Li Ka-shing's Magic Trick: Unlocking Billions From Undervalued Assets

Ching Ling Foo was the first Chinese to dazzle international audiences with magic. In one of the signature tricks that made him famous at the turn of the 19th century, he would produce a large bowl of water from an empty cloth. As with all magic tricks, much of its success relies on transparency. The audience is convinced there is no trap door on the stage, and the bowl is large enough to make it obvious that the magician could not have hidden it beneath his clothing.

Early this year another renowned Chinese impresario performed some dazzling magic, of the financial kind. Hong Kong tycoon Li Ka-shing announced a major reorganization of the two pillars of his family business empire, Cheung Kong (Holdings) Ltd. and Hutchison Whampoa Ltd. Their real estate holdings are being combined into one listed company, Cheung Kong Property Holdings Ltd., while most of the other assets, which include energy, ports, telecoms, and retail holdings, will reside in a company called CK Hutchison Holdings Ltd. In a press release announcing the changes, the company also said it was removing the layered holding structure between Cheung Kong and Hutchison to allow public shareholders to directly invest in the two separately, alongside the Li family trusts.

There has been much speculation about the reasons behind Li’s reshuffle, and media have shared many juicy conspiracy theories. No matter what rumors suggest, from an academic perspective these moves make sense and indicate a very rational decision by a shrewd, experienced businessman.

The major reason for Li to restructure his empire is to get the market to revalue stock in his listed companies. Numerous studies have shown that the stocks of family-owned Hong Kong conglomerates such as Li’s tend to trade at a significant discount – specifically, what academics refer to as the ‘pyramid ownership discount’ and the ‘diversification discount’. South Korean family chaebols have the same issue. When a wide variety of holdings is combined into one entity, the market feels there is not enough information to properly assess the company. Research also shows that these family conglomerates have a higher rate of tunneling (when family members or majority shareholders manipulate company assets for personal gain) and misappropriation of funds. They also tend to practice less transparent corporate governance. Their stock trades at a discount because investors are taking into account the actual risks they face due to these issues, and therefore require higher returns. The relationship between price and risk results in a lower stock price.

Li estimates that shares of Cheung Kong (Holdings) Ltd., with its mixture of real estate and other holdings, have recently been trading at a 23% discount. He anticipates that his financial magic can potentially unlock HK $87 billion in book equity value for shareholders  by spinning the real estate assets off into a separate entity. The company said it expects the restructuring to be completed within the first half of this year. Market reaction was swift and positive. Shares in Cheung Kong (Holdings) Ltd. (SEHK: 0001) closed at HK$ 124.80 on Friday, January 9 and at HK$ 143.20 on Monday, January 12, the first day of trading following the restructuring announcement. Shares in Hutchison Whampoa Ltd. (SEHK 0013) closed at HK$ 87.40 and HK$ 98.35 on those dates, respectively.


In reorganizing his companies Li is also shifting from entrepreneur to capitalist. There’s a big difference between these two roles. A capitalist focusses on short term opportunities; when there’s a good opportunity to make a profit he tends to cut the deal quickly. A mere two weeks after the reorganization, it was announced that Hutchison Whampoa was spending US$ 15 billion to buy UK wireless carrier O2. Seeking both tax benefits and a legal environment more conducive to capitalist-style deal making, Li is registering CKH Holdings in the Cayman Islands, so we can expect to see many more big deals from that company.

Why is Li reorganizing now? Obviously the economic and political environments in China and Hong Kong have had some influence. However Li is not the only investor shifting assets from Asia to Europe. At 86 years old, Li must obviously be thinking about retiring. Though he has been grooming his son Victor to eventually take over the family business, I think, like most founders he wants to ensure his empire will continue to grow for many generations. He may feel his son does not yet have the guts, or the experience, to resolve these structural issues in a way that would be credible to investors. Now, thanks to Li’s expert stagecraft, the market is speculating that several other Hong Kong family conglomerates, such as Wheelock & Co., will soon attempt the same financial magic. Investors should welcome more of these acts.