Keck Seng Investments - Heller House Investment Memo - 4-7-16

Heller House Opportunity Fund, L.P. Investment memo April 7, 2016

Keck Seng Investments Recent price: HK$5.75 Ticker: 184 HK

High quality real estate assets, fortress balance sheet, management with a history of value creation, and an incredibly cheap valuation under any metric. Reasonable market multiples would result in a stock three times the current price.

Executive Summary of Valuation Discrepancy Keck Seng (“KS”) owns the W San Francisco and the Sofitel in Midtown Manhattan, both exceptionally well located, prime assets. In addition, it also owns 1.2 million square feet of hotels in Canada, Vietnam, China and Japan, and residential and commercial properties in Macau and Singapore. The current stock price implies the following: 

  

A 24% cap rate; applying an 8.1% cap rate would result in a stock price 216% higher 1

Paying for the U.S. properties and getting all 1.2 million square feet outside of the U.S., net of all liabilities, for free

A price to net asset value multiple of 0.3x (based on an asset by asset mark-to-market valuation), implying a potential triple if the shares traded at NAV

A price to free cash flow of only 8.9x and a price to earnings multiple of 8.5x. 2

Typically, we only find these types of securities if (a) the assets are of poor quality (b) the assets have substantial debt encumbering them or (c) the cash flows are declining. In KS’s case, none of these factors is true. In fact, the assets are of high quality, the balance sheet is fortress-like with a loan-tovalue ratio of only 2.5% 3, and free cash flows are growing at an attractive rate. 4 Furthermore, KS’s controlling shareholders have a history of value creation, growing book value consistently over the 1 The 8.1% cap rate is the result of dividing the company’s 2015 NOI by a mark-to-market enterprise value, which is derived by marking each individual asset to market, instead of using KS’s historical cost valuation. The median cap rate for listed hotel companies in the U.S. is currently around 7.6%. 2 The median P/E multiple for listed hotel companies in the U.S. is currently around 22x. 3 Net debt divided by our NAV estimate, as detailed further in this report. 4 Free cash flow grew 37% in 2013, declined 1% in 2014 and grew 18% in 2015.

1111 Brickell Ave, Suite 2135 Miami, FL 33131

hellerhs.com

1

Heller House Opportunity Fund, L.P.

past fifteen years. As a result, KS qualifies as an attractive, growing, safe investment with enormous potential upside.

In this report, we will walk through each asset owned by KS, and demonstrate the gap between the current stock price and our estimate of intrinsic value. But first, below is a snapshot of Keck Seng’s book value per share as reported on a GAAP basis (blue bars) and its current share price. The stock is cheap on that basis, with book value at HKD 10.1 and a stock price of HKD 5.75.

However, an asset by asset analysis reveals a substantially higher net asset value. This stems from Keck Seng’s accounting policies, which account for properties at cost, with the exception of a small fraction of the portfolio which is marked to market every year. Marking KS’s entire portfolio to market would result in a net asset value 3x greater than the current share price.

Assets owned by KS Before delving into an asset-by asset valuation, below is a bridge to net asset value showing the various components of KS’s NAV:


hellerhs.com

2


U.S. Hotels Keck Seng owns two hotels in the U.S.: the Sofitel NY in midtown Manhattan, and the W San Francisco in SoMa. Both hotels are 100% owned by KS. Sofitel NY

https://www.tripadvisor.com/Hotel_Review-g60763-d208454-Reviews-Sofitel_New_YorkNew_York_City_New_York.html

The Sofitel is KS’s newest asset, having been acquired in August 2014. It is very well located, on West 44th Street between 5th and 6th Ave:


hellerhs.com

3


Bryant Park

New York Public Library


hellerhs.com

4


KS paid a 5.1% cap rate on 2013 NOI for the Sofitel. This is not a bargain purchase like other acquisitions KS has made in the past. However, we believe that the superior location and quality of this asset will allow the company to enjoy an adequate return over what it expects to be a long-term holding period. At the time of acquisition, KS financed part of the purchase through a mortgage, representing a conservative 29% loan-to-value ratio on that property.

Summary financials and acquisition numbers for the Sofitel: U.S. '000 Hotel revenue Room Food and beverage Others Hotel expenses Room Food and beverage Others

Other operating expenses Marketing and selling expenses NOI

2011

2012

2013

6M 2013

6M 2014

$ 45,433 8,106 1,745 55,284

$46,686 8,424 1,596 56,706

$49,030 10,016 1,449 60,495

$ 22,200 4,792 684 27,676

$ 22,087 4,611 693 27,391

16,614 3,488

17,364 3,800

17,722 4,088

8,671 1,982

8,844 1,993

12,744 8,621 1,180 22,545

12,637

13,157 9,384 1,216 23,757

11,785

14,011 9,875 1,300 25,186

13,499

6,754 4,777 613 12,144

4,879

6,989 4,927 633 12,549

4,005

Because the Sofitel is now lumped together with the W San Francisco and reported in the U.S. segment, we no longer have broken out financials post-acquisition. Here are the acquisition metrics for the Sofitel: Price paid (USD) Rooms $/key $/square foot Acquisition cap rate on 2013 NOI

$265,000,000 398 $665,829 $901 5.1%

RevPAR for this hotel was down 3.6% in 2015 versus the prior year, on higher occupancy (88.1% vs. 86.8%) and lower ADR ($366.30 vs. $385.70). KS is reportedly in negotiations with Sofitel to invest in a renovation of the hotel, with the aim of increasing the daily rates charged by the hotel. 1111 Brickell Ave, Suite 2135 Miami, FL 33131

hellerhs.com

5


W San Francisco https://www.tripadvisor.com/Hotel_Review-g60713-d81669-Reviews-W_San_FranciscoSan_Francisco_California.html

The W San Francisco was acquired in 2009 from an overleveraged Starwood. The deal had been in the works for a year, and after the market began recovering, Starwood tried to back out of it but the sale and purchase agreement had already been signed. The purchase price was $90 million, representing a 15.1% cap rate on 2008 NOI. Since then, NOI has recovered and grown alongside RevPAR:

