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Fidelity China (FCSS)

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Tuesday 12 June, 2012

Fidelity China

Final Results


 

FIDELITY CHINA SPECIAL SITUATIONS PLC

Preliminary Announcement of Results

For the year ended 31 March 2012

 

 

Chairman's Statement

 

RESULTS FOR THE YEAR ENDED 31 MARCH 2012

 

I present the second Annual Report of Fidelity China Special Situations PLC.

 

PERFORMANCE REVIEW

During the year ended 31 March 2012 the net asset value of the Company fell by
18.5%, under-performing the MSCI China benchmark index by 6.0%. The Company's
share price fell by 26.4% (all figures on a total return basis). This is
clearly a disappointing outcome for shareholders.

 

The exposure to small and medium cap stocks was the largest detractor from
performance as these experienced an unprecedented level of volatility during
the year under review. The Company's decision to use bank borrowings to
increase exposure to the market while valuations remain attractive detracted
further from relative performance. Both of these factors are expected to
enhance the performance of the Company relative to the market in more
favourable conditions.

 

For much of the year under review, there was an intense debate between those
predicting a "hard landing" for the Chinese economy and those expecting a more
benign outcome. Investors focused on forecasts for an overall slowing of GDP
growth in China, despite the fact that expected growth this year is in line
with the Chinese Government's five-year plan and comfortably higher than the
growth rates forecast for the developed economies. The Company, advised by the
Portfolio Manager, believes the Chinese Government will take the necessary
measures to ensure a stable growth environment, especially in light of the
transition of leadership scheduled for late 2012.

 

Compared to its Western counterparts, the Chinese Government has more freedom
to use the tools at its disposal to manage inflation, interest rates, local
government and bank debt, credit expansion, exchange rates, and the property
market and we expect it to continue to use these tools to effect the desired
"soft landing" for the economy. Nevertheless the market impact of such measures
will continue to be influenced by shifts in global risk appetite, especially
with regard to the ongoing debt crisis in Europe.

 

The Board's annual due diligence trip to China confirmed its continuing
confidence in the long-term prospects for the Chinese economy and in the
Company's ability to generate attractive returns to its shareholders over the
long-term.

 

I would encourage you to read some of the stock examples detailed in the
Manager's Report.

 

PORTFOLIO MANAGER

The Board is pleased that Anthony Bolton has decided to extend his minimum
tenure to at least April 2014.

 

DISCOUNT AND PREMIUM

The Board believes it is in the best interests of shareholders and of liquidity
if the share price of the Company tracks closely the underlying Net Asset
Value, which is published each business day. The Board has the ability to issue
shares at a premium to NAV and to buy shares back at a discount to NAV for
cancellation. During the year, in furtherance of this policy, the Board
authorised the issue of 6,250,000 Ordinary Shares at a premium to NAV and
repurchased at a discount and cancelled 2,900,000 Ordinary Shares. The Board is
seeking shareholder consent to continue these powers, at the forthcoming Annual
General Meeting.

 

GEARING

On 17 February 2012, the Company entered into a revolving facility agreement
with Scotiabank Europe PLC for US$150,000,000, which has been fully drawn down.
The US$100,000,000 revolving facility with JP Morgan Chase Bank has been repaid
in full.

 

The Company also uses derivatives to achieve further gearing by the use of
Contracts for Difference on a number of the holdings in the Company's
portfolio, totalling a further £39,329,000 as at 31 March 2012 (2011: £
38,127,000).

 

REGULATORY CHANGES FOR INVESTMENT COMPANIES

Regulatory changes continue to present a challenge for all boards of UK listed
companies. For UK investment companies, the two key items are the Alternative
Investment Fund Managers Directive ("AIFMD") and the Retail Distribution Review
("RDR").

 

It is widely acknowledged that the AIFMD will add to the complexity of the
governance framework for investment companies and substantially increase
operational costs. However, the AIC, FIL and others in the investment trust
industry, continue to lobby regulators on the draft proposals, in an effort to
make the proposed regulations less onerous.

 

With the advent of RDR, Companies will no longer be able to pay commission on
new assets from adviser intermediaries. This may also mean independent
financial advisers will take a fresh look at the investment trust sector.

 

THE BOARD

The Board is pleased to welcome Elisabeth Scott as a new member of the Board as
of 1 November 2011. Ms Scott has extensive investment experience, particularly
in Hong Kong, where she was Managing Director and Country Head of Schroder
Investment Management (Hong Kong) Limited.

 

The Board wishes to thank Gary Shaughnessy for his valuable contribution
following his decision to resign from the Board on 26 March 2012, having left
employment with FIL.

 

On 21 May 2012, the Board announced the appointment of Andrew Wells, who is
FIL's Global Chief Investment Officer, Fixed Income and Investment Solutions
Group, and a member of FIL's Global Operating Committee.

 

Elisabeth Scott and Andrew Wells will be subject to election at the forthcoming
Annual General Meeting and all other Directors will be subject to re-election
at that time, in accordance with corporate governance requirements for FTSE 250
companies. A biography of each Director is included on page 17 of the Annual
Report.

