Citic Bullish Bets Near One-Year High on Acquisitions: Options

Aug 17, 2014 6:07 pm ET

(For an Options column news alert: SALT OMA.)

Aug. 18 (Bloomberg) -- Options traders are betting Citic Pacific Ltd. will extend the second-best rally on the Hang Seng Index this year amid an expansion into banking and stockbroking as Chinese policy makers open up the nation’s financial markets.

The steelmaker will continue its 39 percent advance as it completes the acquisition of $36 billion of assets from its state-owned parent, including stakes in Citic Bank Corp. and Citic Securities Co., according to Jefferies Group LLC. One- month calls that profit if the shares climb 10 percent cost 5.8 points more than puts at the end of last week, according to data compiled by Bloomberg. The difference climbed to 6.6 points on Aug. 5, the highest since May 2013.

“The new Citic Pacific will be a good proxy for the Chinese economy,” Christie Ju, head of research at Jefferies in Hong Kong, said by phone on Aug. 14. “The share price performance reflects investors’ optimism that China’s economy has turned the corner.”

Citic Pacific is at the heart of the most sweeping China policy shifts in decades, with President Xi Jinping pledging in November to allow more private capital in state-owned enterprises to boost efficiency. The asset injection, the biggest into a Hong Kong-listed unit from the mainland, may become a model for similar moves by government-controlled companies. Citic Group, the parent company, had $669 billion in assets as diverse as real estate to banking to golf as of the end of last year.

Stimulus Boost

Chinese stocks listed in Hong Kong have rallied 21 percent from a March low after the government deployed targeted stimulus in efforts to meet its 7.5 percent goal for economic expansion. Growth has been slowing as China seeks to steer away from reliance on exports toward a more consumption-oriented model and contain lending risks. Gross domestic product growth is expected to decelerate to 7.4 percent this year, according to a Bloomberg survey.

State energy producers are also seeking outside investors, with China Petroleum & Chemical Corp. planning to sell a 30 percent stake in its retail gasoline unit. The nation’s three major telecommunications operators, China Mobile Ltd., China Telecom Corp. and China Unicom Hong Kong Ltd., are drafting plans to open Internet, information and data analysis services to investment, according to an Economic Information Daily report last week citing an unidentified person.

“The reduction of state ownership in these SOEs is positive for the market,” Mixo Das, a Hong Kong-based strategist at Nomura Holdings Inc., said by phone on Aug. 12. “Given low valuations in China, it doesn’t take a lot of good news to move the market.”

Relative Value

Citic Pacific shares traded at 17.7 times estimated earnings as of Aug. 15, compared with a multiple of 11.5 times for the benchmark Hang Seng Index and 8.8 times for the Shanghai Composite Index, according to data compiled by Bloomberg. The stock rose 1.4 percent to HK$16.46 at the last close.

Jefferies on March 27 maintained its buy rating and raised its price target on Citic Pacific to HK$17.10 from HK$13.90 after Bloomberg first reported the possible asset purchases.

Citic Securities, China’s biggest brokerage, will benefit from plans to connect the Shanghai and Hong Kong bourses, according to Kenny Tang, general manager of AMTD Financial Planning Ltd. in Hong Kong.

Record Inflows

Exchange-traded funds focused on China are recording record inflows ahead of the start of cross-border trading, which will begin around October and promises unprecedented access to the mainland’s $3.6 trillion equity market. Hong Kong Exchanges & Clearing Ltd. has been the Hang Seng Index’s best performer this year, gaining 42 percent on optimism the link will boost volumes for the bourse operator.

Citic Pacific’s market value will rise to about $40 billion, Chairman Chang Zhenming said in April when plans were announced. Besides stakes in China Citic Bank and Citic Securities, the restructured company will also hold real estate, engineering and infrastructure assets.

“Through this transaction, Citic Pacific undergoes a fairly monumental transformation,” Karim Salamatian, an analyst at Credit Suisse Group AG in Hong Kong, wrote in a note on June 19. “The new Citic Pacific will have vastly improved scale, and exposure to more volatile, lower-return and capital-intensive businesses such as iron ore and specialty steel will be greatly reduced.”

Private Investment

The company raised about $5.8 billion in May and June to help finance its acquisitions, which are expected to be completed this month. Investors included China’s National Social Security Fund, China Life Insurance Co., AIA Group Ltd., Tencent Holdings Ltd., Och-Ziff Capital Management Group and companies controlled by the families of billionaires Robert Kuok and Cheng Yu-tung.

“The share placement spurred confidence in the stock,” Andrew Sullivan, head of sales trading at Espirito Santo Securities Inc. in Hong Kong, said by phone on Aug. 12. “Now investors need to find something else to move the needle a bit further. It will now be a matter of whether Citic Pacific will be delivering on the hopes and expectations of the market. Historically, the management of Citic Pacific hasn’t been the best.”

Citic Pacific incurred a currency-derivative loss of about HK$15 billion ($1.9 billion) in 2008, forcing Larry Yung to step down from the chairmanship and prompting a bailout from Citic Group. Current Chairman Chang cited an iron-ore operation in Australia as a “financial burden,” beset with cost overruns and delays.

Volatility Gauge

The HSI Volatility Index, which measures the cost of options on the Hong Kong gauge, dropped 3.1 percent to 14.97 on Aug. 15, a three-week low.

Implied volatility, used to gauge the cost of options, for one-month Citic Pacific calls jumped to 35.2 on Aug. 15 from this year’s low of 18.2 on July 2, according to data compiled by Bloomberg. Implied volatility for puts rose to 29.4 from 22 in the same period.

Traders have been reducing the number of bearish Citic Pacific bets relative to bullish contracts. The ratio of outstanding puts versus calls on the stock fell to 1.45-to-1 last week after peaking at 2.73-to-1 in May, data showed. A Hong Kong-based spokeswoman for Citic Pacific declined to comment on the options trading.

“After the injection of assets from the parent, profits will be boosted substantially,” AMTD’s Tang said by phone on Aug. 11. “We need to revise upwards our price target and earnings estimates to take into account contributions from banking and stockbroking, which will be the company’s main businesses.”