The hotel is very well located, in the SoMa (South of Market Street) section of San Francisco, across the street from the Moscone Center, a 700,000 square foot convention center which frequently hosts well-known events for the tech industry such as the Google I/O and Apple Developers Conference. The center is undergoing a $500 million expansion that aims to increase meeting space by an additional 305,000 square feet. The center is so popular and hotel space so constrained, that Salesforce was exploring the option of renting a cruise ship to provide additional accommodations for convention participants. 5 5

http://www.ktvu.com/news/4669886-story


hellerhs.com

6


Moscone Center West

Moscone Center


hellerhs.com

7


How much are the Sofitel NY and the W San Francisco worth? Based on recent comparable acquisitions of hotels in the upper scale tier, but below full luxury hotels, we believe that an appropriate valuation is a cap rate of 6.5% on 2015 NOI 67. We apportion this based on the room split, resulting in HKD 4.76 per share for the W and HKD 4.69 per share for the Sofitel. This split is arbitrary, since we don’t have more granular NOI numbers for each hotel. The total should be roughly in line with market values. Below is a sensitivity analysis showing what these hotels might be worth using different cap rate assumptions (values in HKD ‘000 except per share amounts): 2015 NOI

Cap rate Value Per share: W San Francisco Sofitel NY Total

209,048

6.0% 3,484,133

HKD 5.2 5.1 10.2

6.5% 3,216,123 4.8 4.7 9.5

7.0% 2,986,400

4.4 4.4 8.8

7.5% 2,787,307

4.1 4.1 8.2

8.0% 2,613,100

3.9 3.8 7.7

This is a recent deal for various hotels in Manhattan at a 5.4% cap rate: http://www.snl.com/Cache/1001206551.PDF?Y=&O=PDF&D=&FID=1001206551&T=&IID=4019891 7 JLL’s Q4 2015 survey shows New York cap rates at 6.0% and San Francisco at 5.9%: http://www.us.jll.com/united-states/en-us/Research/US-Investment-Outlook-Lodging-Q4-2015JLL.pdf?dccf6024-e4e8-4930-836f-4444ffd28396 “Among the 14 major U.S. markets surveyed, Boston and San Francisco are the only markets for which cap rates are not anticipated to increase according to the majority of investors surveyed, as both markets benefit from robust demand dynamics as well as exceptionally high barriers to entry.” See p. 5. 6


hellerhs.com

8


Vietnam Hotels

Caravelle

KS owns two adjacent hotels in Vietnam, the Sheraton Saigon Hotel & Towers and the Caravelle Hotel. Both were acquired before 2002. The Sheraton Saigon is 64.12% owned by KS, while the ownership stake in the Caravelle is 25%.

Sheraton Saigon

Caravelle

These hotels are unusually profitable due to a combination of very low labor costs, low capital expenditure requirements (historical capex as a percentage of sales have been well below 2%), and a high contribution from slot machine revenues. As a result, these hotels have very high EBITDA margins (33-36% for the Sheraton, compared with margins in the low 20s for the U.S. hotels, for instance) and 1111 Brickell Ave, Suite 2135 Miami, FL 33131

hellerhs.com

9


generate substantial free cash flow to the group. Both hotels are well regarded and garner good reviews from guests: Sheraton

https://www.tripadvisor.com/Hotel_Review-g293925-d304523-ReviewsSheraton_Saigon_Hotel_Towers-Ho_Chi_Minh_City.html Caravelle

https://www.tripadvisor.com/Hotel_Review-g293925-d306255-Reviews-Caravelle_SaigonHo_Chi_Minh_City.html

In the latest annual report, KS attributes the occupancy decline at the Caravelle to renovations, offset by higher rates.

How do we value KS’s Vietnam hotels? The only data point we were able to find on cap rates in this market report pointed to a cap rate of 9% in mid-2014: 8 8

http://www.us.jll.com/united-states/en-us/Research/JLL_Hotel_Investor_Sentiment_Survey_June_2014.pdf 1111 Brickell Ave, Suite 2135 Miami, FL 33131

hellerhs.com

10


For conservatism, we use the average of 10x free cash flow and a 9% cap rate for the Sheraton, which is equivalent to a 11.2% cap rate on 2015 NOI. This 11.2% cap rate equals a P/E multiple of 13x for the Sheraton; so we apply a similar multiple to KS’s share of profits from the Caravelle to arrive at the value of the Caravelle that accrues to KS. The result is a contribution to net asset value of HKD 3.71 per share for the Sheraton and 0.45 per share for the Caravelle. We believe this valuation is conservative given the high cap rate used.

Canada Hotels

KS owns two hotels in Canada: the International Plaza Hotel adjacent to the Toronto airport, and the Sheraton Ottawa Hotel. The stake in the International Plaza is 25%, while the Sheraton is 50% owned by KS.

The Toronto airport market is lousy, and the hotel loses money on a GAAP basis. Our understanding is that KS is pursuing a rebranding of this hotel with a view to selling it (the hotel was branded Doubletree by Hilton until 2013, but the flag was abandoned due to expensive renovation requirements). We value this hotel at only $50,000 / key, or $48 per square foot, which we believe is 1111 Brickell Ave, Suite 2135 Miami, FL 33131

hellerhs.com

11


appropriately conservative. At this valuation, this hotel contributes only 0.12 per share to net asset value. https://www.tripadvisor.com/Hotel_Review-g155019-d183783-ReviewsInternational_Plaza_Hotel_Toronto_Airport-Toronto_Ontario.html Sheraton Ottawa

The Sheraton Ottawa is very well located, only a few blocks from tourist attractions such as Parliament Hill:

Parliament Hill


hellerhs.com

12


https://www.tripadvisor.com/Hotel_Review-g155004-d182988-Reviews-Sheraton_Ottawa_HotelOttawa_Ontario.html

Due to increased control over the subsidiary that owns the hotel, KS began breaking out results for the Sheraton Ottawa in 2015. We estimate the value of this asset using an 8.3% cap rate on 2015 NOI, which is equivalent to CAD 175,600 per key. We understand this valuation is appropriate for this market 9. Using the current spot rate for the Canadian dollar, this translates into 0.36 per share.