 

DIVIDEND

As the Company's objective is to achieve long-term capital growth, the Board
does not expect that dividends will constitute a material element of any return
to shareholders. However, in order to continue to qualify as an investment
trust, the Company is required under Section 1159 of the Corporation Tax Act
2010 not to retain more than 15% of the income it derives from shares and
securities.

 

The Board recommends a final dividend of 0.75 pence per Ordinary Share to be
approved by shareholders at the forthcoming Annual General Meeting.

 

The dividend will be payable on 3 August 2012 to shareholders on the register
on 20 July 2012 (ex dividend date 18 July 2012).

 

Shareholders may choose to reinvest their dividends to purchase more shares in
the Company. Details of the Dividend Reinvestment Plan are set out on page 64
of the Annual Report.

 

THE ANNUAL GENERAL MEETING - 24 JULY 2012

The Annual General Meeting of the Company will be held at the Merchant Taylors'
Hall, 30 Threadneedle Street, London EC2R 8JB, on Tuesday 24 July 2012 at
11.00am.

 

The Board is looking forward to having the opportunity to speak to
shareholders. The Portfolio Manager, Anthony Bolton, will also be attending in
order to give his yearly presentation and to meet shareholders.

 

 

 

John Owen CMG MBE DL

Chairman

11 June 2012

 


Manager's Report

 

Anthony Bolton has more than 30 years' experience of managing equity funds and
began investing in Chinese equities in 2004. He previously acted as portfolio
manager for a number of Fidelity funds, including Fidelity Special Situations
Fund, which he managed from 1979 until 2007. He also managed the portfolios of
two listed investment trusts, Fidelity Special Values PLC (from 1994 to 2007)
and Fidelity European Values PLC (from 1991 to 2001).

 

It is now just over two years since the launch of Fidelity China Special
Situations PLC and I admit I am not where I had hoped to be. The value of the
fund's net assets (NAV) has fallen by 20.0% since launch and the share price by
26.3% (as at 11 June 2012). There has been a recovery in the second half of the
reporting year, with the NAV up 14.6%, but the share price is up by only 7%
over that period but markets have again been difficult in the last couple of
months. As outlined in the interim financial report, the fund has suffered from
its ability to employ bank borrowings, which has magnified the impact of market
movements, and from a relatively high exposure to more volatile medium and
smaller companies in an environment where for much of the last 18 months their
performance has been disappointing. A chart showing the share price and NAV
against the performance figures of the Hong Kong-listed Chinese mid and small
cap indices, which I believe are better short-term benchmarks is on page 5 of
the Annual Report.

 

I hope these figures will help explain the performance of the Company, although
I must stress that if I did not believe my strategy could out-perform the
broader MSCI China Index in the medium to long-term, I would not be pursuing
it. To recap, there are four main planks to my investment strategy:

 

1.     To be exposed mainly to the consumption and service sectors which depend
on the domestic economy in China. After two years here I feel even more
strongly about the attractions of these areas. Not a week goes by without
statements from Chinese politicians and leaders or evidence from our company
meetings that support this stance. The fact that April was China's national
consumption promotion month says it all.

 

2.     I am focusing on private medium and small-sized businesses rather than
the large state owned enterprises. These are the entrepreneur-run businesses on
which I believe China's long-term prospects are based. Yes, they can be more
risky but the good ones have the potential to be much more rewarding.

 

3.     I am trying to find business models with which I am familiar from my
experience of investing in the UK and continental Europe. These are the models
that I know work. If well run, they should be able to do well for the next 5-10
years as they are normally at an early stage of their development in China.

 

4.     I am trying to buy shares in these companies on reasonable or, if
possible, cheap valuations. At the time of writing, I believe that there are
many bargains available among the smaller stocks. I particularly like stocks
that look cheap against their international peers or where the sum of the parts
is much greater than the valuation of the whole.

 

In the next section of my report I describe a number of companies the fund
holds, all of which fit these criteria. I have picked fourteen companies from a
selection of sectors I like and I hope these examples will give a better
understanding of the types of business I am focusing on.

 

Let me start with a few words about the macro situation in China. As the
Chairman has already mentioned, for most of the last year or so the debate has
continued between those who expect a "soft" landing for the Chinese economy and
those who expect a "hard" one, albeit that the definitions of what constitutes
a "hard" landing differ. The consensus expects GDP growth of 8-8.5% this year,
with many thinking that the second quarter will be the trough. I have to say
that I am not as optimistic as this. When I look at economic growth from a
bottom-up perspective, I get to a somewhat lower figure (although it's possible
that we may never see lower numbers published). Yes, consumption will remain
strong, but fixed asset investment, particularly residential property, and
exports are likely to see significant reductions in their growth rates. I am
not in the "hard" landing camp (which generally expects growth of 5% or less)
but I am below the consensus. This does not make me negative about the outlook
for Chinese equities, for which the key measure is growth 6-12 months hence
rather than growth now, but it does make me even keener to be in the areas that
are doing best.

