There is a Chinese saying for relationships: "You come together because of misunderstanding, and you separate because of understanding". When it comes to stock investments, I find that this saying applies as well, at least for me. When I am thinking of buying a stock, the stock would tend to look attractive, even though I would study its financial statements carefully before buying. As the saying goes, the grass is always greener on the other side. However, after I have bought the stock, I would follow its announcements closely and realise that I have not understood the stock well enough. This is when I would regret buying the stock, regardless of whether the stock has risen or fallen in price. For Global Logistic Properties (GLP), which is the largest holding in my portfolio, the same pattern holds true.
GLP is a very attractive stock, which I blogged about it last week in The GLP Story. I find it so attractive that I built up a 22% concentration in the stock within weeks! In contrast, my next largest stock concentration is only 2.5%. Stock concentration is something that I have not attempted previously in my 18 years of investing with my own money. However, because I swallowed too much too quickly, indigestion soon followed.
Although I am very used to fluctuations in stock prices, almost all of my stocks are diversified, with concentrations of up to 2.5% only. GLP, with its 22% concentration, is a different matter altogether. Every 3-cent drop (equivalent to 1.5% drop) in the share price was enough to give me jitters. By Dec last year, I had realised that I could not hold on to such a large concentration and planned to reduce it come Jan, when stocks usually rise with the January effect. Unfortunately, stocks dropped in Jan instead, triggered by the meltdown in the circuit-breakers in the Chinese stock market. Furthermore, there were news of heavy capital outflows from China, triggering memories of the Asian Financial Crisis. I decided to reduce my risks and cut my concentration to 16% at a loss. But when the stock dropped further, it was too tempting and I bought back some shares, raising my concentration back to 19%. By this time, after experiencing the stock price dropping by more than $0.50 from my original cost price, I had more or less become accustomed to its stock price fluctuations. My target concentration for GLP (and any single stock) also stablised at between 15% to 20%, rather than going upwards of 20%.
Beside stock price fluctuations, there were other issues that caused concerns. Around the same time as the stock market decline in Jan, it was announced that the CEO had entered into some collar trades on GLP shares in 2012 & 2014 and the trades would be settled in Jan/Feb. A collar trade is a bearish trade, which left me pondering why was the CEO selling his shares. I also checked that when GLP sold a 34% stake in its China subsidiary in 2014, 3.7% was sold to members of the GLP employee team, which included the CEO. Thus, the CEO was selling shares in GLP and buying shares in the China subsidiary, which represents the majority of the company's net asset value but GLP only has a 66% stake. The interests of the CEO and shareholders are not 100% aligned.
However, a bigger concern was the fact that GLP seemed to be overpaying for its acquisitions. The table below shows the acquisitions by GLP for the 1-year period from Aug 2015 to Jul 2016, just before its Annual General Meeting (AGM).
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| GLP Acquisitions from Aug 2015 till Jul 2016 |
As you can see, some acquisitions were made at Price/Book (P/B) ratios above 2 times. In particular, China X-G Technology was bought at a price of USD21.9 million when its book value was only RMB5,700, representing a P/B ratio of over 25,000 times!
GLP's AGM on 29 Jul came at the right time. I took the opportunity to raise the question whether GLP was overpaying for acquisitions and what were the governance and controls in place to prevent overpaying. The CEO explained that the book values were historical values. The accounting rules in China required companies to depreciate the cost of land over time and the book value did not reflect the market value. In its due diligence, GLP had carried out third-party valuation surveys to determine the market value. The CEO further explained that there were independent teams within GLP to review and approve any acquisitions. Depending on the value of the acquisitions, approval might be required from the board. I accepted the explanation. In a subsequent acquisition announcement on 17 Aug in which the P/B ratio exceeded 2 times, the company added a statement to explain that the book value was based on historical cost. The statement read "The book value is based on People’s Republic of China’s Accounting Standards for Business Enterprises, which requires properties to be stated at historical depreciated cost. The consideration paid was based on recent third party appraisal of the value of the property, among other factors."
The AGM was a good outcome. Besides getting answers for the key concern above, I also got to see the CEO for the first time. Throughout the AGM, he answered most of the questions, demonstrating a good knowledge of the operations of the company. For readers who were not present at the AGM, you can refer to the earnings call transcript for the recent 2Q2017 financial results, which he again answered most of the questions raised by analysts.
Coming back to the issue of less than 100% alignment in interests between the CEO and shareholders, the issue boils down to this: how much are you prepared to pay for an intelligent CEO? After seeing his handling of the questions raised at the AGM and in earnings calls, the business strategy and directions of GLP, I am prepared to accept that he has direct interests in the China subsidiary outside of his GLP shareholdings.
Post-AGM, I sold some GLP shares again in Oct and reduced my concentration to 16%, but it was not
because of price fluctuations or any of the above-mentioned concerns. The purpose of the sale was to create some headroom for
averaging down in the event of any general market crash. But after the recent rumours of a group of Chinese investors planning to take over the company, I bought back what I had sold, using CPF funds.
Like human relationships, there will always be an initial rocky phase where each party understands more of the other. My relationship with GLP has
gone past this rocky phase and I look forward to participating in the long-term growth of this company.
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