Hedge Fund Good Guys May Lose at BEA

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(Bloomberg) -- Bank of East Asia investors are treading on thin ice. The last big independent Hong Kong bank refuses to be sold, even as its operating performance is slowly crushed. Shareholders face whiplash if Elliott Management, the activist firm urging the founding Li family to cede control, aborts its mission.

BEA, the foreign lender with the most branches in China after HSBC, posted first-half earnings last week that showed the vulnerability of that country focus. Net profit fell 38 percent from a year earlier to HK$2.1 billion ($271 million), the fourth consecutive half-yearly decline, while return on equity slumped to a paltry 4.8 percent, compared with an average of about 13 percent for its peers, mainly in China, according to data compiled by Bloomberg. Bad loans in a slowing economy are partly to blame, though even elsewhere, the lender struggled to make money:

Elliott began building its stake in the bank in 2010 and now owns 6.9 percent. The firm argues that the lender has been mishandled for 20 years, and has pushed since February to oust the management. So far, it's had little success: Chairman David Li has stuck to his repeated statement that the bank is committed to a long-term strategy and has no plan to change what the hedge fund calls an entrenched executive management team.

To be fair, BEA has had some success under the Lis. A three-year cost savings plan started early this year is bearing fruit, with the cost-to-income ratio edging down to 59 percent from 60 percent at the end of 2015. The bank, Li says, already has achieved 23 percent of the HK$700 million in cost savings it's targeting by the end of 2018 -- after cutting about 180 jobs in June, culling all 22 securities outlets, and pruning some branches in China and Hong Kong.

That Li has been re-elected at every shareholder meeting, and the bank's stock is up 47 percent since early February, seem to justify the virtues of sitting tight. But a valuation that builds in a bid premium only works if the lender is actually put on the block. The stock currently trades at 1.04 times book value, well above the 0.9 times that its Hong Kong and China peers currently command, perhaps reflecting the worth -- to a new owner -- of a China branch network that's the envy of most foreign lenders. That network carries risks of fraud and operational failure, too, however, as highlighted by the IPO prospectus of China Postal Savings Bank.

Without a sale, the current price is hard to justify. China's slowing economy has already nudged bad loans from mainland operations up to 2.8 percent in June, from 2.63 percent at the end of last year. Even the Hong Kong end of operations is seeing credit stress. And in what's perhaps the worst news for investors in these yield-hungry times, BEA cut its interim dividend to 28 Hong Kong cents, from 38 cents in the first half of last year. 

Elliott must be hoping it can turn the tide of bad luck for activists in Asia. Families in the region still dominate a swath of publicly traded companies, from which they are almost impossible to dislodge. A sale would be best for shareholders, but with no sign of a suitor or hint of a transaction, it does appear that they're indulging in some rather expensive wishful thinking.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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