Article written by Finet

On 2 May 2017, Fullshare made an announcement concerning the short selling report published by Glaucus and its plan for resumption. Fullshare pointed out that the short selling research organisation made these ‘misleading and groundless’ allegations in an attempt to profit from the drop of the company’s stock price, and provided evidence to debunk these allegations . At the same time, Fullshare announced its plan to repurchase stocks at a budget of RMB 4 billion. When trading resumed today, the price of Fullshare jumped 15%.
 

Glaucus decided to issue a second report on 4 May 2017, the day when trading resumed for Fullshare, claiming that the stock price of the company is only worth HK$0.55-0.77. So, how should we valuate the worth of Fullshare? Let us do a valuation analysis of our own. We all know that the intrinsic value of an asset can deviate from its current value, and this sets the basis of arbitrage. The importance of valuation is to find out the deviation between intrinsic and current values. There are currently three popular valuation tools: free cash flow to the firm (FCFF), PE ratio, and PB or PS ratio.

However, these three valuation methods are not applicable to all enterprises because the valuation method can differ depending on the company’s development. For example, when an enterprise is investing or developing, its cashflow is generally spent on building infrastructure, and the PE ratio cannot truly reflect its financial situation. PB or PS ratio is the most suitable for valuating growth and expansion companies. As Fullshare began to undergo business transformation in 2015, it is appropriate to use either of these two tools.

Fullshare was short sold in the midst of business transformation

Let’s use this incident as an example to check if Fullshare is overvalued and perform an appropriate valuation of the company. According to Glaucus, the operating margin and PE ratio are severely imbalanced, and it is obvious that the approach used was PE ratio analysis. However, the valuation done by Glaucus only took partial profit into consideration which resulted in a 431x recurring operating profit.

In reality, the business model of Fullshare has already changed, and the company’s investment sector should be considered as a continuing business; however, Glaucus treated individual assets such as real estate assets as a recurring operating profit. According to Fullshare’s 2016 annual report, the company had a net profit of 3.105 billion, and a PE ratio of 13. Having said that, using its PE ratio to determine its value is inappropriate, and fails to reflect the truth value of an expansion and growth company such as Fullshare.

From reading the announcements released by Fullshare, we know that its current businesses include five major categories: real estate, new energy, tourism, medical / healthcare and investment. Among them, real estate was the only core business, while the other assets were all acquired through mergers and acquisitions or expansion during 2015 to 2016, and the total assets of Fullshare in 2016 increased by 4.2 times. In its 2016 annual report, we learn that Fullshare has made the transformation to become a platform with diversified businesses which makes it a typical growth company.

Looking at these data from the annual report, we learn that Fullshare began its expansion in 2015 by diversifying into investment, tourism and healthcare, and new energy in 2016. Although the property sector still provides the main source of income, its percentage in total income [JW1] was decreasing by the year as the company expanded into other businesses. It was 100% in 2014, 86% in 2015, and dropped to 66% in 2016. In the first year of expansion, Fullshare’s income flow increased by 3.8 times.

For expansion and growth companies, their main focus is future income flow, which is defined by how much one dollar is capable of creating within a year. In 2014, Fullshare invested $1 to yield $0.2, and $0.33 in 2015. In 2016, due to increased expansion, the investment of $1 only yielded $0.09, but the overall expansion had increased the amount of income generating assets, producing a significant jump of 65% in the first year.

Size can reduce costs, but it is crucial that the economy of scale can yield sizable gross profit, that is, income produced after deducting the cost of capital. Fullshare can expand its businesses if it continues to bring in new businesses that have a higher profit margin. Looking at its current status, the healthcare and new energy sectors have the highest profit margins, which are 29% and 37% respectively.

In-depth analysis of Fullshare’s income and cashflow in 2017

Spike in income flow from property in 2017

In order to evaluate how much income flow and net cashflow the five businesses will yield for Fullshare in the future, we should look into its real estate division first. The real estate division and properties of Fullshare are mainly concentrated in Nanjing, but because of tightened real estate policies, the income from the sale of small and medium properties was not satisfactory. In 2016, the real estate business of Fullshare only grew 8.7%, but there is evidence that income will surge in 2017.

[H2]

According to Fullshare’s 2016 annual report, there is an amount of RMB1.29[JW3]  billion in unpaid sales contracts, which means there will be an income flow of RMB 1.29 billion coming in the next year. Using the unpaid sales income and saleable area as basis, it is calculated that each square metre is worth RMB19,000. Fullshare’s Amber Garden has a gross area of 278,464 square meters, and a saleable area of 231,696 square meters, which totals to 510,160 square meters.

