This article first appeared in Corporate, The Edge Malaysia Weekly, on July 18 - 24, 2016.

OF the 929 public-listed companies in Malaysia, more than half — or to be precise, 527 — are penny stocks, which by definition are priced at less than RM1.

The high-velocity penny stock world has always been a playground for traders and speculators, who seek to make quick and easy money in a short period of time.

As for retail investors, trading in penny stocks due to its highly speculative nature is more like playing musical chairs — you don’t want to be left holding the shares when the rally stops.

But the thing is that, for now, the bullish sentiment is absent.

With investors staying away from oil and gas stocks and export-oriented counters losing favour, not to mention that it is still too early to bet on plantation stocks, there are not many themes left to play at the moment.

Market movers may thus see this as a good time to get in to spur the market by buying into some financially distressed companies and at the same time, selling their impending turnaround stories.

Sources from local investment banks tell The Edge that groups of local sophisticated investors, comprising high-net-worth individuals, have pooled funds amounting to RM200 million to actively buy into Bursa Malaysia-listed penny stocks in the next few months.

It is learnt that one of the exclusive investment clubs is eyeing 20 penny stocks, and it has thus far identified at least three potential target companies.

“They are approaching a few investment banks to help them hunt for penny stocks that are valued at below 50 sen per share, preferably loss-making and debt-laden companies in the services and manufacturing sectors. Basically, they will come in as white knights with restructuring and turnaround plans,” a source says.

A quick check on Bloomberg shows that within the penny stock universe, shares of 336 companies are trading at below 50 sen. Of these, 176 are making losses. On closer inspection, 94 out of the 176 are in a net debt position.

It is worth noting that the pool of RM200 million is a fairly substantial amount because more than three-quarters of the 94 loss-making and debt-laden penny stock companies have market capitalisations of less than RM100 million each — ranging from RM2 million to RM95 million.

In other words, this group of investors could easily buy out any of these troubled companies if they want to. But since they are targeting 20 firms, their average budget would be RM10 million per company, which is more than enough for them to take up substantial stakes in these companies.

Another source highlights that the period from June to August is usually the most popular season for the trading of penny stocks because it is easier to create excitement when the market is running low on trading ideas.

“It’s not something unusual because it happens almost every year, but I would say that the situation is getting more severe this year. There are always concerns that the so-called ‘white knight’ investors may pull out their investments after the share prices move up, leaving some clueless retail investors in limbo,” he warns.

Indeed, it is not always the case that the white knight investors can successfully revive ailing companies. In an unfortunate scenario, retail investors could even find themselves stuck if these white knights are not genuine investors in the first place.

Hong Leong Investment Bank Bhd dealer representative Frank Lin says it is important to identify whether these groups of investors are speculators out to make a quick buck or white knights who intend to stay for the long term.

“I think [knowing] the background and reputation of these people is very important. We need to look into the past and find out what they have done. If they haven’t got any track record as white knights, then most likely it’s going to be a hit-and-run thing,” he says.

Interestingly, Lin acknowledges that market participants, especially retail investors, do welcome a certain amount of speculative activity, more so when the stock market lacks fresh leads.

“The blue chips are fairly stable now and this provides a conducive environment for the stock market. The second and third-liners, including penny stocks, are all hungry for action. Yes, from a fundamental point of view, speculation is not healthy for the market in the long run. But then again, you need this kind of excitement to entice retail investors to stay in it,” he says.

Areca Capital Sdn Bhd CEO Danny Wong Teck Meng opines that while the backgrounds of the white knights do carry a certain weight, it is more important to keep track of the execution of their turnaround plans.

“Of course, if the white knight is an established firm or a reputable person, the chances are the company or individual is a genuine investor. But at the end of the day, actions speak louder than words,” he says.

He also advises retail investors not to be overly excited about the turnaround stories before the plans are carried out.

“If the share price moves up slowly but steadily while the company is recovering, it’s good. But if the share price and trading volumes jump significantly before they manage to turn around the company, then you need to be extra careful. I always believe that it’s not too late to buy later because a real turnaround usually takes time,” he adds.

Wong points out that a notable turnaround story is Melaka-based Yong Tai Bhd, a loss-making garment manufacturer that returned to the black in its financial year ended June 30, 2015, helped by its property development venture.

Yong Tai signed five proposals in August last year, providing it with five potential property developments in Johor, Melaka and the Klang Valley with a combined gross development value of about RM7 billion over the next eight years.

Meanwhile, a head of research, who prefers to remain anonymous, admits that it is difficult to identify whether potential white knights are genuine investors.

“In general, if somebody comes and tells you, ‘I’m going to buy into this company and I’m going to turn it around’, then you shouldn’t believe in that person because he probably just wants you to help him support the share price. Worse still, he may have already cornered the shares and he just wants to dump them on you without having to turn the company around. I’m not saying that you will definitely fail, but it’s a risky gamble,” he says.

“I do know that there is a group of investors who have been going around investing in undervalued small-cap stocks, hoping that these companies will turn around, but not so much declaring that they will turn them around themselves. They see potential in these little-known but well-managed companies, and they don’t mess around with their operations. They are there, but they keep quiet.”

A senior corporate observer says retail investors should do their own research on white knights instead of just relying on restructuring plans drafted by investment banks.

“Very often, a non-genuine white knight will go around telling people his ambitious plans, but it is just old wine in a new bottle. To put it bluntly, he wants to sell you something that you don’t need [to know], akin to selling combs to monks,” he says.

He highlights the positive impact at Borneo Oil Bhd after Tan Sri Lau Cho Kun emerged as a substantial shareholder in the company in October 2014. Cho Kun is the nephew of the late Tan Sri Lau Gek Poh, who founded the Hap Seng group.

In July last year, Bursa approved Borneo Oil’s rights issue with free warrants, enabling it to raise RM223.39 million to expand its gold mining operations in Peninsular Malaysia.

Those who are bold enough to invest in penny stocks, however, will have to put up with volatile share price movements. Over the years, such companies have often been queried about unusual market activity (UMA) by Bursa, either for a sharp rise in their trading volumes and share prices, or a sudden plunge in their share prices.

Besides, shareholder changes and a change of company name are a common occurrence for penny stocks, causing confusion over their corporate identity.

For instance, mention Formis Resources Bhd, My-Infotech (M) Bhd and Man Yau Holdings Bhd in the same sentence and many may not be aware that they are all previous names of Omesti Bhd, a digital business solutions provider.

Similarly, ICT lifestyle retailer Sterling Progress Bhd was previously known as 1 Utopia Bhd and Tejari Technologies Bhd, while ICT solutions provider MMAG Holdings Bhd was formerly known as Ingenuity Consolidated Bhd and Ingenuity Solutions Bhd.

Given the uncertainty, constant changes and high risks associated with investing in penny stocks, those who want to take the chance and are willingly go on a roller-coaster ride should be aware of the downside risks. High risk, high returns but the downside could be equally dramatic.

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