 

I continue to believe that the biggest medium-term challenges for China are
social and political as it shifts from being a poor society to a wealthier one,
as the middle classes' aspirations grow, as it changes from a rural to an urban
economy and from a closed to a more open society and as it shifts out of
low-value exports into higher-value manufacturing as well as domestic
consumption and services. As I have argued in previous reports, I think the
financial challenges that worry some of the most vocal China bears are
generally surmountable - China has the financial resources and resolve to
address them. Let me give you a quick update on some of these.

 

Inflation has fallen back sharply in recent months as I thought it would and
many now expect it to fall further to 3% or lower later this year. Although the
short-term outlook for prices is good, the high wage increases expected over
the next few years in China mean the structural level in the medium-term is
likely to be higher, at say 5-7%. In my view this is not an alarming rate but
something that will need to be monitored closely.

 

The bad debts of the local government financing vehicles have, as expected,
been pushed into the future. I continue to feel the authorities have enough
financial fire power at the centre to manage these. Also, this problem is well
understood today by regulators and investors.

 

I remain cautious on the outlook for Chinese residential property developers
and the Company holds none of these (although it does hold shares in several
Hong Kong-based developers). Despite the fact that the stocks have recovered
strongly from their lows and many argue that the worst is over, I am not so
sure about this. Also, unlike in 2009, I think the recovery, if it has started,
will be a slow one. With the exception of support for property purchases by
first time buyers, I expect the Chinese authorities to keep their current
property controls in place for some time.

 

I maintain my view that the current backcloth of falling inflation and a slow
loosening of monetary policy should be a favourable one for the stock market.

 

I often get asked about the quality of corporate governance in China, including
the quality of management and of published financial data. I strongly believe
that the best companies are as good as any in the West but the worst can be
much worse and there are more of these in China. The very worst are scams or
frauds as we have seen from some high-profile examples over the last year or
two. This is why I have put an increasing effort into our due-diligence
process, both internally but also externally, using several specialised firms
in this area. I am sure we will not spot every problem but I hope we can spot
most. I recently did a five-day trip to Hong Kong and China with half a dozen
leading UK financial journalists. We met about 18 companies, mainly companies
the Company holds, and the journalists appeared to be impressed by the quality
of the managements they saw and this was reflected in their generally positive
coverage.

 

I continue to see Hong Kong as a major beneficiary of the trends in China. The
population is about 7 million people but 42 million people visited Hong Kong
last year, including 28 million mainlanders - a number that is likely to
continue to grow. The Company has exposure to Hong Kong-based banks, small
property companies, hotel companies, the largest telephone company and the
leading TV company that is expanding its involvement in the mainland.

 

To date the road has been hard but my enthusiasm for this amazing country
remains unabated. Every time I visit mainland China my conviction about it
increases and I return more impressed about the investment opportunities there.
I strongly believe that China is not the house of cards some have suggested and
it is not about to collapse. Of course, like most places it is not risk-free.
One of the regional risks I have written about before is North Korea. Here the
situation has deteriorated again after a period of improvement.

 

I still believe world equity markets offer attractive returns over the next few
years, even more so since the last ten years or so have been so disappointing.
Specifically on Chinese stocks, valuations are still near their ten-year lows
and sentiment has again become very negative. Sentiment regarding the "A" share
market remains especially depressed despite a new policy in China designed to
help it recover - a significant policy change. I continue to believe that those
who stick the course in China will be amply rewarded.

 

I am very pleased that we have recently been able to announce that my tenure in
managing the portfolio is extended for at least one further year to April 2014.

 

As referenced earlier in my report, I list below fourteen companies from a
selection of sectors, all of which I like, and I hope they will give you a
greater understanding of the types of businesses I focus on.

 

REXLot (Market capitalisation: £460m)

(Portfolio weighting: 3.1%)

There is only one legalised form of gambling in China - the two state-owned
lotteries, namely the Welfare Lottery and the Sports Lottery. These raise money
by selling a range of products such as scratch cards, computer-generated
tickets, bets on single-match sports games and on video lottery terminals.
Interestingly the total size of the two lotteries in terms of take is about
US$35bn, a bit larger than the size of the total take in Macau and this figure
is growing at about 30% a year. Exciting new products are being brought in that
will allow tickets to be sold via mobile phones and the internet. Because of
the involvement of the state the area is not without risks. REXLot is one of
the largest service providers to the lottery sector and is actively involved in
developing the newer products. It is growing at about 20% a year, but only
sells at about 8 times this year's estimated earnings.

 

AsiaInfo-Linkage (£520m) (2.3%)

This is a US-listed Chinese company that Fidelity's Chinese private-equity
business invested in before it listed on the stock market. Its main business is
providing IT services and systems for the three large telecom carriers in
China. It is a similar business to the US-listed Amdocs. The stock has done
poorly over the last 12 months or so until recently due to general fears about
US-listed Chinese companies and some softness in its business at a time when
costs have continued to rise. The growth rate is about 15% while the shares
sell at about 11 times this year's estimated earnings (or only 6.6 times,
stripping out the company's net cash from the market capitalisation). Amdocs is
growing at about 6% and sells on a similar valuation. The company has recently
been approached by Chinese private equity investors who are looking to buy out
the company.