http://www.colliershotels.com/2014/CHIR/Colliers-2014CHIR.pdf and http://cbrecanada.uberflip.com/i/661999-q1-2016-canadian-cap-rates-investment-insights?var=thankyouQ12016 9


hellerhs.com

13


Best Western Hotel Fino Osaka KS’s only hotel in Japan was acquired in 2011 for $20.7 million, or around $116k per key. At the time, this was equivalent to a 7.5% cap rate on trailing twelve month NOI. The hotel was newly opened at the time and is 96.46% owned by KS. It is very well located, close to the subway and walking distance to Shinsaibashi, Osaka’s largest shopping area. https://www.tripadvisor.com/Hotel_Review-g298566-d1798409-ReviewsBEST_WESTERN_Hotel_Fino_Osaka_Shinsaibashi-Osaka_Osaka_Prefecture_Kinki.html


hellerhs.com

14


This has certainly been one of the better performing hotels for KS, with exceptional growth in daily rates and a steady rise in occupancy. RevPAR growth year-over-year was 22% in 2013, 25% in 2014 and 35% in 2015:

This being a limited service hotel, the daily rates are quite modest (at year-end, the ¥11,763 daily rate was equivalent to $98). The performance of this hotel is attributable to a soft Yen, increased tourism in Japan, and a supply constrained market. These charts from Savills Japan 10 illustrates where Osaka fits among other large cities in terms of occupancy and rates:

http://pdf.savills.asia/asia-pacific-research/japan-research/japan-hospitality/jp-hotel-spotlight-03-20161.pdf 10


hellerhs.com

15



hellerhs.com

16


How do we value this hotel? According to another report by JLL 11, hotel cap rates in Osaka are just over 5%.

For conservatism, we apply a 7% cap rate instead, resulting in a value per KS share of 0.98, and present here a sensitivity analysis table:

2015 NOI (HKD) Cap rate Value to KS Per share:

11

24,284

5.0% 468,487 HKD 1.38

5.5% 425,897 1.25

6.0% 390,406 1.15

6.5% 360,375 1.06

7.0% 334,634 0.98

http://www.ap.jll.com/asia-pacific/en-gb/research/731/hotel-investor-sentiment-survey-15 1111 Brickell Ave, Suite 2135 Miami, FL 33131

hellerhs.com

7.5% 312,325 0.92

17


Holiday Inn Wuhan Riverside Like Japan, KS only owns one hotel in China. The Holiday Inn Wuhan Riverside was acquired prior to 2002 and is 41.26% owned by KS. https://www.tripadvisor.com/Hotel_Review-g297437-d305965-ReviewsHoliday_Inn_Riverside_Wuhan-Wuhan_Hubei.html

The performance of this hotel has deteriorated significantly since 2010, with estimated NOI declining from ~HKD 20 million to only 12.3 million in 2015. This cannot be attributed to foreign exchange differences since the Yuan has barely moved against the HKD during that period (the five-year change was only 1.2%). KS explains in its annual report that a decline in business-related travel has hurt the 1111 Brickell Ave, Suite 2135 Miami, FL 33131

hellerhs.com

18


hotel. We value the Holiday Inn Wuhan Riverside at a conservative 10% cap rate on 2015 NOI, which results in an estimated value of HKD 123 million ($50k/key) 12. This happens to be the book value (segment assets less segment liabilities) for the hotel as well. We are told by management that the value of this hotel, given its good location, exceeds book value, but for conservatism, this is what we use. The total value per share is only 0.15. Macau

KS owns a number of properties in Macau, and some of these are carried at values significantly below their current worth. Macau is a short, 40-minute ferry ride from Hong Kong. Like Hong Kong, it is a Special Administrative Region (SAR) of China, and the most densely populated region in the world 13. It has been the subject of intense media coverage 14 recently due to the decline in gaming revenues stemming from a Chinese government crackdown on corruption, which has driven away high rollers. Despite this, Macau remains much larger than Las Vegas in terms of gaming revenues. It also sports a very high $91,376 GDP per capita. 15

Its economy, however, is much less diversified. Las Vegas derived 64% of its resort revenue last year from nongaming sources compared with less than 10% for Macau, and in 2015 it welcomed 42 million guests to Macau’s 8 million visitors. 16 Recent efforts by the government to diversify Macau’s economy by creating nongaming, entertainment zones, should create long-term benefits.

Below is a schematic 17 of Macau and the surrounding areas showing existing and proposed infrastructure, including the Hong Kong-Zhuhai-Macau bridge, all of which will likely vault Macau into an even stronger and wealthier economy:

We were unable to find market cap rates for Wuhan hotels; 10% feels “right” and given that it coincides with book value, we believe this is probably appropriately conservative. 13 https://www.wikiwand.com/en/Macau 14 http://www.bloomberg.com/news/articles/2015-07-28/gambling-mecca-macau-doubles-down-as-chinagrowth-slows 15 Las Vegas had 2014 GDP per capita of nearly the same level, at $94,521. See http://cber.unlv.edu/CCEconData.html and https://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&bcs=d&nselm=h&m et_y=ny_gdp_pcap_cd&scale_y=lin&ind_y=false&rdim=region&idim=country:MAC:HKG&ifdim=region&hl=en &dl=en&ind=false 16 http://www.lvcva.com/stats-and-facts/ 17 Extracted from http://mpofund.com/wp-content/uploads/2016/02/MPO-IR2016-web.pdf 12


hellerhs.com

19


1

1

Luso Int’l Bank Bld

2

Ocean Gardens

2


hellerhs.com

20


Properties classified as investment properties (marked to market yearly by KS) These are the only properties KS marks to market on its balance sheet. Here is a summary of the properties in this group:

Luso International Bank Building

Ocean Plaza, I and II Ocean Tower Total

Group's Interest

Gross floor Gross area floor (sqm) area (sf)

Floor area, group's part (sqm)

Floor area, Floor area, group's min interest part (sf) (sf)

Type

No. of units

100.00% Office

40

2,812

30,264

2,812

30,264

70.61% Office

19

4,618

49,703

3,260

35,095

70.61% Comm

47

8,782

94,525

16,211 174,492

6,201 12,273

Value at 12/31/2015 (HKD ‘000) Value at 12/31/2015 (USD ‘000) $ / SF HKD / SF HKD / m2 Estimated minority interest, HKD ‘000

66,744 132,103

-

Address 1, 3 and 3A Rua do Dr. Pedro Jose Lobo, Macau

14,608

Ocean Gardens, Macau

27,781

42,389 [A]

Ocean Gardens, Macau

778,000 100,321 $575 4,459 [B] 47,993 188,996 [A] x [B]

The locations of these properties are noted in the schematic above (the Ocean Plaza and Ocean Tower are in the same location as the Ocean Gardens residential units, which we value below).

