Up In Smoke? Not Exactly For Huabao, Crown Jewel Of China's 'Vaping Queen'

Key Takeaways:

• Huabao’s chairman Zhu Linyao reappeared last week after more than a year under house arrest
• The tobacco flavoring company’s CFO Choy Man Har was detained just days later by Hong Kong’s anti-corruption watchdog

By Edith Terry

When it comes to feasting on China’s lucrative state tobacco monopoly, Huabao International Holdings Ltd. (0336.HK) and its affiliated Huabao Flavours & Fragrances Co. Ltd. (300741.SZ) are about as deeply integrated into the machine as they come. But life hasn’t been a bed of roses lately for the major supplier of tobacco flavorings to China National Tobacco Corp. (CNTC).

Huabao’s Chairman Zhu Linyao, also known as Chu Lam Yiu, spent years working her way into the innermost recesses of China’s lucrative tobacco monopoly, only to get caught up in an anti-corruption campaign targeting the industry dating back to 2021. That campaign has resulted in at least 20 arrests so far of CNTC executives and officials from its closely-tied regulator, the State Tobacco Monopoly Administration (STMA).

The trail of smoke has found its way into Huabao’s house, resulting in Zhu’s sudden disappearance last year and surprise resurfacing last week. That was followed just two days later by a raid on the company’s Hong Kong offices by the city’s anti-corruption watchdog.

The winds of China’s latest anti-corruption campaign first came to Huabao in January last year, when Zhu was placed under house arrest for “suspected disciplinary violations,” a phrase that usually means suspicion of corruption. Huabao shares fell by 65% when that happened, causing her net worth to fall from $5.8 billion in late 2021 to $2.6 billion at the time of her detention. It seemed like the end of the line for the 52-year-old, once touted as one of China’s 10 richest women.

But bribery investigations in China are not so cut-and-dried as in other parts of the world, most often targeting government officials. In such cases, the corporate executives who pay bribes as a cost of doing business often later become star witnesses in corruption cases against those corrupt government officials.

That may have been the case with Zhu, who was released on Monday last week, igniting a 27% celebratory surge in Huabao’s stock price the next day. The main victim of the investigation was not Zhu herself, but possibly Zhang Hong, a former head of STMA’s technology department who was placed under investigation on July 12 – just days after Zhu’s release.

But the story didn’t end there. Just two days after her release, Huabao CFO Choy Man Har was arrested without charges on July 5 by Hong Kong’s Independent Commission Against Corruption (ICAC). Choy was released on bail and, after a brief suspension, Huabao began trading again on July 6. Huabao’s stock initially fell as much as 16% after Choy’s arrest, before recovering slightly in the following days. All told, Huabao’s stock is still down by about three-quarters from where it traded before Zhu’s original detention in January 2022.

Early Exit

While she is frequently referred to as China’s “vaping queen” Zhu actually began steering away from the controversial vaping industry well before 2019, when local regulators began clamping down on the sector with a ban on online sales. Zhu’s ties with the tobacco monopoly may have helped her avoid the fate of vaping startups like RLX RLX and Smoore International (6969.HK) after China announced major new restrictions on e-cigarettes in March last year.

While the newcomers’ stocks dropped precipitously on that news, Huabao’s shares actually began trending up. By that time, Huabao may have already monetized a big portion of its vaping-related holdings with the sale of its U.S. e-cigarette business to Juul in October 2018 for $75 million.

No longer a vaping company, Huabao is now focused on reconstituted tobacco leaf (RTL) products, which use real tobacco and can be inserted into electronic devices. That’s significant for the China market, where vaping is still allowed but only using tobacco-flavored products. Huabao is now building its first factory for RTLs outside China in Indonesia, as well as a technology center in Singapore.

Zhu is no stranger to the kinds of wheeling-and-dealing that have kept Huabao afloat and allowed it to thrive when others have stumbled, earning her another nickname as the “cash-out queen” for her fondness for buying and selling assets. Her company’s shares briefly soared when it proposed a spin-off for its condiment subsidiary in November 2021.

Following her release, Zhu may return her focus to Huabao’s close ties with CNTC, which controls 97% of China’s highly lucrative cigarette market. The monopoly’s actual profitability isn’t known because it is state-owned. But one estimate said it recorded a $214 billion profit in 2021, and accounted for 40% of the world’s total cigarette consumption.

By comparison, Huabao’s revenue totaled a far more modest 3.8 billion yuan ($529 million) in 2022, down slightly from the previous year, including about half of that from sales of flavors and fragrances, mainly to CNTC. It lost about 1 billion yuan for the year, reversing a 675 million yuan profit a year earlier. The company trades at a price-to-sales (P/S) ratio of about 2.6, trailing the 4.6 ratio for RLX and 3.5 for Smoore International.

So, what’s next for this deal-making tobacco queen? Zhu currently holds 71% of Huabao’s shares, giving her a net worth of HK$7.8 billion, or roughly $1 billion, based on the company’s latest valuation.

While her next step remains to be seen, her intent to keep Huabao in the family is clearer. Zhu’s heir apparent is her 30-year-old son Lam Ka Yu, who was named co-chairman in June 2021 alongside his mother. When Lam was detained less than a month after his mother in 2022, Zhu appointed her daughter, Lam Ka Yan, as an executive director to be “involved in the formulation and implementation of the group’s strategy.”

Details on Zhu’s past are scant. Born in Southwest China’s Sichuan province in 1970, she studied business at a university in Beijing before marrying Lin Guowen, also known as Lam Kwok Man, then known as the “king of flavorings” around 1990. It’s unclear whether she helped Lin build the client base of his company, Huabao, around flavorings for the food and tobacco industry, or if he invested in her first company around 1996, to manufacture tobacco flavorings such as menthol.

But Zhu soon began working with China’s major tobacco mills, providing flavorings for Hongta Tobacco Group, one of China’s major cigarette brands, as early as 2001 through a joint venture. She did one of her first major deals in 2004 involving a reverse takeover of her China-based flavorings company. That ultimate paved the way for Huabao to list on the Hong Kong Stock Exchange in 2006.