 

CSI Properties (£205m) (1.2%)

CSI is a small Hong Kong-based property developer. I was originally attracted
to it because of the very cheap valuation of the shares which sold at a 75%
discount to net assets, a level of discount I have only rarely come across in
the West. I thought that if this could sell at a 50% discount (still a very
high level) the shares could double in price. The portfolio also owns several
other small Hong Kong property developers on similarly high discounts. What
makes CSI different is the fact that it is run by an entrepreneur who is active
in the property market and wants to see a higher share price over time. Some of
the others are controlled by families, who appear to have little interest in
the share price (although I believe in a better stock market environment the
shares might still do well). CSI Properties shares have risen recently and now
sell on a discount of 69%. I believe that in the developer market small
companies can often be more attractive than larger ones as they are more geared
to successful property deals, provided they are well-financed as CSI is.

 

Hutchison China MediTech (£230m) (1.2%)

I have spent some time trying to find Chinese companies developing Western-type
small molecule drugs in China. My searches led me to this company (and an "A"
listed company I also hold in the portfolio). It is a 71% subsidiary of a large
Hong Kong-listed conglomerate, Hutchison Whampoa Group, and is, somewhat
surprisingly, listed in the UK on the AIM market. It has three main businesses:
a drug-discovery business which has some very interesting drugs in the
pipeline, including one the company has recently joint-ventured with
AstraZeneca on very

attractive terms, and a later-stage drug aimed at colitis (which the company
estimates has the potential to have US$1bn in sales). The company also has a
healthcare division growing at about 20% a year selling traditional Chinese
medicines in China. This is a partnership with local pharmaceutical state-owned
enterprises which themselves are poor at marketing. The company also owns a
smaller consumer business selling food and beverages, beauty care and baby care
products. The valuation of the shares can be justified by the latter two
businesses alone while the drug discovery business, which could be very
valuable if it finds a winner, is thrown in effectively for free.

 

3SBio (£180m) (1.5%)

Sadly, one of the fastest-growing diseases in China is diabetes. This is due to
the changing nature of the Chinese diet as the country becomes better off and
the fact that, in general, Chinese people are not particularly focused on
healthy eating. Diabetes is the most common cause of kidney failure for which
the usual treatment is kidney dialysis. A large number of people who need
kidney dialysis go untreated in China due to a lack of dialysis centres,
although this is slowly changing. To benefit from these favourable industry
dynamics, I used to own United Laboratories in the portfolio, a company that
had developed an analogue insulin product, but I sold this holding as I became
less sure about the prospects for its traditional antibiotic business. 3SBio's
main product is Erythropoietin ("EPO") which is used to help maintain red blood
cell counts. All patients who go through dialysis need to take an EPO. 3SBio's
EPO has a 41% share by value of the EPO market in China, nearly 3 times that of
its nearest competitor. It is also developing a number of other drugs and, in
the future, is looking to sell its EPO outside China. The stock is growing at
about 20% a year and sells on about 14 times this year's earnings (or 8.4 times
excluding cash).

 

WuXi PharmaTech (£640m) (1.3%)

WuXi, a US-listed Chinese company, is another business Fidelity knows well as
its China-based private equity business was a shareholder before it listed. It
is the largest contract research organisation ("CRO") in China, several times
bigger than its nearest rival. As global pharmaceutical companies find the
going tougher, with product patent expiries and the cost of developing new
drugs escalating, they are putting more focus on cost control and a lot of the
development process they used to do internally is now being outsourced to
companies like WuXi. Costs in China, even with wages rising, are still
considerably below those in Western economies. India, which has been very
successful in other outsourcing businesses, has made little impact in the CRO
area, which needs a highly-skilled scientific workforce. The largest listed CRO
business in America, Covance, is growing revenues at a rate in the mid to high
single digits and sells at about 17 times this year's earnings. WuXi has guided
investors towards 15-20% revenue growth this year and sells on about 12 times
this year's earnings (or 9.7 times excluding cash). Last year, Charles River,
another US-listed CRO, tried unsuccessfully to take over WuXi and in the long
run we may see further consolidation in this industry.

 

Daphne International (£1,425m) (1.2%)

Daphne is a shoe retailer with 5,600 stores in China and over half of these are
in the smaller tier 4 to 6 cities. It is one of the best ways, in my view, to
play the growth of consumption in these lower tier cities, which in some cases
is growing faster than in the tier 1 and 2 cities. TPG, the private equity
house, became a 14.5% shareholder in 2009 via the issue of convertible bonds
and warrants. It revitalised the management and improved operations through
areas such as supply chain management, IT systems and product focus. Today the
company is growing earnings at about 20% a year and the shares sell at about 17
times this year's estimated earnings. They have performed well recently and the
Company purchased stock at lower levels.

