HOT STOCK ENVY
What makes a share price start to shimmy? For CFOs of small cap companies, the answers are not as hard as they used to be.
By Carla Rapoport

When Alison Bailey gets up in the morning, she walks the dog, takes her six-year-old daughter to the school bus stop, and then she starts to worry about her company's share price.

As CFO of Tai Ping Carpets, a Hong Kong-listed manufacturer of custom-designed carpets, Bailey finds it hard to believe that the stock market values her US$58 million-a-year company at less than half its book value. "There's no one like us in the world," she says, her voice pealing with enthusiasm. "We're the brand leaders in Asia in carpets and we're well known in the US and Europe." She has reason to be proud. Since Bailey signed on in 1996, she's helped recapitalize the company and turn it from a disjointed collection of businesses that lost money into a single-minded money maker with palpable growth potential.

And her work hasn't gone unnoticed. "Conscientious and bright," says Michael Nock, CEO of Doric Capital, a Hong Kong-based hedge fund, of Bailey and her CEO, Kent Yeh. In fact, Doric invested in Tai Ping last year. Still, Tai Ping's stock is so poorly rated that whole weeks go by without a soul buying a share. And Bailey can't blame the usual boogey-man of poor market conditions. True, stock markets have been sickly this year. But, at the same time, many small cap stocks have, in fact, been taking off.

Small Desires

In Singapore, for example, where the Straits Times Index has dropped 13 percent since March, the Business Times reported that 19 out of the 20 best performing shares were small cap stocks priced below S$1.00 (US$0.56). In Hong Kong, most profitable small caps have handsomely outdistanced the beleagured Hang Seng Index this year, with some showing share price increases of as much as 50 percent. Even in the US, the Value Line Arithmetic Index, which tracks 1,600 small stocks, has risen 17 percent over the past two years, versus a 30 percent drop in the S&P 500.

What's going on? According to Phillip Kimmel, vice-president and director of Kingmaker Footwear, a US$136 million-a-year Hong Kong-listed company, small caps are benefiting from the demise of the dot.coms. "It used to be, we're growing 20 percent per year and making a product, so what? Now, it's real products and real profits that make sense," he says. Nicholas Tan, head of small cap research for UBS Warburg in Hong Kong agrees: "Rather than look for the next GE, people are looking for the next Johnson Electric. To get to GE's size is not possible given Asia's maturity and development. But to go from US$100 million to US$1 billion is possible with compounded growth of 20 percent per year."

Given all this fresh interest both regionally and globally in Asia's smaller players, why does Bailey have to start each day with a frown when she checks her company's share price? Tai Ping's pricing woes reflect some basics common to many Asian companies, large and small. And these basics cut to the heart of what prevents Asia's bigger corporate bretheran from stepping up to the status of multinational, with a widely spread shareholder base and a true global reach. The first of these is that family or founding shareholders normally control more than 50 percent of an Asian company. This casts a shadow over the stock's liquidity while preserving a conservative management mindset. The second is a deeply felt desire to keep dividend pay-outs to a minimum and reinvest all available cash into the business.

Kingmaker's shares have tap danced all over the Hang Seng Index, proving to be one of Hong Kong's best performing shares. And this year's performance follows on from an extraordinary 2001, in which Kingmaker trounced the Hang Seng Index by nearly 85 percent. Tai Ping, by contrast, saw its shares lose ground during the same period, despite the company's solid profitability and sharply improved balance sheet, its enviable position as the largest carpet maker in the bubbling China market and its carpets-to-the-stars business serving the likes of Tiger Woods and Mariah Carey.

Fund managers and analysts look at a variety of factors when judging a share, but most say that the decision boils down to four primary hot buttons: price-to-book ratio, dividend yield, price/earnings ratio and return on equity. For a small cap, as Doric's Nock explains, investors want to see a single-digit P/E and a price-to-book of less than one, which shows that the shares are good value and reasonably priced. Taking historic figures, Tai Ping and Kingmaker were winners on both counts last year, before the market discovered the shoe maker.

