- Adriano Milani
Haier: an arbitrage-like opportunity between Frankfurt and Hong Kong
Updated: Feb 1, 2021
If you had the chance to buy two identical financial instruments at a 38% price difference to one another, which one would you buy? And how long would you expect the price difference to persist? Haier Smart Home’s recent relisting in the Hong Kong Stock Exchange created this kind of opportunity, for investors willing to trade liquidity for return.
Haier Smart Home is an international manufacturer and distributor of home appliances, mostly white goods (refrigerators, washing machines, dishwashers and the likes). It owns brands such as Candy, Hoover and GE Appliances. The company was founded in 1984 and it is based in Qingdao, China. It was known as Qingdao Haier until June 2019, when it changed name to Haier Smart Home. It is a healthy company with growing revenues, positive earnings and low debt, but the opportunity I will describe is independent from its fundamentals.
One company, three markets
Currently, Haier Smart Home has shares listed in three markets: A-shares in China (ticker: 600690), D-shares in Germany (ticker: 690D) and H-shares in Hong Kong (ticker: 6690). The Shanghai stock exchange is its original market, and the company is listed there since 1993. In 2018, Haier relisted in Germany, issuing D-shares in the China Europe International Exchange (CEINEX), based in Frankfurt. Haier was the first company to list in this exchange, which was meant to bridge Chinese and European markets, as the name suggests. The operation was not really successful: Haier sold fewer D-shares than initially planned - 271 million shares versus 400 million - at a pretty large 35% discount to Shanghai’s A-shares. Moreover, D-shares traded very poorly in the following months, with average volumes well below €100.000 per day, and the discount to A-shares further increased over time. To this day, Haier is the only company listed in CEINEX.
As you can see from the graph above, the discount suddenly decreased about a month ago, and here is why. On 23 December 2020, Haier relisted in Hong Kong with its H-shares. With shares now trading in three different markets, the Hong Kong listing prospectus clarified the relationship between different classes of shares. The document clearly states that all shares have equal rights. There are a few bureaucratic differences, but not in voting rights, liquidation rights or economic rights. In particular, page 290 reads: “A Shares, D Shares and H Shares shall rank […] equally for all dividends or distributions declared, paid or made”. This does not automatically mean that all classes of shares should trade at exactly the same price. There are many reasons to justify a difference: liquidity, currency preferences, possibility of being included in local indexes, and availability to retail investors. In particular, outstanding shares in each market are as follows:
D-shares represent only 3% of total shares, which call for a liquidity premium. However, D-shares are currently trading at a 38% discount to H-shares and 46% discount to A-shares, which seems excessive to me.
A shrinking discount
Having H-share listed generated a more apple-to-apple comparison for D-shares, as they both trade in offshore markets. Money managers who can freely invest in Hong Kong and Germany should prefer the German shares, as they provide a higher dividend yield. On the other hand, they might require a liquidity premium, but the resulting equilibrium is unlikely to be a 38% discount, in my opinion. In fact, D-shares appreciated more than 100% since December 23, to catch up with the Hong Kong ones (which also increased in price). The discount to H-shares has dropped from around 50% in early January to below 40%. I believe the gap will shrink further.
However, I think Asia-focussed investors looking at the H-shares for the first time are unlikely to notice the D-shares immediately. The Hong Kong relisting is a relatively recent event, and it is easier for local investors to compare H-shares with Shanghai’s A-shares, due to both geographical proximity and similar capitalization. Frankfurt’s CEINEX is a forgotten exchange, somewhat of a failed experiment, and trades around €500 million worth of a company with a €30+ billion market cap. However, I think that the market will acknowledge the situation within a reasonable timeframe (say less than twelve months). The opportunity has already been discussed in a bunch of different places (see for example here, here, here and here), and I think it is just a matter of time before a broader audience gets involved.