 

Natural Beauty Bio-Technology (£240m) (1.1%)

The cosmetics industry in China has excellent growth prospects as women become
more affluent and take greater interest in their appearance. Unfortunately,
from this Company's point of view, it is largely dominated by large
multinationals such as L'Oreal and Estee Lauder. As a result I became quite
excited when I came cross this small company that was historically based in the
spa business. In 2010 the founding family sold half its shareholding to the
private equity group Carlyle. Carlyle changed the management, bringing in
experienced Chinese businessmen and women who had previously worked for large
multinationals and completely revamped the store look and layout. The stores
are mainly run by franchisees and Natural Beauty makes its money by selling
products to them, the stores today being more focused on product sales than in
the past. It is also developing a counter business in department stores. The
store conversion to the new style is progressing apace, a new advertising
campaign is just starting and the number of stores is growing quickly. New
stores' refurbishment typically pays back in about six months. The earnings are
growing at about 25% a year and the valuation is about 20 times this year's
earnings (or 16.5 times excluding cash). Although not at bargain levels I think
this will look attractive as returns improve. Natural Beauty aims to be the
number one beauty spa business in China by 2014. This is a brand about which I
expect we will hear a lot more in the future.

 

Kingdee International Software (£365m) (0.9%)

Kingdee is one of the leading software companies in China. Its origins were in
packaged software products but it is also now in middleware and enterprise
resource planning systems. As Chinese businesses modernise there is great
demand for better systems particularly amongst the smaller and medium-sized
companies ("SMEs"). Last year was a difficult one for the company; it let costs
expand significantly at a time when there was some softness among its SME
clients due to China's financial tightening. The stock performed poorly and the
chief executive was replaced. This has given the opportunity for me to increase
the fund's holding. The long-term growth rate should be around 25-30% while the
stock is on about 15 times this year's estimated earnings. Kingdee has some
similarities to the UK's Sage when I first came across it in the 1980s and
1990s.

 

China Lodging Group (£480m) (1.0%)

As the Chinese become more affluent and travel more, the hotel sector should
benefit. The sector is dominated by traditional state-owned inns and small
lodging houses and the chains with purpose-built product only account for 2% of
the market, a much lower proportion than in the developed world. There are
three US-listed companies in the budget chain area. I believe China Lodging is
the most impressive and it was started by the founder of Ctrip (the leading
travel internet site). Today it has 675 hotels in 100 cities consisting of
three brands: 'Hanting Express' in the economy area, 'Hanting hi inn' in the
budget area and 'Hanting Seasons Hotels' in the mid-scale, limited service
area. The company has very ambitious plans, looking to open 2,000 hotels by
2016 and 5,000 by 2021 and it believes the rollout can be funded by net cash,
new debt and cash flow. Customers are split 60% business and 40% leisure and
two-thirds of bookings come from a 4.4m strong loyalty scheme membership. China
Lodging is growing at about 35% a year and sells on about 35 times this year's
earnings or 10 times earnings before interest, taxes, depreciation and
amortisation. However, earnings are being penalised by new opening costs and
without these the 5% operating profit margin would be nearer 13%.

 

SouFun (£900m) (1.2%)

SouFun, a US-listed Chinese business, owns the leading residential property
website in China with an estimated 40% market share. The number of unique daily
users is about 2.9m. Because most property transactions today are in new
properties, property developers are the biggest advertisers and information
providers but, as a secondary market grows in China, estate agents will become
a bigger source of revenue. The downturn in the residential property market has
given a chance to buy this leader growing long-term at about 25% a year on only
11.5 times this year's estimated earnings (or 10 times excluding cash).
Although I do not own any Chinese residential property developers in the
portfolio at the moment, as I believe the market will be tough for a while, I
am happy to hold this very attractive franchise. We could be seeing a Chinese
Rightmove in development (the UK website that dominates property search).

 

Modern Media (£90m) (0.9%)

I came across this company quite by chance as I screened Chinese media
businesses listed in Hong Kong. I asked my assistant to have a quick look and
on the back of this we arranged a meeting. Its main business is magazines,
including the leading current affairs weekly magazine in China called "Modern
Weekly". Three years ago saw the launch of a women's magazine, "U+ Weekly", and
this has become the most popular women's magazine in China, overtaking
international titles like Marie Claire and Cosmopolitan. In 2011 Modern
launched a business magazine jointly with Bloomberg. The most exciting growth
area is its move into digital delivery. It has one of only seven national
digital publishing licenses in China. In 2010 it acquired the Chinese media
application "iWeekly" and this is now the most popular media app in China, with
6 million downloads. Modern has other interesting plans in the digital, TV
(called "iTV" which was a case of déjà vu for me!) and e-commerce areas. It is
growing at about 30% a year and sells on about 10 times this year's earnings.
The chairman is one of the most impressive media people I have met in China.