What caused the rush into Kingmaker shares, however, were the other two buttons - dividend yield and ROE. A loss-maker as recently as 1999, Tai Ping was reluctant to step up its dividend pay-out last year, keeping it reined in at 1.9 percent. Kingmaker had no such qualms, paying out a handsome 8.72 percent in the year to March 2001. In his write-up of Kingmaker as the 2001 Christmas Pick, shareholder rights advocate David Webb pointed out that including a bonus issue of 1:10, dividends and price appreciation, his so-called "boys in boots" returned a total of 53.2 percent last year. "Lovely jubbly," Webb pronounced. He went ahead to recommend the stock as a buy for 2002 as well, encouraged in no small part by the company's ROE of 33 percent. Tai Ping, by contrast, returned just 7 percent last year.

Low Flying Carpets

For Tai Ping, founded in 1956 as a source of jobs for refugees from China, Kingmaker's success is somewhat galling. After all, Tai Ping carpets have been fitted at no less an address than Queen Elizabeth's Windsor Castle, as well as the corporate boardrooms of Ford Motor and Chase Manhattan Bank in the US. The company makes a real product and a real profit (nearly HK$52 million last year) and generates a strong cashflow. The hard work of divesting unrelated businesses - from cement factories to bottled water plants - is finished. Two recent rights issues allowed Bailey to reduce the debt-to-equity ratio to just 23 percent by the end of last year. She also helped arrange the buy-out of the company's partners in its Thai carpet business, raising its stake to 99 percent.

It's a good story, but according to Bailey, only one investment analyst has called on her to hear it. When asked about Tai Ping, UBS Warburg's Tan snapped: "Never heard of it." And the analyst who did visit Bailey, Mavis Hui of Kim Eng Securities, a Hong Kong-listed brokerage, was impressed but didn't put out a note about her visit. "I will certainly keep track of Tai Ping," says Hui. "Any company that is a leader of its industry is worth a look and the price-to-book is attractive. But the company would be more attractive if it paid out more," she says.

Bailey takes Hui's criticism on the chin. "It's really a chicken-and-egg situation. We need to conserve cash to grow the business. But if you don't pay a dividend, you don't attract investors and a good share price. For now, our view is to invest in the business," she says. And this investment, she points out, is one of the reasons why the company's ROE looks unusually modest. "All our free capital has been reinvested in updated capacity, new dyeing facilities, and full integration from fiber extrusion and carding right through to the final carpet design," says Bailey. As a result, the company's book value continues to grow even while its share price shrivels.

Over time, Bailey reckons the dividend policy should loosen as the company's profits and sales growth remain on track. But hot buttons aside, she has an even bigger hurdle to jump if she wants more investors taking an interest in the stock. As she explains, Bailey can literally name the owners of 70 percent of her shares - 50 percent of the total is held by one of the founding families, the Kadoories. While this makes for a small, relaxed annual general meeting, it means that investors who want liquidity will steer clear of Tai Ping.

Bailey's non-executive chairman, Dinty Dickson Leach, understands the problem well. Also chairman of Sir Elly Kadoorie & Sons, the company that manages the Kadoorie family's many investments, Dickson Leach has invested a lot of his time assisting Bailey and Tai Ping's CEO Yeh on the group's transformation. Speaking from the elegant Kadoorie office in Central, Hong Kong, amidst art by Henry Moore and David Hockney, Dickson Leach also shows unbridled enthusiasm for the potential of Tai Ping. "If we don't blow it, we can become one of the biggest companies in the world in this business," he says.

He says the Kadoorie family is not wedded to the idea of holding on to their stake indefinitely. "They, the Kadoories, understand that if we don't do something, we're going to go nowhere. Once the liquidity improves, people can get in and out," he says. At the moment, Tai Ping is looking at two alternative ways to reduce the Kadoorie stake. One would be to find an acquisition that could be bought with cash and shares and lift the company to the US$100 million-a-year threshhold. The other route would be to find a strategic investor to buy some of the Kadoorie holding. In the second case, Bailey is keen that the investor should "bring something to the party" in the form of global reach, customers or marketing know-how.

While neither has a specific time frame for unwinding the Kadoorie holding, both admit that sooner would be better than later. "We don't use our quote. In a way, it's crazy that we're a public company," admits Dickson Leach. Indeed, one of the scenarios with a potential investor would be to take the company private until it reaches the kind of critical mass that would allow it to pay out the kind of dividends investors require.

