Regulation needed to provide greater clarity on valuations
with Shirley Yam
Classic investment advice will tell you a share price rises as profits rise. But flamboyant tycoon Joseph Lau's Chinese Estates Holdings has defied this law.
The property investor's share price has climbed 12.9 per cent in the past month after announcing a HK$8.8 billion loss for the year 2010 versus a HK$8.6 billion profit in 2009.
The share price increase is not only twice the return of the Hang Seng Index but the stock also outperformed many of its peers, which have reported stellar 2010 results. During the same period, Cheung Kong and Sun Hung Kai have risen only 5.5 per cent and 1.15 per cent respectively.
Chinese Estates has even outshone Henderson Land, which has climbed 11.3 per cent with its controlling shareholder Lee Shau-kee paying HK$10 billion for additional stakes.
In this little town, when something obviously stupid happens, it is normally not that stupid. Let's go into the numbers.
Chinese Estates' loss is the result of a HK$10.8 billion, or 23.9 per cent, drop in the fair value of its investment property. The decline has put the value of its investment property back to its pre-2007 level. That is shocking for several reasons.
First, despite the government's cooling measures, Hong Kong's property market is witnessing one of its best years. Twelve major listed developers all had the valuations of their investment properties revised up, at an average of 12 per cent, in their 2010 results.
Second, Chinese Estates is holding several prime shopping malls in town, including The ONE in Tsim Sha Tsui. I don't need to tell you the shopping spree our mainland tourists have been on. By the way, the valuation of Wharf Holdings' investment properties, including Tsim Sha Tsui's Harbour City, has gone up by 28 per cent.
Third, the only time that Chinese Estates has seen the value of its investment properties go down in the past 10 years was in its 2008 results. That was less than three months after Lehman Brothers collapsed and the global economy was in chaos.
On what basis was the value of the company's property investments cut? Chinese Estates explained this by saying it had changed appraisers. It switched from Norton Appraisals, which has served the company since 2004, to BI Appraisals.
An executive director of BI, William Sham, explained his valuation involved a conservative view of The ONE shopping mall.
'The rent is high. Actually, it's the highest in the region. My only concern is it won't stay high in the coming two years. There is risk,' said Sham in the Hong Kong Economic Journal.
Are investors convinced? Judging from the share price hike, the majority aren't. Not only do they not believe Chinese Estates is worth less, they are betting the opposite.
A fourth privatisation attempt for Chinese Estates by Lau is what many are looking at. Their logic is simple. The lower the valuation, the lower the net asset value and the lower the privatisation cost will be. Rather than a fair and accurate appraisal, investors see the new valuation as a preparation for privatisation.
Lau holds 74.3 per cent of Chinese Estates. The remaining 25.7 per cent minority stake is worth about HK$7 billion. The developer is sitting on more than HK$10 billion in cash.
Chinese Estates has not commented on the privatisation rumour. Sham said he has not been influenced by company management, adding that he actually had to explain his valuation findings to the 'surprised' management.
Whether a privatisation will occur is anybody's guess. What matters here is we have a valuation that is in stark contrast to market trends and common sense. This is the last thing a regulatory regime that emphasises disclosure of fair and accurate information should tolerate.
Regulators must act. But it isn't straightforward. Unlike auditors and lawyers - who have statutory professional bodies to investigate and discipline any wrongdoing by their members - appraisal houses have no self-regulating organisation.
But that is no excuse for silence. The Financial Reporting Council (FRC) has been established to monitor whether an audited financial statement fairly and accurately reflects the financial condition of a listed company.
That includes asking an auditor what it has done in accepting the work of an appraiser in assessing the value of a business or asset before signing off on a financial statement.
In the case of Chinese Estates, HLB Hodgson Impey Cheng (HIC) has been the auditor since 2006. It has agreed with the valuation by Norton Appraisal, which put the fair value of the developer's investment properties at HK$40.7 billion in its 2009 financial statement.
On what basis has it agreed with a valuation that put the same properties at HK$27.4 billion after a year? And what steps has it taken to reach that conclusion? These are fair questions for the FRC to ask. HIC did not respond to our inquiry.
The FRC should start an investigation into Chinese Estates' 2010 financial statement, decide whether it has to be restated, determine whether there has been any wrongdoing and who should be disciplined. Further silence erodes the integrity of our market.
As a long-term remedy, a statutory regulatory framework for appraisers should be established, given their increasing role in our corporate governance.
We rely on independent appraisers to be the gatekeepers on many crucial decisions. That includes telling us how much the asset owned by a new issuer is worth; whether a company is buying a factory from its controlling shareholder at a market price; and whether a company is selling a building cheap.
Yet there is little regulation concerning appraiser qualifications and work, especially when compared to the tightening supervision over the accounting profession.
The market has never been short of controversies over the work of appraisers. The Chinese Estates case should serve as a deafening alarm bell for action.