 

Ajisen (£765m) (0.6%)

Ajisen is an example of how I hope I can transfer the techniques of buying
recovery shares from the UK to China. It is a restaurant chain with 670 outlets
in 118 cities in China selling a Japanese, Ramen-style menu. It has expanded
strongly with a logistics-based model of central kitchens and noodle factories
which keeps cooking preparation in the restaurants to a minimum. In July last
year an article was published saying their soups were not fresh and prepared on
the spot but made from powder (they are not actually made from powder but from
paste). In a market that is very focused on food quality and ingredients, sales
were adversely affected especially in Ajisen's Shanghai base. It came as a
surprise to many customers that the ingredients were not fresh (despite the
fact that many chains use this model). The share price collapsed from $18 to
$10 and I repurchased a holding (I had held it earlier but sold out when the
valuation reached a high level). Sales have since been recovering, not as fast
as the company had hoped, but I take encouragement that same-store sales in
Hong Kong (where they have a few units) turned positive in November and in
Beijing earlier this year. The company admits it was slow to react to the
article, particularly as it had never experienced anything like it in its
history and, for example, it now has a public relations office which it did not
before. The company is continuing with its rollout and plans 1,000 units by
2013. The stock should return to growth of 25% a year and currently sells at
about 22 times this year's earnings (or 17.5 times excluding cash), not a cheap
level but this reflects the fact that earnings are depressed by the incident.

 

PAX Global Technology (£110m) (0.5%)

Credit card use will mushroom in China over the next 5-10 years. Banks will
benefit from this trend but, in my view, a better way to play this is via the
growth of electronic payment systems. The penetration of these in China is
about 3 per 1,000 inhabitants compared with 20-30 per 1,000 in the West. The
global industry is dominated by two big listed international companies,
VeriFone in the US and Ingenico in France (a company I used to follow when I
was running European funds). Although a small company, PAX Global is one of the
biggest in China with about 70% of its revenue arising there. Ingenico, often
recommended by brokers for its emerging market exposure, is growing earnings at
10-15% a year and sells on 18 times this year's estimated earnings. PAX is
growing at about 30% and sells on 8 times this year's estimated earnings (or,
amazingly, only 1 times excluding cash). Provided the management continues to
execute its strategy well, I believe at some stage the valuation could be
materially higher.

 

These investments have been chosen from the hundreds that our team in Hong Kong
analyse on a continuing basis and are only a small proportion of the companies
that I personally visit in China and in Hong Kong. Since arriving in China I
have conducted over 780 company meetings, and the ones we like are then
researched before the Company makes an investment.

 

(all data as at 27th April 2012)

 

 

Anthony Bolton

Portfolio Manager

11 June 2012

 

Enquiries:

For Press Enquiries, please contact Anne Read on 020 7961 4409 or 07850 549839

 

 

Income Statement for the year ended 31 March 2012

 

                            Year ended              Period from                  
                             31.03.12               19.04.10 to 31.03.11         
                                                                                 
                  revenue   capital     total       revenue    capital      total
                                                                                 
                    £'000       £'000       £'000     £'000      £'000      £'000
                                                                                 
Revenue                                                                          
                                                                                 
Overseas                                                                         
dividends          11,145           -      11,145     8,783          -      8.783
                                                                                 
Overseas                                                                         
scrip                                                                            
dividends           1,252           -       1,252       664          -        664
                                                                                 
UK dividends          515           -         515         -          -          -
                                                                                 
Deposit                                                                          
interest                9           -           9        12          -         12
                                                                                 
Income from                                                                      
Fidelity                                                                         
Institutional                                                                    
Liquidity                                                                        
Fund plc                -           -           -        11          -         11
                                                                                 
Dividends                                                                        
received on                                                                      
long CFDs           1,064           -       1,064        68          -         68
                                                                                 
Interest paid                                                                    
on long CFDs        (390)           -       (390)      (38)          -       (38)
                                                                                 
Interest                                                                         
received on                                                                      
short CFDs             10           -          10         -          -          -
                                                                                 
Dividends                                                                        
paid on long                                                                     
CFDs                (134)           -       (134)         -          -          -
                                                                                 
Total revenue      13,471           -      13,471     9,500          -      9,500
                                                                                 
(Losses)/                                                                        
gains on                                                                         
investments                                                                      
designated at                                                                    
fair value                                                                       
through                                                                          
profit or                                                                        
loss                    -   (155,156)   (155,156)         -     32,177     32,177
                                                                                 
Net gains/                                                                       
(losses) on                                                                      
derivative                                                                       
instruments                                                                      
held at fair                                                                     
value through                                                                    
profit or                                                                        
loss                    -      27,460      27,460         -   (12,211)   (12,211)
                                                                                 
Foreign                                                                          
exchange                                                                         
gains/                                                                           
(losses) on                                                                      
other net                                                                        
assets                 80           6          86      (39)      (513)      (552)
                                                                                 
Foreign                                                                          
exchange                                                                         
(losses)/                                                                        
gains on bank                                                                    
loans                   -     (1,605)     (1,605)         -      3,004      3,004
                                                                                 
Total revenue                                                                    
and gains/                                                                       
(losses)           13,551   (129,295)   (115,744)     9,461     22,457     31,918
                                                                                 
Expenses                                                                         
                                                                                 
Investment                                                                       
management                                                                       
fee               (4,156)     (4,156)     (8,312)   (3,746)    (3,746)    (7,492)
                                                                                 
Other                                                                            
expenses          (1,655)           -     (1,655)   (2,435)          -    (2,435)
                                                                                 