In the meantime, however, Bailey stresses the value of the company's intangible assets, which have yet to be recognized by the market. "We're a home-grown Hong Kong brand name, like Bossini," she says. She points out that the company is now a supplier to Boeing as well as one of the three preferred suppliers to the Marriott and Hyatt hotel chains in the US. Dickson Leach, who met and married Bailey after she joined Tai Ping, adds: "What's a Kingmaker? When they lose their contract for the best-selling shoe, then what?"

Hot Shoes

Tai Ping investor Nock at Doric Capital agrees that Tai Ping should enjoy a brand name premium but says it's up to the company to get its story out. "They need to get close to a few brokers who can start pushing the story," he says. But he's also eager for bigger dividends. "Unless the company can come up with new ways of spending the company's money which can generate a significantly higher ROE, they should give the money back to the shareholders. For example, he says, if they paid out 66 percent of last year's earnings as dividends, they would be on a yield of 10 percent. "That would be very sexy," he says.

But does a small cap company need a brand name to get noticed? Kingmaker's Kimmel remains unconcerned about the group's relatively unknown status outside the investment community. A small company doesn't need to be a brand, he says. Instead, "you need to align yourself with key brands and make sure you are atuned to what's hot and what's not. And it helps," he says with no false modesty, "to be among the most flexible manufacturers in the world. We make everything from men's steel-toed boots to shoes for babies."

He uses, he says, a restaurant approach to manufacturing. "You can't just offer people pancakes. When the brand names come calling, we want to offer them the widest possible choice, on-time delivery, quality and fair pricing," says Kimmel. The strategy seems to be working as Kingmaker's biggest contract is for Timberland shoes. The trendy teen shoe Skechers takes second place, accounting for 25 percent of the company's sales. Warburg's Tan has a name for small cap Asian companies like Kingmaker, who can align themselves successfully to big brand names. He calls them clones. "These are little companies that do business extensively with Home Depot, Wal-Mart, Nike. They are easy to relate to. With the big outsourcing trend, [Asia] is where the back end is. The front end is all in the [US]," he says.

Kimmel agrees, saying Kingmaker benefits from the global trend to outsourcing manufacturing and, in particular, the increasing dependence on China as a global manufacuturing hub. "Why are people closing factories in Mexico?" he asks. It's actually cheaper to make shoes for the US market there, than ship them from Asia, he points out. "The key phrase about China is work ethic. The Chinese have it. Cheaper isn't necessarily better," he says.

Kimmel has also rejected cheaper manufacturing sites closer to home, ruling out Indonesia and the Philippines where workers will labor for less than in southern China, as well as other far flung locations like Bangladesh or Africa. And his commitment to China hasn't hurt Kingmaker's bottom line one bit. Between 1997 and 2001, Kingmaker's sales grew 26 percent to just over HK$1 billion (US$128 million). Pre-tax profits, meanwhile, more than doubled to HK$163 million (US$21 million), producing a comfortable profit margin of more than 15 percent.

These numbers, plus the company's commitment to generous dividends, have prompted investment analysts and fund managers to pour into the company's modest offices in Tsim Sha Tsui, Kowloon. Already, Kimmel has entertained more than 30 fund managers this year, compared to 15 for the whole of last year. And none of them have been overly concerned by the fact that the company's founding family still holds 50 percent of the business. "The main shareholder in Kingmaker is passionate about the business," says an investment analyst who asked not to be named. "I'm not sure you can say this about the Kadoories and Tai Ping."

Dickson Leach responds to this in his typical straight-up manner: "It's probably true that when Michael Kadoorie dies, they'll find the Pennisula Group etched on his heart, not Tai Ping Carpets," he says, referring to one of the Kadoorie family's larger holdings. Despite this emotional distance, both Bailey and Dickson Leach are confident that the Kadoories will do what's best for Tai Ping. And clearly, as shareholders, they've shown great patience, giving Bailey a free hand to restructure the company.

Breaking, or loosening, the ties to the Kadoorie family should help the company make a start toward refashioning its image with the investment community. And when that happens, Tai Ping's stock should start to heat up, giving Bailey one less thing to worry about each morning.

Carla Rapoport is managing editor of CFO Asia.