Because we value every other asset net of minority interests, we do not deduct the full minority interest on KS’s balance sheet so as to not double count. Therefore, for these assets we estimate what minority interest should be, using the mark-to-market HKD per square feet valuation and multiplying that by the square footage not owned by KS ([A] x [B] above).

The Luso International Bank Building above is very well located next to the main attractions in Macau 18.

18

https://goo.gl/maps/BHqXbEBZuAB2


hellerhs.com

21


The other buildings, Ocean Plaza and Ocean Tower, are located in Taipa, a short drive south across the bridge. Ocean Tower is where Keck Seng’s corporate offices are located (on the 4th floor). Cotai, adjacent to Taipa, is where most new casino developments are happening in Macau. Ocean Gardens is a development made on reclaimed land in the late 1990s by the family that controls KS.

Since these properties are revalued yearly by independent appraisers using market rents and cap rates, we take these valuations at face value, but verify them against other sources (below). Net of minority interests, these properties contribute 2.29 per KS share.

It should be noted that the gross yield on valuation – rents received by these properties divided by property values – is extraordinarily low at 3.6% in 2015 (in the three years prior to that the gross yields on valuation were between 2-2.9%, while rents have nearly doubled). This is unusual to those of us used to cap rates – which is net operating income divided by property values (i.e., rents received less expenses) – of at least 6% or 7%. We have been unable to find detailed real estate reports for Macau property (although there are short ones 19) but we note that a London-listed fund (Macau Property Opportunities Fund, or MPO Fund) 19

http://pdf.savills.asia/asia-pacific-research/macau-research/mo-residential-09-2015.pdf 1111 Brickell Ave, Suite 2135 Miami, FL 33131

hellerhs.com

22


with investments in Macau has its properties valued by Savills Macau and consistently uses similarly low cap rates. 20

We trust these valuations because they are consistent with values we have observed in KS’s residential transactions, which are held for sale. To check those valuations, we use publicly available statistics from DSEC, the statistics and census office of Macau. These statistics corroborate not cap rates, but the implied $/square foot numbers. Because DSEC shows a lot of transactions over the years at these $/square foot numbers, we are comfortable with the implied low cap rates because that is how the market actually prices these assets in real arms-length transactions. We will go over all of this in depth below. Properties classified as held for sale (held at cost by KS)

KS’s management built a number of buildings in Ocean Gardens, Taipa, in the late 1990s, with some properties (Aster Court and Bamboo Court) having been completed in the mid-2000s. Over the years, KS has harvested these investments by selling individual units for multiples of their cost. During this period, Macau real estate values have skyrocketed, in conjunction with the vast growth of the gaming industry in the region, low incremental supplies of housing, very low unemployment rates, and very high GDP per capita.

Below is a photo of Ocean Gardens dated 2013 21. The author visited the properties in 2015 and can attest they look substantially the same.

Keck Seng’s valuers are Jones Lang LaSalle while MPO Fund uses Savills. http://mpofund.com/investors/publications/financial-results/ 21 More photos available at https://www.dropbox.com/sh/5yeq9s8dvrctvw7/AAAdKsjVj68I2hpotHXZbkpga?dl=0 20


hellerhs.com

23


As mentioned earlier, the preferred means of arriving in Macau is through a 40-minute ferry from Hong Kong, or by plane. Macau’s airport however is quite small, with a capacity for only 6 million passengers per year and only one runway. It is operating near capacity, with 5.8 million passengers in 2015 22.

Hong Kong International Airport, on the other hand, is also operating at capacity, but can process 68 million passengers per year. It’s among the top three busiest airports in Asia 23. There are plans to add a third runway to increase capacity 24.

Hong Kong and Macau authorities had an idea: wouldn’t it be great if there were a bridge connecting Hong Kong’s airport directly to the gaming facilities in Macau? This thinking led to the Hong KongZhuhai-Macau bridge 25 project, which began in 2009. The entire link will be 31 miles long when completed and significantly shorten travel time for tourists (who take the ferry) and freight through the Pearl River delta (which takes the much longer way around, cutting travel time from 4.5 hours to https://www.wikiwand.com/en/Macau_International_Airport https://www.wikiwand.com/en/Hong_Kong_International_Airport 24 https://www.wikiwand.com/en/Hong_Kong_Airport's_Third_Runway and http://www.scmp.com/news/hong-kong/economy/article/1888008/hong-kong-airport-third-runwayproposal-take-hk5-billion-loan 25 http://www.hzmb.hk/eng/ 22 23


hellerhs.com

24


40 minutes). The much larger Pearl River Delta Economic Zone is a major reason for the bridge as well. 26 As can be expected with any massive and complex engineering project, this one is over budget and delayed, with the latest projections pointing to a late 2018 opening. 27 Once the bridge does open for business, KS’s management expects a new cyclical peak in Macau real estate values, and they have therefore held off on selling more units in Ocean Gardens until the bridge is completed. From the 2015 annual report:

The economic growth was reduced in 2015 as a result of significant decrease in Macau’s gaming revenue. Real GDP fell 17% in real terms in 2015 as compared to 2014. Tourism arrivals to Macau, however, dropped only slightly to 30.7 million in 2015, as compared to 31.5 million in 2014. As several large-scale hotel and entertainment projects as well as public construction works were still ongoing, unemployment remained extremely low at 1.9% at the end of 2015. Against this background, income from leasing of properties has grown to HK$90.9 million in 2015, an increase of 28.8% as compared to HK$70.7 million in 2014. There was no sale of properties in Macau during 2015, as it is the view of the directors that the completion of the Hong Kong-Zhuhai-Macau Bridge will have a strong positive impact on the value of residential properties in Macau. The directors therefore consider that the Group should continue to closely monitor property market conditions, and to conduct sale of properties at a time and price that will optimize profits for the group. In the meantime, properties held for sale in Macau are leased to maximize profits. (Emphasis added.)