Based on the price of RMB19,000 per square metre, if all properties under construction and unsold are sold this year, revenue can reach RMB96.9304 billion, adding the RMB1.29 billion in account receivables, Fullshare will have a total cash flow of RMB10.983 billion in its real estate sector alone. And in 2016, its real estate business only brought in RMB28.95 billion, and even if properties under construction and half sold are included, the real estate sector is still expected to bring in 67.4% more revenue than in 2016 which translates to RMB4.85 billion.

An expansion on the mergers and acquisitions in health and new energy with China Transmission being the dark horse in income[JW4] 

Fullshare values its healthcare and new energy sectors the most, and has made various mergers and acquisitions, especially in its healthcare business. In 2016, Fullshare became a major shareholder in three listed companies with a 23.14% stake in Hin Sang Group, 16.65% in Medicskin, and 20% in Bio Beauty; and acquired multiple companies, such as Shenzhen Anke High-tech, Life Medical, and Precision Medical. As for the new energy sector, Fullshare acquired the industry giant China Transmission.
 

Since no relevant financial data is available for non-listed companies, let’s use the listed companies Fullshare acquired and has a stake in as references, from the chart above, we can see that the healthcare sector has a high gross margin, but these companies show a lower net income, indicating that despite the need to expand, it takes time for net income to grow. However, this is not the case for China Transmission of the new energy sector, the company recorded a growth of 396% in 2015 with a three-year average growth rate of 208%.

According to China Transmission’s 2016 Annual Report, its main product is wind power transmission equipment, which possesses a 29% market share globally. If the net profit is calculated based on its three-year average growth rate, its net income in 2017 can reach $3.39 billion, and Fullshare will stand to gain $2.53 billion. Excluding the contribution of non-listed companies and the increased value of assets from acquired companies, Fullshare’s income from the healthcare and new energy sectors will total to $2.55342 billion in 2017.

According to the above analysis, the property, healthcare, and new energy businesses combined can bring in an income flow of $7.403 billion in 2017. If the income flow of its tourism and investment sectors remain consistent, Fullshare will achieve an operating income of $75.4144 billion. These incomes represent the cashflow created by asset investment, and not profit generated by asset appreciation.

Fullshare’s market value underestimated and is expected to grow by 24%

So, is Fullshare’s current market value reasonable? To illustrate properly, we will first compare its assets with the market value. For the past three years, Fullshare has an average growth rate of 285%, the Q ratio was 0.32 in 2014, 2.79 in 2015, and 1.3 in 2016. If the market value equals to the value of total assets, the value of Fullshare is $1.3/share, which is not expensive. According to inside sources, the net asset value of Fullshare will reach $50 billion this year, and will substantially bring down its PB ratio.

In fact, income is also considered as an asset, and can be included in current assets through receivables, cash or payables. If we use the same method to compare income with market value, the price-to-sales ratio of Fullshare is 1.8 in 2014, 9.59 in 2015, and 16.5 in 2016. If we only look at the PS ratio for 2016, 16.5 is a rather huge number, but with an average growth rate of 122.3%, it will only take Fullshare three years to catch up to its market value.

Based on our conservative estimation, Fullshare will have an income of $754 million in 2017, and its revenue will reach $915 million if the average growth rate is 122.3%. In fact, there is no surprise to this conclusion if other unknown sources of income are also taken into account. If we make the assumption that all income is converted into assets and other conditions remain unchanged, the asset value of Fullshare will total to $57.45 billion in 2017. If we use asset value as our basis, at $1.3/share, the market value of Fullshare shall become $74.69 billion.

Whether Fullshare can maintain its average growth rate is an unknown, and there is no telling if the growth rate will skyrocket due to expansion. Currently, real estate and China Transmission are Fullshare’s main moneymakers; but all eyes are on the healthcare sector. Despite its lack of financial contribution to Fullshare, the company has made huge investment in this area, and companies such as Shenzhen Anke High-tech are likely to become the dark horse in Fullshare’s income.
 

Back to where we left off with the short selling of Fullshare by Glaucus, the 11.89% drop in stock price left Fullshare with a market value of HK$49.717 billion, which translates to RMB43.76 billion, and its market value before the suspension was HK$564 million (RMB497 million). We have learned from the above analysis that the company’s current market value has been underestimated and not overestimated. Even at $1/share, Fullshare’s estimated market value in 2017 should be $57.45 billion, which shows a 24% difference.

There is a great probability that Glaucus will face margin calls. According to inside sources, Glaucus and other short-sellers have borrowed 950 million shares of Fullshare and sold 770 million shares on 10 February 2017 at an average selling cost of HK$3. As the 15% jump in Fullshare’s price gets close to the selling cost, the gap will continue to close if the price maintains on a rise, short-sellers will be getting margin calls and even face the risk of liquidation.