Profit/(loss)                                                                    
before                                                                           
finance costs                                                                    
and taxation        7,740   (133,451)   (125,711)     3,280     18,711     21,991
                                                                                 
Finance costs                                                                    
                                                                                 
Interest on                                                                      
bank loan           (878)       (878)     (1,756)     (523)      (523)    (1,046)
                                                                                 
Profit/(loss)                                                                    
before                                                                           
taxation            6,862   (134,329)   (127,467)     2,757     18,188     20,945
                                                                                 
Taxation(¹)         (289)       (237)       (526)     (426)          -      (426)
                                                                                 
                                                                                 
                                                                                 
Net profit/                                                                      
(loss) after                                                                     
taxation for                                                                     
the year/                                                                        
period              6,573   (134,566)   (127,993)     2,331     18,188     20,519
                                                                                 
                                                                                 
                                                                                 
Earnings/                                                                        
(loss) per                                                                       
Ordinary                                                                         
Share               0.99p    (20.33p)    (19.34p)     0.47p      3.67p      4.14p
                                                                                 

(¹) This relates to overseas taxation only.

 

The Company does not have any income or expense that is not included in the net
profit/(loss) for the year/period. Accordingly the "Net profit/(loss) after
taxation for the year/period" is also the "Total comprehensive income for the
year/period" and no separate Statement of Comprehensive Income has been
presented.

 

The total column of this statement represents the Income Statement of the
Company and is prepared in accordance with IFRS. The revenue and capital
columns are supplementary and presented for information purposes as recommended
by the Statement of Recommended Practice issued by the AIC.

 

All of the profit/(loss) and total comprehensive income is attributable to the
equity shareholders of the Company. There are no minority interests.

 

All items in the above statement derive from continuing operations. No
operations were acquired or discontinued in the year.

 

The Company was incorporated on 22 January 2010 and operations commenced when
its shares were listed on the London Stock Exchange on 19 April 2010.


Statement of Changes in Equity for the year ended 31 March 2012

 

                                share      capital                                            
                                                                                              
                    share     premium   redemption     other     capital   revenue       total
                                                                                              
                  capital     account      reserve   reserve     reserve   reserve      equity
                                                                                              
                    £'000       £'000        £'000     £'000       £'000     £'000       £'000
                                                                                              
Period from                                                                                   
19.04.10 to                                                                                   
31.03.11                                                                                      
                                                                                              
Proceeds from                                                                                 
offer for                                                                                     
subscription                                                                                  
and placing         4,600     455,400            -         -           -         -     460,000
                                                                                              
Fees and                                                                                      
expenses of                                                                                   
the offer for                                                                                 
subscription                                                                                  
and placing             -     (3,168)            -         -           -         -     (3,168)
                                                                                              
Cancellation                                                                                  
of share                                                                                      
premium                                                                                       
account*                -   (452,232)            -   452,232           -         -           -
                                                                                              
Issue of                                                                                      
Ordinary                                                                                      
Shares                387      42,262            -         -           -         -      42,649
                                                                                              
Additional                                                                                    
share listing                                                                                 
costs                   -       (200)            -         -           -         -       (200)
                                                                                              
Proceeds from                                                                                 
"C" Share                                                                                     
offer and                                                                                     
placing             1,577     164,673            -         -           -         -     166,250
                                                                                              
Fees and                                                                                      
expenses of                                                                                   
the "C" Share                                                                                 
offer and                                                                                     
placing                 -     (2,087)            -         -           -         -     (2,087)
                                                                                              
Net profit                                                                                    
after                                                                                         
taxation for                                                                                  
the period              -           -            -         -      18,188     2,331      20,519
                                                                                              
Equity                                                                                        
shareholders'                                                                                 
funds at 31                                                                                   
March 2011          6,564     204,648            -   452,232      18,188     2,331     683,963
                                                                                              
Issue of                                                                                      
Ordinary                                                                                      
Shares                 63       6,921            -         -           -         -       6,984
                                                                                              
Repurchase of                                                                                 
Ordinary                                                                                      
Shares               (29)           -           29   (2,323)           -         -     (2,323)
                                                                                              
Net (loss)/                                                                                   
profit after                                                                                  
taxation for                                                                                  
the year                -           -            -         -   (134,566)     6,573   (127,993)
                                                                                              
Dividend paid           -           -            -         -           -   (1,656)     (1,656)
                                                                                              
Equity                                                                                        
shareholders'                                                                                 
funds at 31                                                                                   
March 2012          6,598     211,569           29   449,909   (116,378)     7,248     558,975
                                                                                              

 

*      Court approval was given on 21 April 2010 for the Company's "share
premium account" to be cancelled. As a result £452,232,000 was transferred to
"other reserve".

 

The Company was incorporated on 22 January 2010 and operations commenced when
its shares were listed on the London Stock Exchange on 19 April 2010.