Because of the rise in property values in Macau, our estimated value for these properties is much higher than the values reflected in KS’s balance sheet, which are at cost. Our estimates are corroborated in two ways. First, we show in the table below how KS has consistently harvested its properties held for sale, every year selling at higher multiples of cost, primarily due to property appreciation in Macau. Second, we can access Macau’s statistics office records (DSEC) to look at residential transactions in Taipa and estimate where the Ocean Gardens units should trade when they are eventually sold.

https://www.wikiwand.com/en/Pearl_River_Delta_Economic_Zone See http://www.scmp.com/content/search/zhuhai%20macau%20bridge and https://www.wikiwand.com/en/Hong_Kong%E2%80%93Zhuhai%E2%80%93Macau_Bridge 26 27


hellerhs.com

25


Macau property appreciation – Ocean Gardens HK$’000 unless noted Properties held for sale Square footage HKD / SF (remaining cost) $ / SF (remaining cost) Rental inc from properties Rental yield on cost Rental yield on sales price Rent in $ / SF Cost of prop’s sold during yr Proceeds sale of properties Multiple of cost Units Ocean Ind. Centre, Phase II Ocean Park Heng Fa Chuen (HK) Poplar Court Rose Court Begonia Court Orchid Court Lotus Court Sakura Court Syringa Court Kapok Court Lily Court Dahlia Court Cattleya Court Magnolia Court Beijing Riviera Aster Court (Lot W) Bamboo Court (Lot W) Total Gross floor area (sq ft) Ocean Ind. Centre, Phase II Ocean Park Heng Fa Chuen (HK) Poplar Court Rose Court Begonia Court Orchid Court Lotus Court Sakura Court Syringa Court Kapok Court Lily Court Dahlia Court Cattleya Court Magnolia Court Beijing Riviera Aster Court (Lot W) Bamboo Court (Lot W) Total Number of units sold Square footage sold Avg size of unit(s) sold Avg size of remaining units Cost / SF Sale price / SF

2002 2003 2004 2005 2006 2007 268,169 305,326 238,833 207,428 335,671 331,842 1,050,903 1,090,948 987,145 315,754 502,599 497,325 255 280 242 657 668 667 $ 33 $ 36 $31 $85 $86 $86

(95,014) (136,762) (55,988) (34,298) (19,538) 151,988 223,033 162,330 180,201 98,587 1.6x 2.9x 5.3x 5.0x 3 6 2 4 3 19 36 1 42 4 3 37 7

2008 332,767 478,790 695 $90

2009 2010 324,278 306,190 473,271 456,446 685 671 $88 $86

(4,687) (15,377) 25,160 82,053 5.4x 5.3x

(8,489) (18,088) 47,695 106,339 5.6x 5.9x

2011 2012 303,384 283,527 452,739 426,790 670 664 $86 $86 36,044 12.7% 1.7% $11 (2,806) (19,857) 17,191 129,597 6.1x 6.5x

2013 2014 280,658 280,658 423,083 423,083 663 663 $ 86 $ 86 42,756 54,666 15.2% 19.5% 1.5% $ 13 $ 17 (2,869) 24,686 8.6x

2015 280,658 423,083 663 $ 86 62,616 22.3% $ 19

3 6 2 4 3 19 36

3 6 2 2 3 4 36

3 5 2

3 5 2

3 5 2

3 5 2

3 5

3 5

3 5

3 5

3 5

3 5

3 5

3 4 19

3 4 4

3 4 2

3 4 2

3 4 2

3 4 2

3 4 2

3 4 2

3 4 2

3 4 2

3 4 2

42

42

42

42

42

37

36

32

31

24

23

23

23

32

29

29

29

29

29

28

28

28

28

28

28

107

40 40 172

40 40 170

40 40 165

40 40 162

40 40 157

40 40 156

40 40 149

40 40 148

40 40 148

40 40 148

22,921 22,921 22,921 22,921 22,921 12,438 12,438 12,438 10,550 10,550 1,812 1,812 1,812 1,812 1,812 5,576 5,576 2,374 11,121 11,121 11,121 11,121 11,121 50,103 50,103 10,548 10,548 10,548 94,932 94,932 94,932 50,103 10,548 1,792 155,694 155,694 155,694 155,694 155,694 4,120 3,090 1,030 68,981 60,993 58,996 53,005 53,005 9,414 2,108 63,935 1,503 608,909 606,782 616,309 113,200 113,200 1,050,903 1,090,948 987,145 315,754 502,599

22,921 10,550 1,812

22,921 10,550 1,812

22,921 10,550

22,921 10,550

22,921 10,550

22,921 10,550

22,921 10,550

22,921 10,550

22,921 10,550

11,121 10,548 5,274

11,121 10,548 5,274

11,121 10,548 5,274

11,121 10,548 5,274

11,121 10,548 5,274

11,121 10,548 5,274

11,121 10,548 5,274

11,121 10,548 5,274

11,121 10,548 5,274

155,694

137,159

133,452 118,624

114,917

88,968

85,261

85,261

85,261

53,005

53,005

51,008

51,008

51,008

51,008

51,008

113,200 113,200 497,325

113,200 113,200 478,790

113,200 113,200 113,200 113,200 423,083 423,083

113,200 113,200 423,083

2 5,274 2,637 2,925 $114 $612

5 18,535 3,707 2,902 $107 $571

197

1 33 2 47 1 195

198

364

394

328

18 66 221 25,393 103,803 671,391 1,411 1,573 3,038 2,769 3,010 2,951 $ 694 $69 $7 $1,131 $201 $35

