let’s try to do a linear regression for YY to see how we can use CQQQ’s return to explain YY’s.

First, scatterplot the return of them, the best fit line already looks positive and close to 1.

20181017_3_ScatterPlot

Based on below linear model, slope of CQQQ is highly statistically significant (p value basically is 0). In other words, CQQQ’s return has high power to explain YY’s return. Note YY is less than 3% of CQQQ’s holdings.

20181017_tbl_formula

20181017_tbl_lm

 

In conclusion, my interpretation is that Mr. Market may not know more about each of these individual company than I do, rather it may be more driven by overall fear to macro events.

Investor Letter – 2017 4Q

Below is general commentary section excerpt from my investor letter for 17Q4

Download pdf: TaoValue_2017_Q4_final

General and Market Commentary

If anything is to be remembered for the financial markets in 2017, the lack of volatility will be on the list. S&P 500 index, for an example, finished positive for all 12 months, unseen for majority of the investors living today. The unprecedented financial market quietness was also accompanied by the mania in cryptocurrency as all major cryptocoins pocketed astronomical returns for 2017. It is not hard to identify bubbles everywhere under traditional definition, but I find it is meaningful to think through a level deeper. Below is my attempt to find some common lessons by doing quick studies of “bubbles” in three distinct markets. As always, I like to think about the most controversial ones, as they are the most “information-rich”. I hope they are interesting read for you as well.

Tesla (Public Market)

2017 is not Tesla’s best year, as it underdelivered the dream they sold before about Model 3 by large margin. However, Tesla bears are bewildered by the lack of reaction of Mr. Market to negative developments. One possible reason to this phenomenon is the bulls’ almost religious belief in Tesla. That means the time for Tesla short to work out is not the “change of the fact”, but rather “change of collective perception towards the changed fact”.

To see whether this positive collective perception is justified, I think of the Tao (i.e. the societal value it creates and the corresponding return it takes) of Tesla. An alternative way to see it is that Tesla may be Elon Musk’s clean energy social campaign disguised as a corporation. If you in 2003 were given a mission to push the global auto industry to a more innovative and socially responsible (e.g. cleaner energy) direction, what would be your estimate of the time line and budget? Tesla single-handedly took about a decade and 0.08% of the societal value created in 2017 (Tesla EV/Projected 2017 Gross World Production). Not a bad score for a social campaign.

However, whether the incremental societal value would be entirely accrued to Tesla in forms of shareholder value is uncertain. This is why I wish Tesla could have remained private, thus funded by more loss-tolerant classes’ wealth. I also wouldn’t short it, because there is still possibility some incremental value could accrue to Tesla through M&A.

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A Valuation Framework for Bitcoin

There is no new thing under the sun.

– The Bible

Disclosure first: This piece might be sacrilegious to many value investors. In Nov 2013 (yes, the last Bitcoin “bubble”), I put a small percent of my net worth then into Bitcoin. I have been holding and plan to hold them until it reaches my estimated value (showed below). Please do NOT see this piece as a defense to Bitcoin critics or as investment advices (In fact, I am always ready to change my view, however I just didn’t come across convincing counter-arguments. Or put it differently, I’ve been most of the critics’ place and held similar suspicion before but changed later). I see this piece as an alternative thinking framework to a potential significant invention in human history, and I welcome any sort of comments/feedbacks/critiques.

A few lemmas I want to establish before going further:

  1. The universe we live in consists of two and only two elements: energy and information. (mass, or material, could be unified to energy by Einstein’s famous equation: E = MC^2)
  2. Bitcoin’s value is binary (i.e. it should either 0 or something very large, there is no middle ground)
  3. If “intrinsic value” is defined as “present value of expected cash flow from a value producing asset”, Bitcoin (as well as all kinds of money) has NO intrinsic value.
  4. Global governments as a whole, is not as prudent and resposible as developed counties’.
  5. I have been wrong and could be wrong on Bitcoin

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Chinese ADR “Go-Private” Deals Overview-  A Changyou Buyout Inspired Study

On 5/22/2017, Changyou [CYOU] received a preliminary non-binding offer from its chairman Dr. Charles Zhang, who is also the CEO and Chairman of Changyou’s parent company Sohu, to take the company private with and offer of $42.10 per ADS. The offer letter can be seen here: http://ir.changyou.com/05_22_2017.shtml. It is interesting that it is Charles Zhang, the person, not the parent company Sohu, to make the acquisition.

As a current CYOU shareholder, I think it’s a OK deal despite I had higher expectation of the turnaround execution which just started to show some positive signs. As of 5/31/2017, there is still about 8% spread between the close price of $38.9 and offer price $42.1. If the deal could be closed timely, it would be a good risk arbitrage opportunity.

Inspired by this event, below I did a general study of all the Chinese ADR “go-private” deals in past few years. I’m keen to get answers to these 3 questions (which could help me evaluate upcoming similar deals’ risk/reward):

  1. How much percent of these deals fell through?
  2. What are the characteristics of the failed deals? (does CYOU have any of these traits?)
  3. How long do they usually take to close?

 

History of Chinese ADR Privatization Deals

Let’s begin with a rough understanding of a typical ADR privatization process. Credit to a Credit Suisse’s study [link here], here is a great chart showing the 6 milestones of such a process.

CPD_GoPrivateDealProcess

It is also important to understand the main incentive of such privatization deals, specifically for these US listed Chinese companies. Like most of the PE backed LBO deals, Chinese ADR privatization deals also target for a relist for higher valuation. However the difference is that, rather than streamlining and growing the businesses for a few year in private arms (in LBO cases), the Chinese ADR companies could seek a faster re-valuation by relisting the firm to its home market (which offered richer valuation, especially back in 2015 before the crash). This also explained why there were so many proposed deals announced in 2015.

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How much do finance people make in Chicago? – 2016 CFA Compensation Survey

Following the 2015 comp survey (find 2015’s number in this old post), CFA Chicago Society recently published 2016 version. This is the second year of this informative survey. PDF report can be downloaded from the link at the bottom.

CFAChicagoComp_2016

Download link: compensation_survey_2016

 

 

Indirect Hard Lessons – Gurus’ Recent Mistakes

As an old saying says, “you best teacher is your last mistake.” However what’s challenging for value investors is that it’s very difficult to realize you’ve made a mistake to start with. As you are always going against herds, you’ve already made “mistakes” in others’ eyes, meaning you are left alone to make the judgement. Plus, you have to re-convince yourself about your verdicts when the name keeps going down after your purchases, or if the names move higher you just cannot stop feeling good about yourself, either way it’s really hard to maintain an objective view on your own past decisions.

Market recently has seen some big failures on names backed by some legendary value investors. Although may not be able to learn the lesson as deeply as the investor themselves do, I found these are great case studies nonetheless.

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