 


Balance Sheet as at 31 March 2012

 

Company No. 7133583

 

                                                           2012        2011    
                                                                               
                                                               £'000      £'000
                                                                               
Non current assets                                                             
                                                                               
Investments designated at fair value through profit or       629,709    720,287
loss                                                                           
                                                                               
                                                                               
                                                                               
Current assets                                                                 
                                                                               
Derivative assets held at fair value through profit or        11,582      2,729
loss                                                                           
                                                                               
Amounts held at futures clearing houses and brokers            3,922      3,280
                                                                               
Other receivables                                              9,146      7,388
                                                                               
Cash and cash equivalents                                     20,123     25,184
                                                                               
                                                              44,773     38,581
                                                                               
Current liabilities                                                            
                                                                               
Derivative liabilities held at fair value through            (3,792)    (1,582)
profit or loss                                                                 
                                                                               
Bank loans                                                  (93,841)   (62,013)
                                                                               
Other payables                                              (17,874)   (11,310)
                                                                               
                                                           (115,507)   (74,905)
                                                                               
Net current liabilities                                     (70,734)   (36,324)
                                                                               
Net assets                                                   558,975    683,963
                                                                               
Equity attributable to equity shareholders                                     
                                                                               
Share capital                                                  6,598      6,564
                                                                               
Share premium account                                        211,569    204,648
                                                                               
Capital redemption reserve                                        29          -
                                                                               
Other reserve                                                449,909    452,232
                                                                               
Capital reserve                                            (116,378)     18,188
                                                                               
Revenue reserve                                                7,248      2,331
                                                                               
Total equity shareholders' funds                             558,975    683,963
                                                                               
Net Asset Value per Ordinary Share                            84.72p    104.20p
                                                                               

 

 


Cash Flow Statement for the year ended 31 March 2012

 

                                                                    Period from
                                                                               
                                                             Year              
                                                            ended   19.04.10 to
                                                                               
                                                         31.03.12      31.03.11
                                                                               
                                                            £'000         £'000
                                                                               
Operating activities                                                           
                                                                               
Cash inflow from investment income                         11,063         7,736
                                                                               
Cash inflow/(outflow) from net derivative income              508          (26)
                                                                               
Cash inflow from other income                                  11            21
                                                                               
Cash outflow from Directors' fees                           (146)         (105)
                                                                               
Cash outflow from other payments                          (9,933)       (6,645)
                                                                               
Cash outflow from the purchase of investments           (613,873)   (1,066,951)
                                                                               
Cash outflow from the costs of derivatives               (13,711)      (16,857)
                                                                               
Cash inflow from the sale of investments                  554,516       380,884
                                                                               
Cash inflow from the proceeds of derivatives               34,528         3,499
                                                                               
Cash outflow from amounts held at futures clearing                             
houses and brokers                                          (642)       (3,280)
                                                                               
Net cash outflow from operating activities before                              
servicing of finance                                     (37,679)     (701,724)
                                                                               
Servicing of finance                                                           
                                                                               
Cash outflow on interest on bank loans                    (1,594)       (1,040)
                                                                               
Net cash outflow from operating activities and                                 
servicing of finance                                     (39,273)     (702,764)
                                                                               
Financing activities                                                           
                                                                               
Cash inflow from the offer for subscription and                                
placing                                                         -       460,000
                                                                               
Cash inflow from the issue of Ordinary Shares               6,984        42,649
                                                                               
Cash inflow from the "C" Share offer and placing                -       166,250
                                                                               
Cash outflow from the costs of the offer for                                   
subscription and placing                                        -       (3,168)
                                                                               
Cash outflow from the costs of the issue of Ordinary                           
Shares                                                          -         (200)
                                                                               
Cash outflow from the costs of the "C" Share offer                             
and placing                                                     -       (2,087)
                                                                               
Cash outflow from the repurchase of Ordinary Shares       (1,345)             -
                                                                               
Cash inflow from bank loans                                30,223        62,013
                                                                               
Cash outflow from dividend paid to shareholders           (1,656)             -
                                                                               
Net cash inflow from financing activities                  34,206       725,457
                                                                               
(Decrease)/increase in cash and cash equivalents          (5,067)        22,693
                                                                               
Net cash and cash equivalents at the start of the                              
year/period                                                25,184             -
                                                                               
Effect of foreign exchange movements                            6         2,491
                                                                               
Cash and cash equivalents at the end of the year/                              
period                                                     20,123        25,184
                                                                               

 

The Company was incorporated on 22 January 2010 and operations commenced when
its shares were listed on the London Stock Exchange on 19 April 2010.

 

 

The above statements are prepared in accordance with International Financial
Reporting Standards ("IFRS"). This Preliminary Statement, which has been agreed
with the Independent Auditor, was approved by the Board on 11 June 2012. It is
not the Company's Statutory Financial Statements. The Statutory Financial
Statements for the year ended 31 March 2012 have been approved and audited but
have not yet been filed with the Registrar of Companies. The Statutory
Financial Statements for the year ended  31 March 2012 have received an
unqualified audit report do not include a reference to any matters to which the
Auditor drew attention by way of emphasis without qualifying the report and do
not contain statements under section 498(2) and (3) of the Companies Act 2006. 


The Annual Report and Financial Statements will be posted to shareholders as
soon as is practicable and in any event no later than 22 June 2012.