15 39,555 2,637 2,922 $64 $320

53,005

51,008

113,200 113,200 113,200 113,200 473,271 456,446 3 5,519 1,840 2,921 $198 $ 1,114

5 16,825 3,365 2,907 $138 $812

113,200 113,200 113,200 113,200 452,739 426,790 1 3,707 3,707 2,902 $97 $597

7 25,949 3,707 2,864 $99 $644

1 3,707 3,707 2,859 $100 $859

The table above shows how KS has harvested its Ocean Gardens development over the years. Note how the multiple of cost has risen over time as property prices have increased (note that cost / square foot was likely distorted until 2004, when a large number of units were monetized in Beijing; since 1111 Brickell Ave, Suite 2135 Miami, FL 33131

hellerhs.com

26


then, sales have been primarily in Macau). Only recently has KS started disclosing rental incomes for this group of properties held for sale. The yield on cost in 2015 was 22.3% compared with cap rates for sold properties in 2012-2013 of 1.5-1.7%. We can also compare $/SF for sold properties with transactions in DSEC (below) to further buttress our valuation.

It’s important to note that it was only in 2002 that Macau ended the monopoly system for gaming licenses, opening up the opportunity for the arrival of Wynn Resorts, Las Vegas Sands, Galaxy Entertainment, among others. 28 At this point it is likely that KS’s management began throttling back on property sales given the expected further development of Macau. DSEC

Macau’s government-run statistics database is a very useful source of data on the economy and on real estate transactions. 29 The database reports numbers in HKD/square meter so we will use this metric going forward.

As can be seen in the table above, KS marks its remaining units at HKD 663 per square feet or HKD 7,140 per square meter. A full 90% of these units (by area) are properties in Ocean Gardens, Taipa. The remaining 10% are split in two properties. The first, Ocean Industrial Centre, Phase II, is an industrial property in Macau. We value this at $250 / SF, which we feel is appropriately conservative, although we do not have direct comps 30. Ocean Park is a residential property in Singapore. Recent transactions at Ocean Park seem to have been around $900-1,200 per square feet 31. We convert the lower end from Singapore dollars to arrive at $667 / SF for this piece. The remaining 90% of units, in Ocean Gardens in Macau, can be compared with the DSEC database for transactions in “Jardins do Oceano, Taipa” (Ocean Gardens). Below we chart these transactions.

https://www.wikiwand.com/en/Gambling_in_Macau http://www.dsec.gov.mo/TimeSeriesDatabase.aspx?lang=en-US 30 If we’re wrong, it does not materially affect our thesis. 31 http://www.propertyguru.com.sg/project/ocean-park-293 and https://www.dropbox.com/s/5zjty7r2v56rpil/Ocean%20Park%20transactions.PNG?dl=0 28 29


hellerhs.com

27


The chart shows the dramatic rise, and recent fall, of property prices in Macau 32. The fall has been strongly correlated with the decline in gaming revenues, although the number of visitors to Macau has remained very stable 33. We feel our valuation is conservative, as it sits at a 35% discount to recent transactions and a 54% discount to the peak. At $552 / SF, it also has an implied cap rate of 3.5%. By Technically, these numbers are in MOP / square meters, but since the Macau Pataca is pegged to the HKD and the ratio is very close to 1:1, we simplify the presentation and show the chart in HKD. 33 We share a number of other statistics in useful charts here: https://www.dropbox.com/s/9955i16h8018ddl/Macau%20statistics%20-%20PUBLIC.pdf?dl=0 32


hellerhs.com

28


comparison, MPO Fund marks its Waterside residential properties at a cap rate of 2.4% and $1,408 / SF. 34 At cost, these properties held for sale are only 0.60 per KS share. At our valuation, they would be worth 3.75 per share, a multiple of 6.3x cost.

Given the supply and demand characteristics of residential housing in Taipa, it is very likely that the completion of the Hong Kong-Zhuhai-Macau bridge will indeed lead to a rise in values for the Ocean Gardens properties. Below is a sensitivity analysis table (we keep the industrial and Singapore properties at their current valuations, and only apply the HKD / sqm values below to Ocean Gardens):

Sensitivity analysis on Ocean Gardens valuations HKD / sqm 46,100 50,000 60,000 80,000 100,000 Total value (group's part) 1,277,212 1,376,889 1,632,470 2,143,632 2,654,795 Per share 3.75 4.05 4.80 6.30 7.80

Remaining NAV items

The only remaining NAV items are cash (4.19 per share), “other assets” on the balance sheet (0.47 per share) and all liabilities and minority interests not already deducted, at -7.74 per share.

Our total NAV estimate therefore stands at HKD 18.19 per share, and as we have hopefully demonstrated along the way, we believe this is based on current market valuations. Calculation of free cash flow

Our bridge from net income to free cash flow is presented below. A few items should be noted. 





KS has substantial non-controlling interests due to partial ownership of many properties. The overall split is about 70.3% of net income accruing to shareholders of KS, so we use this split for free cash flow as well. While an asset-by-asset free cash flow estimate would be more accurate, we have performed the exercise and the outcome isn’t materially different. The hotel industry uses 4% of sales as an estimate of capital expenditures. We use this across all sales figures. Again, this is likely off, as it overestimates capex (since a large portion of sales come from non-hotel properties), but the result shouldn’t be materially off.

We deduct non-recurring items such as the increase in mark-to-market in property values, interest income on bank balances, and losses from trading securities (although this last item is immaterial).

Waterside is located in Macau proper (and has extensive high end shopping on the ground floor), is much newer more attractive than Ocean Gardens, and probably deserves a to be valued at a large premium.

