In a just world, Gome Electrical Appliances Holding would be a stock market investor's darling. As China's second-largest white goods retailer, Gome is a rare Hong Kong-listed play on the mainland's growing consumer sector. And the company is making money, too. Yesterday the company announced a 66 per cent rise in first-half profits, on the back of a 22 per cent increase in revenues. Yet investors are wary. At Friday's close, Gome's shares were valued at around 20 times last year's earnings or 2.6 times the company's book value. That might sound fully priced, but Gome's valuation is modest for a company in such a sought-after sector. Compared to arch-rival Suning Appliance, which is priced at 32 times trailing earnings or 6.8 times book value, or mainland retail favourite Wumart which is on 37 times earnings, Gome is trading at a significant discount to its peer group (see the first two charts below). Gome's problem is its founder, Wong Kwong-yu. Once lauded as the richest man in China, Wong is currently languishing in a Beijing prison cell where he is serving a 14 year sentence for bribery, insider trading and illegal business dealings. Yet, although he was ousted as Gome's chairman following his November 2008 arrest, Wong remains the company's largest shareholder with a 32 per cent stake. And although he may be banged up, he clearly believes he should retain a major say in how the company he founded is run. That conviction is causing friction. Although his arrest hit the company's business hard - sales contracted sharply in the first half of 2009 and profits collapsed by 50 per cent - Gome has moved on since Wong's time at the helm. His successor as chairman, Chen Xiao, has closed down unprofitable shops, streamlined the company's supply chain and brought in outside investors. Last June, US private equity outfit Bain Capital paid HK$3.6 billion for a 10 per cent stake in the company, a deal which won Bain the right to appoint three non-executive directors. Chen's measures have successfully lifted Gome's margins, restored the company's former growth trajectory and boosted the share price, which has climbed 34 per cent since trading resumed last June after a protracted suspension (see the third chart). But they have also infuriated the incarcerated Wong, even though the prisoner has gained handsomely from the stock's rebound. In May Wong used his shareholding to vote down the routine re-election of the thee Bain directors at Gome's annual general meeting. The directors were immediately reappointed, but Wong has kept up the pressure. More recently he has called for the chairman Chen and another director to be sacked and replaced by his sister and his lawyer, and proposed that the board be stripped of its right to issue new equity which could dilute his shareholding. Last week, Wong sent a letter to Gome staff accusing the company's management of incompetence and of selling out to American investors. In response, yesterday Gome said it would hold a special general meeting next month to vote on Wong's proposals. Given the company's turnaround, Gome's board can be confident of marshalling enough support among minority shareholders to reject Wong's proposals. But defeating the former chairman in a vote is unlikely to solve Gome's problems. Wong will remains the largest shareholder, and if anything, he is likely to be even more aggrieved. That leaves Gome's management with two options. They can come to some sort of accommodation with Wong, either persuading him to pipe down or to sell down his shares. Alternatively, they could issue enough fresh equity to dilute his shareholding to the point where he is no longer a disruptive influence. There are problems with both courses of action. Striking a deal with Wong would be tricky, not least because the board has no direct contact with the convict. And even if communication were to be established, Wong has given no indication that he would be prepared to back off. On the contrary, he shows every sign that he wants to re-establish his control over the company he founded. Diluting Wong's holding by issuing new shares would be problematic too. That would dilute minority shareholders as well, and would be hard, if not impossible, to square with the board's claim of superior standards of corporate governance. In the long run, however, dilution might be the only solution to Gome's problems, either through a genuine capital raising to fund future growth, or through acquisition. In the meantime, unless the board can strike some sort of deal with Wong, it looks likely that Gome will continue to suffer from an unwelcome discount to its sector.