Swire Pacific B Shares May Offer Opportunity for the Small Guy

HONG KONG -- In a world in which institutional investors seem to get all the breaks, it's nice to find a stock that lets small retail investors command the upper hand.

The big brokers who move stocks with a buy or a sell rating often send their research to their biggest customers first and it's no secret that big customers can often get a better price from their brokers than an individual buying 100 or 1,000 shares. Happily, for buyers of venerable Hong Kong conglomerate Swire Pacific (SWRAY Quote - Cramer on SWRAY - Stock Picks), the smaller investor has a distinct advantage.

That's because Swire has two classes of shares listed in Hong Kong: Almost any broker's report talks about the A shares, the ones that are part of the benchmark Hang Seng index, not to mention the regional indexes compiled by Morgan Stanley Capital International. The A shares are also the ones you get when you buy Swire's ADR.

The bargain lies in Swire's Hong Kong-listed B shares, which carry the local ticker code 0087.HK. The B shares carry the same voting rights as the A shares but are nominally worth only 20%. In reality, the Bs now trade at a 44% discount to the conglomerate's net asset value, compared with a 19% discount for the A shares, according to Salomon Smith Barney. The reason? Because the B shares are less liquid, they consistently sell at a discount to the A issue.

"There's no real difference between the two," said Rob Hart, an analyst for Morgan Stanley Dean Witter, who has a buy on Swire. With the B shares, "you get more bang for your buck," he says, pointing out that the B shares are the way in which the Swire family controls more than half the voting rights of the company with just 28% of the equity.

The B shares may not be liquid enough for many fund managers, but they trade heavily enough for most individuals punting modest sums. On Monday in Hong Kong, volume on the B shares was about 1/20th of that of the A shares. The reason brokerage analysts such as Hart don't follow the B shares is that their big customers are large institutions which often move hundreds of thousands of dollars on every trade.

That's not to say that the B shares will ever close the valuation gap completely.

For instance, A shares closed at $HK45.30 ($5.85) while the B shares, which logically should trade at HK$9.05, were instead $HK6.35. That's because a lack of liquidity will prevent the spread from closing completely. But that said, right now analysts say the gap between A and B shares is larger than it's normally been. Arbitrageurs tend to gather in rising markets, and even though Swire has outperformed the Hang Seng index for much of this year, Hong Kong's overall swoon has left a gap between the A and B shares, said Hart.

If Swire is worth buying at all, it's worth picking up in B-share form as opposed to the A share or the ADR. But is it worth buying?

Analysts in Hong Kong think it is. Swire makes about two-thirds of its pre-tax profit from real estate: developing and renting out some of Hong Kong's nicest shopping malls and office buildings. The company also owns 45.1% of Hong Kong's flag carrier Cathay Pacific Airways (CPCAY Quote - Cramer on CPCAY - Stock Picks), bottles Coca-Cola in Hong Kong and China and handles cargo at Hong Kong's container port.

Not many U.S. mutual funds own Swire stock. Legg Mason International Equity Trust (LMGEX Quote - Cramer on LMGEX - Stock Picks) had almost 1% of its fund in Swire last year. The fund has consistently lagged its peers, so it may be a Swire buy signal to learn that according to Bigdough.com, Legg Mason dumped its Swire shares by the end of March, just before the stock rallied.

A group that still owns Swire A shares is World Asset Management of Birmingham, Michigan. They are index investors, so they have no choice but to buy the A shares. WAM advises the Framlington and Munder fund families, which offer the Munder International Equity Fund. The class A shares of the Munder fund come with a hefty 5.5% front-end load, but a tempting 1.2% total expense ratio. The C class shares have no front-end load, but cost 2% a year to hold. The way the math works out, if you hold the fund for five years or more and assume a 9% annual return, paying the front-end load is worth it. On the other hand, betting on holding for five years assumes the same management as is in place now, which can never be guaranteed.

Swire A shares are forecast to earn HK$3.35 each this year and HK$3.80 next year, giving them a forward price-earnings ratio of 13 and 11.4 times. Simon Rogers at Warburg Dillon Read estimates that fair value for Swire A shares by the end of this year should be no more than HK$50.65, an 11% premium to Monday's closing. That may not sound like a stellar return, at least not compared to the scorching performance tech stocks turned in last year. But Swire can at least offer solid businesses, a 25% debt-equity ratio and time-tested management. Then, there are those cheap B shares.