34


hellerhs.com

29


Free cash flow bridge (2015) 35 Total net income (+) D&A (-) Increase in fair value (-) Other revenue (+) Other losses = FFO % attrib to shareholders FFO to shareholders FFO per share 36 Capex % of revenues (-) Capex = FCF FCF to shareholders FCF per share FCF yield

325,756 130,112 (35,000) (33,885) 2,738 389,721 70.3% 273,933 0.81 4.0% (77,583) 312,138 219,400 0.64 11.2%

We note that this calculation of free cash flow results in free cash flow per share of 0.40, 0.55, 0.55 in 2012, 2013 and 2014, respectively. Calculation of cap rate and leverage

Cap rates are one favored way of calculating real estate values. Hopefully we have demonstrated though our sum of the parts analysis above that our NAV estimate of over HKD 18 per share is conservative. On a consolidated basis, we can also calculate an implied cap rate by dividing EBITDA by enterprise value 37.

http://www.keckseng.com.hk/Files/Announcement/2015/LTN20150924472.pdf FFO is funds from operations, another metric used to value publicly traded real estate. KS trades at a P/FFO multiple of 7.1x, which is also quite undervalued. The flaw in this metric is that it does not consider leverage, or the amount of debt the company carries. This isn’t a problem for KS, with its very underleveraged balance sheet. 37 EBITDA is earnings before interest, taxes, depreciation and amortization, and is equivalent to the net operating income of a property; enterprise value is the market cap of a company, plus debt and less cash, which is equivalent to the value of a property. 35 36


hellerhs.com

30


Implied cap rate (2015) Total net income (+) D&A (+) Taxes (+) Interest expense (-) Increase in fair value (-) Other revenue (+) Other losses = EBITDA Current stock price Shares outstanding Market cap (+) Total debt (-) Cash (+) Minority interests = Enterprise value Implied cap rate Estimated NAV Cap rate at est. NAV

325,756 130,112 96,417 34,105 (35,000) (33,885) 2,738 520,243 [A]

HKD 5.75 340,200 1,956,150 1,942,625 (1,790,706) 96,784 2,204,853 [B] 23.6% [A] / [B] 18.2 8.1%

The cap rate implied by the current share price is 23.6%, which represents a dramatic undervaluation relative to real-world real estate transactions. As noted on the first page, the median cap rate for hotel companies listed in the U.S. is 7.6%, with luxury hotels being valued towards 6% cap rates and limited service hotels at around 9-10%. Since we have valued KS on an asset by asset basis, our target price of HKD 18.2 already incorporates individual cap rates for each property. On a consolidated basis, our target price would represent a cap rate of 8.1% for the whole company, which is another way to determine that 18.2 is indeed a reasonable target price. A similar calculation would have resulted in cap rates of 66%, 57% and 17% in 2012, 2013 and 2014, respectively, using the HKD 5.75 stock price noted above. The reason for the higher numbers was due to a lower enterprise value, since KS took a mortgage to purchase the Sofitel NY, enlarging enterprise value but growing EBITDA modestly, given the tight cap rate at which that acquisition was made. It should also be noted how solid KS’s balance sheet is. The estimated NAV of 18.2 per share can be compared with total debt per share of 5.7 for an LTV of 31%; however, including cash we arrive at net debt per share of 0.4 for an LTV of 2.5%.


hellerhs.com

31


Source of mispricing It is always important to understand why a security is undervalued, so here we list some reasons we believe KS trades at such a wide discount to intrinsic value: 

 







No analyst coverage As far as we are aware, there are no sell-side analysts who cover KS. Securities without sell-side coverage tend to fall through the cracks and frequently trade at low valuations.

Small cap status The current market cap of KS, at HKD 5.75 per share, is $252 million, quite small by U.S. standards, and too small for most institutional investors to take a position.

Limited float The controlling family owns 74.82% of the shares outstanding, which means that there is only about $63 million of free float available. It is our understanding that the listing rules in Hong Kong require that at least 25% of the shares remain freely traded, so this may preclude further stock buybacks 38.

Lack of awareness by investment community We believe this idea was completely unknown to the majority, if not all, western market participants, until it was posted in an excellent write-up, to which we are indebted for the idea 39.

Misperception regarding take under risk One common objection to this investment idea is that the controlling shareholders could take the company private through a lowball bid, depriving minority shareholders of the full value of their shares. Hong Kong law allows 10% of the minority to block any such attempt, making it very difficult for such a take under attempt to succeed 40. Unfocused investor relations effort KS does not employ IR professionals or prepare investor presentations, hold conference calls, or conduct roadshows. Despite this, the company does hold annual meetings and is responsive to shareholders through email and phone calls.

Cyclicality of the hotel business

The data below is from Smith Travel Research and the U.S. Department of Labor. Over time, ADR and RevPAR have done well compared to CPI, but one can note the cycles of rising ADR/RevPAR leading to a rise in supply, resulting in a down cycle, and so forth. If this chart holds, we should be bracing for an increase in supply and another downturn. We are already witnessing this in markets like New York (see links under the Risks section below). Supply https://www.hkex.com.hk/eng/listing/listreq_pro/listreq/equities.htm although the company does have a stock buyback authorization http://www.keckseng.com.hk/Files/Announcement/2015/LTN20150424436.pdf 39 https://valueinvestorsclub.com/idea/Keck_Seng_Investments/114379 40 http://www.scmp.com/comment/insight-opinion/article/1436426/new-companies-law-will-boost-hongkongs-competitiveness 38


hellerhs.com

32


appears constrained in Vietnam, which is the other large contributor to KS’s profitability, but this cannot be expected to last forever.

