A leading full-service public relations firm helping start-ups IPO, conduct follow-on offerings, and manage investor relations since 1996 (performing many of the duties of an investment bank), Wonderful Sky (HKG:1260) has fallen out of favor with investors and shares are down 90% since 2016, with the market cap sinking from HK$2.5b to HK$250m. I’ve been buying since late 2021 at an avg price of HK$0.28. At a tenth of its 2016 price, I’m betting on its future.
If you’re wondering, I’m not writing about it because it’s my highest conviction pick; quite frankly my conviction has little bearing on which dirt-cheap micro-cap is likely to do well and become attractive in the eyes of other investors. There are two reasons: firstly, this company at one point had a lot of attention from institutional investors and was a liquid, frequently traded stock, so a few people might’ve heard of it before and I find it a very interesting case, whereas other picks I have are more obscure (excluding a few larger Japanese ones). Secondly, the price action has been weird after it posted earnings two weeks ago. Most charts won’t show it, but it traded up to HK$0.4 briefly on Friday before retreating down- in micro-cap land this could mean something or absolutely nothing, either way it’s new. Weird stuff is bound to happen when the price is down 90% and trading volume falls 90% in tandem, total daily $ amount traded falls to a tiny fraction (around 2% or so) of what it once was, and finding trading partners is an adventure similar to haggling at a bazaar.
From 2012-17, most investors viewed this as a long-term compounder with a dominant market position, high returns on equity, wide margins, and impressive revenue growth, pricing it at nearly 4x peak 2017 revenue as a result. Operating income averaged HK$177m from its IPO in 2012 until 2019 and has since declined to HK$30m for the past year, with revenue down 55%. Much of this was due to general market conditions, some of it due to worse than expected results given those conditions; since the pandemic their roadshow business has gone kaput, and they likely lost market share in post-IPO fundraising. They’ve been stung hard by the decrease in large-scale HKEX listings. In the 11 years since IPO, the company has generated HK$1.5b in net income and paid HK$690m in dividends. Demand for shares is low, as uncertainty and the current environment make it hard for people to buy with any conviction. The company and its stock have been losers for years, why should anyone bet on them now? Why should it rise now, or ever again?
A number of intelligent, successful investors with impressive investing acumen have written it up in the past; one concise summary can be found here. Mark Walker at Tollymore Partners very honestly and insightfully summarized the firm’s problems in 2021, which ranged from a ballooning investment portfolio mired in poor capital allocation, profit warnings in a worsening IPO market, a potentially deteriorating culture, and the risk of privatization.
The Hong Kong IPO market reached a low point in 2022, with funds raised falling 67% from 2021- as seen on page 3 here. It likely can’t get much worse than last year, and given a better pipeline of IPOs, there is increasing optimism about the market- 1, 2. Maybe the new dual-currency trading system will improve demand from mainland Chinese investors, it definitely couldn’t hurt.
Wonderful Sky’s high-yield Chinese bond portfolio filled with property developers also helped scare away investors in recent years and accounted for HK$300m+ of losses in 2022. Thankfully, they sold most of that in the past year and paid off all debt. They now have HK$500m in net cash after all liabilities, with an additional HK$200m of securities, and the 9th floor of The Center, which is one of the tallest skyscrapers in the city they acquired in 2018 for HK$600m (HK real estate is notoriously expensive, so snip off as much of that price as you’d like).
Usually by the time I look at a stock, every other fund has sold out, and it’s just insiders and I staring at the price. Frequently funds sell because operating losses are painful to endure (they want the profitable ones, of course); but another important reason is that they are forced sellers under a certain arbitrary market cap, as most of them mandate against micro-caps. When the company was selling shares from 2012-17, numerous large asset managers such as Dimensional Fund Advisors, UBS, Value Partners HK, GAM, all bought and held positions then later dumped them when things got ugly around 2018. In this case, I’m surprised a handful of them are still around, including Fidelity’s China special situations fund. It could be an anomaly given that the company hasn’t yet experienced an operating loss since IPO, it likely makes holding much easier.
Company-related risks not already mentioned include potential nepotism, potential for waste of cash (a portion of it has been earmarked for the development of an app since 2015), a holding company structure (which is off-putting to foreigners but common in HK), a tiny float at 29% of shares outstanding, and a possible re-entry into weird securities buying. These risks have existed since IPO but we now get a good price for accepting them. They also bought a yacht a while back (which sadly isn’t rare- see Time Watch Investments which recently sold theirs), managed to nab some Tencent shares at the tippy top, and the company bought back shares during the pandemic without proper reporting or requirements given the limited float. Despite improvement with the balance sheet and the large bond profit this year, operating earnings momentum remains weak, so there’s no guarantee it improves, whether the HK IPO market continues suffering or not. SGA as a % of sales has spiked recently with inefficient staffing and rent costs as revenue declines deleverage their “fixed costs” so to speak, so margins could deteriorate further or widen exponentially at management’s discretion.
I’ve done a great job of offering optimism for this stock, and so far it’s felt like the final rap-battle of 8 Mile listing the company’s problems, but all these recent negatives have allowed for the remarkable change in sentiment among investors from long-term compounder to worth less than cash, and clearly few people now have confidence in its prospects. I don’t view this as a different company than it once was, even if the culture and/or staff have been affected. It’s the same company, put in an entirely new environment, and operating under extreme conditions that investors are unfamiliar with. We’re just seeing what it looks like when bad things happen, and few people want to stick around for it. In their IPO prospectus they explicitly note the volatility in fundraising patterns and the risk of high staff turnover/discontent in bad times, those things just happened to happen.
The potential rewards to investors include a mean reversion in profits with an upswing of the HK fundraising market, share buy-backs and/or a reinstatement of the dividend. Given its price and the potential if it regained prior levels of business, this type of bet doesn’t need to work out the majority of the time to be highly profitable. Investors frequently overpay for the appearance of certainty and underestimate the rewards of accepting uncertainty in moderation when conditions are likely to improve. We’ve seen the company at its best, and also in the worst possible environment; at this price I believe any seller is forking over high risk-adjusted returns by the truckload.
This isn’t a recommendation, suggestion, solicitation, or advertisement, and doesn’t constitute investment advice. The opinions offered above aren’t recommendations to transact in any securities, and I could be missing something, or entirely incorrect on any potential fact, assumption, opinion, or claim provided. There are numerous risks associated with holding thinly-traded, micro-cap contrarian stocks such as this that most investors are unwilling to accept, including significant or total loss, and this stock isn’t excluded from that risk. Other than our position, I have had no communications/dealings with the company mentioned, and receive no compensation for discussing it.