Curious Case of China Art Financial (HK.1572)
A friend/reader of my blog emailed me about China Art Financial (HK.1572) 中國藝術金融控股有限公司 and we took a quick look at its financials.
Introduction
China Art Financial Holdings is an art financing service provider. Think of it being your typical pawnshop however they deal with art collaterals. Along with that, it performs online/offline art auction services for their customers and pockets a pre-agreed commission cut. Some of their artwork portfolios include zisha artworks, paintings, calligraphies, ancient teapots, and jewel artworks. The company was founded in 2004.
Market Cap: USD $154.9m
Industry: Consumer Finance
For 4-years CAGR, the earnings per share grew by 24.2%. A very clean balance sheet that is flushed with enormous cash. High net profit margins of 58.3%, return on equity of 22.3%, low capital expenditure company, and it is trading at EV/EBIT of 1.87x.
A fast-growing company with high returns on equity and flushed with cash. On a surface glance, I do think it is too good to be true. How are they able to be so profitable? On my side, I will perform my due diligence to understand it more. Basically, this company is every value investor’s wet dream. The founders own 62.25% of the company.
Shareholder Structure of China Art Financial
(source: here)
Big Question Marks
1) A loan-to-value ratio that favors ZT Investment more.
On 26 July 2018, Fan Zhijun (chairman) decided to pledge his (China Art Financial) shares held under Intelligenesis Inv to ZT Investment in exchange for a loan of HKD $250mil. The loan will be given to him, and not the company.
The 62.25% value of the company is worth US$96.24m while the secured value is US$31.85m (or HK$250m). This means the loan-to-value is 33%. Typically, they should be able to get a better loan-to-value of 60% or above. Generally, I do not like pledging of any directors pledging shares to secure loans for their personal benefit.
2) The intention of the transaction
There are three reasons why Intelligenesis Inv is pledging its shares in exchange for an HK$250m loan.
[a] To repay the existing indebtedness of Intelligenesis Inv (HK$40m)
Apart from holding shares of China Art Financial on behalf of Fan Zhijun, why does it have debt?
[b] acquire precious artworks from contemporary Chinese artists such as Xu Beihong (徐悲 鴻), Fu Baoshi (傅抱石), and Wu Guanzhong (吴冠中) for investments. (HK$190m)
The announcement further added that Intelligenesis Inv would consider appointing the Group to arrange for the auction of the artworks to be acquired.
Why does he want to acquire it, then, later on, get it auctioned via China Art Financials? He even has to go through the trouble of pledging his entire shares in China Art Financials to get a lousy loan of HK $250m.
Why don’t China Art Financials acquire it directly then get it auctioned by themselves since its balance sheet has HK$792m cash already? It’s more than sufficient. Are the precious artworks being valued and verified by qualified third-parties?
When given such an opportunity to acquire precious arts, shouldn’t a director’s duty to allow the listed company to gain access to it first? Why does the director choose to buy it himself then appoint China Art Financials to auction for him?
[c] For future investment purposes. (HK$15m)
The intentions of the transaction beg the question whether the management is aligned to the minority shareholders of the company.
The Resignation of Chief Financial Officer
On 10 September 2018, Mr. Tang Man Joe decided to resign as the Chief Financial Officer of the company. Mr. Wong Hong Tak Hagan is set to replace him.
I did a few checks. Isn’t their main business in China? Why is their CFO stationed in Hong Kong?
Conclusion
I would avoid this company for now because the transactions do not make sense to me. It does not mean that things are not proper but it is not logical to me. I am unable to establish trust in the management of the company. Feel free to correct me because I am keen to find out about it too.
Sources:
26 July 2018 – Proposed Non-Enforcement of Undertakings
16 August 2018 – Delay in Despatch of Circular
22 August 2018 – Further Delay in Despatch of Circular
23 August 2018 – Circular
10 September 2018 – Resignation of the CFO