US Lodging Industry Trends: 1992 - 2015

240 220

Data indexed, 1992=100, except rooms added Rooms added (gross), RHS

160,000 140,000

RevPAR

200

ADR

180

CPI

160

120,000 100,000 80,000

140

60,000

120

40,000

100

20,000

80

Occupancy

0

Risks, uncertainties, and why this may not work out 

One risk to the hotel industry is Airbnb. In 2015 Airbnb booked 80 million room nights and $1 billion in revenues 41. Hilton Worldwide mentioned in their Q4 2015 conference call that they still do not see “any material impact from it” and that they believe Airbnb is a real business that will be around for a very long time, but they will coexist with hotels. On the one hand, Airbnb increases supply, probably mostly in high ADR markets 42. On the other hand,

https://www.youtube.com/watch?v=1Bj_QwX7hGk Sotherly Hotels 2015 Q4 conference call: “While we don’t disagree that Airbnb presents a new alternative to the traditional hotel model, we have not seen any disruption in our markets to-date. We believe the negative Airbnb effect will be experienced primarily in the top-five high rate gateway markets where a low-cost alternative is an attractive option.” LaSalle Hotels Q4 2015 conference call: “So it’s hard to say exactly what’s going on there. There is not the greatest data out. But what I would tell you is that, it’s almost like any new supply. While our customers are not necessarily the customers that would be staying at a no-frills limited service hotel, to the extent that you add no frills limited service hotels to market, that supply takes from 41 42


hellerhs.com

33










there are many things Airbnb cannot do, such as host conferences, offer superb room service, and deliver a consistent, branded, superior guest experience that only hotels can deliver. We believe there is no doubt Airbnb is sucking dollars from the hotel industry. So while the risk may not yet be material, perhaps the operative word is “yet” and it’s certainly a risk we’re firmly focused on.

New York is undergoing supply additions and the market is soft 43. On the other hand, land values are high enough that alternative uses are already being sought by some hotel owners, such as conversions into retail (for street level), time share and residential.

Vietnam concentration: around 46% of the profits to shareholders of KS come from its properties in Vietnam, depending on how one allocates corporate overhead; another 31% comes from the U.S. and 16% from Macau, deducting the mark-to-market gain in fair value. So while in terms of net asset value the company is weighted towards the U.S., in terms of profits it is weighted towards Vietnam.

Currency risk: the Vietnamese dong has been a depreciating currency against the U.S. dollar for many years 44, which stimulates tourism and makes goods and services cheaper, but doesn’t bode well for the transfer of profits to KS. The currency however is considered cheap 45 and KS management transfers all cash from Vietnam to banks in Hong Kong and Macau as soon as practicable to avoid currency risks.

Further currency risk: KS reports in HKD and while the HKD is pegged to the U.S. dollar, there have been speculations about the peg being broken 46. By all accounts, the HKD is among the most undervalued currencies in the world; that coupled with capital flows into Hong Kong should be reflected in a higher value for the HKD against the U.S. dollar should the peg break. If that happens, an unhedged investment in KS will rise in value since the shares are denominated in HKD, while net asset value and profitability would decline given a

whatever the closest competition is, who ends up bringing down rates, creating availability and then everyone ultimately becomes more price sensitive.” 43 See http://www.nytimes.com/2015/03/04/realestate/commercial/hotel-market-staggers-in-new-yorkcity.html also http://www.bloomberg.com/news/articles/2015-02-20/nyc-hotel-glut-leading-to-slowdownin-room-rate-increases and https://commercialobserver.com/2016/02/hersha-hospitality-says-supply-glutweakens-growth-in-nyc-room-revenues/ 44 http://www.xe.com/currencycharts/?from=VND&to=USD&view=10Y 45 http://www.economist.com/content/big-mac-index 46 http://blogs.wsj.com/briefly/2016/01/25/hong-kongs-dollar-peg-next-in-the-firing-line-the-numbers/ 1111 Brickell Ave, Suite 2135 Miami, FL 33131

hellerhs.com

34




predominance of non-HKD assets owned by KS. This risk can be hedged by a short position in the HKD.

This stock may never re-rate to a more appropriate cap rate and may remain cheap.

Factors mitigating risks 



It is simply too cheap Assuming the current level of free cash flows can continue and grows – and given the company’s solid balance sheet, there is little reason to imagine why free cash flows would decline over a long enough period of time (excluding short term declines due to currency movements or hotel industry cyclicality), then the stock is already very cheap, trading at a double digit free cash flow yield. Low risk business and low risk balance sheet This security is the archetypal “sleep well at night” investment with low business risk and low balance sheet risk.

Further reading

The company’s annual reports can be accessed at http://www.keckseng.com.hk/Eng/Reports.htm and a list of all announcements at http://www.keckseng.com.hk/Eng/Announcement.htm. Catalysts 



The completion of the Hong Kong-Zhuhai-Macau Bridge may lead to further divestments of property in Macau. Should all properties be divested we expect at least HKD 3 per share to “show up” on the company’s balance sheet (our estimated value of 3.75 per share less the 0.60 at which the assets are currently valued), and possibly more; there is a possibility that the entire current market cap of KS may materialize on the balance sheet once these assets are sold. More value-creating activities by management such as new developments in Macau or other property acquisitions or divestments.


hellerhs.com

35


Important Legal Disclaimer All information provided herein is for informational purposes only and should not be deemed as a recommendation to buy or sell any security mentioned. Heller House may currently or in the future buy, sell, cover or otherwise change the form of its investment in the companies discussed in this memo for any reason. Heller House hereby disclaims any duty to provide any updates or changes to the information contained here including, without limitation, the manner or type of any Heller House investment. Past performance is not necessarily indicative of future results. All investments involve risk including the loss of principal. It should not be assumed that any of the securities transactions or holdings discussed herein were or will prove to be pro�itable, or that the investment recommendations or decisions we make in the future will be pro�itable or will equal the investment performance of the securities discussed herein. Speci�ic companies or securities discussed in this memo are meant to demonstrate Heller House’s investment style and the types of industries and instruments in which we invest and are not selected based on past performance.

The analyses and conclusions of Heller House contained in this memo are based on publicly available information. Heller House recognizes that there may be con�idential or otherwise non-public information in the possession of the companies discussed in this memo that could lead these companies to disagree with Heller House’s conclusions. The analyses provided include certain statements, assumptions, estimates and projections prepared with respect to, among other things, the historical and anticipated operating performance of the companies. Such statements, assumptions, estimates, and projections re�lect various assumptions by Heller House concerning anticipated results that are inherently subject to signi�icant economic, competitive, and other uncertainties and contingencies and have been included solely for illustrative purposes. No representations, express or implied, are made as to the accuracy or completeness of such statements, assumptions, estimates or projections or with respect to any other materials herein. This document is con�idential and may not be distributed without the express written consent of Heller House and does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product.


hellerhs.com

36

Keck Seng Investments - Heller House Investment Memo - 4-7-16

Recommend Documents