Optionality: conversion to H-shares
The main reason for the existence of a discount between Haier’s different classes of shares is that they are not fungible, meaning you cannot buy shares in Germany and sell them in China or Hong Kong “as if” they were A-shares of H-shares. If that were the case, the gap would quickly disappear, as traders would exploit the arbitrage opportunity. However, the conversion of D-share into the newly issued H-share is possible, at least in theory. Haier’s Hong Kong listing prospectus has an entire section titled “Conversion of A shares or D shares into H shares”, which describes the procedure to be followed. This is rather complicated, and it ultimately requires the company’s approval, so I reached out to Haier’s Investor Relations to figure out if they would ultimately allow conversion. I can summarise their reply like this: at present, Haier has no plan to initiate the conversion, but they confirmed this is legally possible and they might re-evaluate the matter in due course. It is ultimately a negative answer, but it leaves the door open for the future. Ultimately, I think the opportunity is compelling even if conversion is never allowed, but it is good to have extra optionality on your side.
The trade, the payoff
So what is the proper discount? It is hard to give a precise answer, since this is a unique situation. The closest comparison are other companies with non-fungible shares listed in different market, such as BHP and Rio Tinto (UK and Australia), and until recently Unilever and RELX (UK and Netherlands). Historically, the less liquid listing of these companies traded at discounts ranging from 5% to 20% to the more liquid listing, with temporary peaks above such levels in times of extreme financial market conditions (such as Covid-19 or the 2008 crisis). Note that the Hong Kong H-shares are also trading at a 10-20% discount to Shanghai’s A-shares. I do not see many reasons for the German D-shares discount to H-shares to be higher than that. Should 20% be the “right” discount (which I think is conservative), D-shares would have to appreciate 29% to close the gap - assuming a constant H-share price. With a more aggressive 10% “target” discount, the upside in D-shares would be 45%.
To bet purely on the discount reduction between D-shares and H-shares prices (irrespective of the absolute level), we can short sell the expensive Hong Kong H-shares, and use the proceeds to buy the cheap Germany D-shares. This is not an arbitrage, as it is possible that the spread widens while we hold the position, but in my view the risk/reward is extremely favourable. A widening discount does not make sense in the long run, as the economic rights of the shares are identical, and both trade in offshore markets. Starting from a level of 38%, I think the chances of being directionally right are extremely high, although it is hard to quantify precisely the “fair” discount. Here is how the payoffs of the trade look like for several discount levels:
Obviously, the main determinant of the payoff is the discount direction, but it is worth noting that the trade becomes riskier (and potentially more profitable) as H-shares price increases, and as the Euro depreciates against the Hong Kong Dollar. The trade is actionable as Haier’s H-shares are available for short selling in abundance, thanks to the large capitalization in the Hong Kong market, and the cost of borrow is below 1.5% at the time of this writing. In practice, borrow is even less expensive, because it is partially offset by the difference in dividend yields between the Hong Kong shorted shares (1.3%) and the German long shares (2.1%).
Let me reiterate that this is not a real arbitrage situation, although it is similar in many aspects. Since it involves short selling, there is no cap to the potential loss. Any scenario in which the Hong Kong shares appreciate while the German shares do not could produce severe losses. This might happen, for example, if Hong Kong shares become very popular with local investors, who cannot or do not want to own the German shares. Additionally, the profitability of the trade might diminish if cost of borrow increases, although I do not think this is likely to become a real problem, as H-shares are very liquid.
Haier recent relisting in Hong Kong generated a compelling opportunity to bet on the reduction of the spread between the new shares and the legacy German shares. It is reasonable to assume that the gap should shrink, as both classes of share trade in offshore market, and the company clarified that they are identical in terms of economic rights. I believe this will happen in a matter of months, as more investors discover the opportunity. On top of that, there is positive optionality provided by the possibility for share conversion in the future.
Disclosure: Integer Investments is long 690D (D-shares) and short 6690 (H-shares)
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