Monday, July 11, 2016

It is frustrating to see this Chinese property agency business so cheap: Hopefluent (733.HK)

Hopefluent (733.HK), Among the largest property agencies in the country

One of the most frustrating value investments in Hong Kong for us has been Hopefluent (733.HK). 
Hopefluent is the dominant property agent in Guangzhou, the largest city in Southern China, with a population of 12 Million residents. To give you an idea of scale, that's more than the population of Belgium.
Like any other property agency business, Hopefluent generates revenue through sales commission. In China however, secondary property market is still nascent and primary market dominates the transactions nationwide. For Hopefluent, primary agency business is three times as large as secondary business. In 2015, primary agency business generated a turnover of HK$1.8bn, from arranging property sales worth HK$215bn. Against this, the country's largest property company, China Overseas Land (688.HK) had primary property sales of HK$135bn in 2015. Hopefluent managed sales for over 900 projects in over 150 cities in China, with over 60% of its primary segment revenue coming from outside Guangzhou.

In addition, the company also has a sizable property management business. Hopefluent managed over 300 properties generating a revenue of HK$350mm in 2015.

It is frustrating to see this Chinese property agent trading so cheap

We own the stock in our portfolio and here are the reasons why we think it is frustratingly cheap. 

1. The company has a net cash of HK$1bn (vs a market cap of HK$1.3bn, or US$175mm, at the stock price of HK$2.03) - net cash forms 77% of the company's current market cap. It has short-term debt of only HK$39mm and no long-term debt. Its 2015 annual report, which will get you this data, can be found here.

2. In 2015, the company earned profits of HK$223bn. Excluding a disposal gain of HK$61mm, the core earnings were HK$177mm. That translates to a trailing core P/E of 7.3x, with trailing 3.9% dividend yield. Do you even want me to talk about ex-cash P/E?

3. The trailing book value is HK$2.23bn, translating to trailing P/B of only 0.6x, at trailing 10% RoE. And again, I'm not even talking about ex-cash P/B.

4. It's not that the stock is going cheap because its earnings are too volatile. Since listing in 2004, company has always been profitable, except one year: 2008. Average profit in the last ten years was HK$131mm; the stock is trading at 10x trailing ten years' average earnings. 

5. Soufun holdings (SFUN.US) acquired about 112mm shares in Hopefluent in 2014 at HK$3.00 per share. The controlling shareholder, Mr. Fu also bought 42mm shares at HK$3.00 per share, since he did not want to get diluted. While the earnings have grown in 2015, stock has languished, trading now at 31% discount to where Soufun and the controlling shareholder bought. 

We are hopeful for Hopefluent

As a small cap value investor, our journey with Hopefluent has been frustrating. The stock price has been virtually flat since 2012. It is down 10% YTD, and 15% since the inception of our fund, when we bought the stock.

Yet, we are hopeful about the company's earnings prospects.

Outlook for 2016 seems rosy. Property sales in China are up. Guangzhou, Hopefluent's key market where property transactions and prices had trailed last year, is seeing revival in transactions as well as pricing this year. The company has made foray into several property related segments late last year, which we believe should start yielding results this year.

The controlling shareholder has been acquiring shares in the open market. Since the beginning of the year, the Chairman Mr. Fu has bought 4.87mm shares in the company, a bit under 1%. Creeping acquisition rules in Hong Kong market allow him to buy 2% per year at most without triggering a general offer. 1H16 results may or may not act as a catalyst, but for a stock that is trading at <2x trailing ex-cash earnings and 0.6x trailing book, we see little downside. As a value investor, we are patiently waiting.

Thursday, May 28, 2015

As Uber and Ola fight it out, Indian consumer is the real winner

My recent visit to India earlier this month was full of pleasant surprises, one of which is the topic of this post. I was visiting my parents in Vadodara, Gujarat. For those unfamiliar with India, Vadodara is a tier-3 city in the state of Gujarat, with a population of 1.8 million. 

Indian taxis - the past, and the present

Upon reaching Vadodara airport, I wanted to take a taxi. Those familiar with the local travel scene in small-town India would probably know that taxi service as we know it -- in the form of sedan cars -- is non-existent in India outside the metros. What we have instead is its small-town avatar, a motorized tricycle, called auto rikshaw. They seat three people and have little room for a suitcase or any bulky item. As a result for the travelers with luggage, car taxis are available at the airport and railway stations in most cities, including Vadodara. 

No patience for haggling

A rental car booth was in the baggage collection area of the airport. I casually inquired, and was told that the charge for a drop anywhere in the city was five hundred rupees. Reckoning that the price was too steep, I decided to try my luck outside. As soon as I came out, a swarm of drivers surrounded me; twelve, fifteen of them. It was seven am and mid-summer sun was out, morning was already warm. The offers started at five hundred rupees. I could have haggled and brought the price down, but I was too tired, having spent the previous night at Mumbai airport. I was willing to take one, anyone, but it was impossible for me to talk to a single person without creating a scene. One man was trying to snatch my suitcase, another tugged at my backpack, a third pulled my sleeve. I braced myself, ran back into the arrival hall, and booked a taxi from the travel counter. 

Now...Taxis in majority of Indian cities, or the "auto rikshaw," look like this 

The future of taxis?

That evening I was recounting the incident to my friend who has settled in Vadodara after a stint overseas. "Next time, try Olacab," he said. And thus I was introduced to India's latest online revolution. 

The next day when I had to go out, I tried Olacab. I called the Olacab hotline number my friend had given to me. I was surprised when the operator told me that I can book a taxi only through their smartphone App. It was a minor irritant, but I managed to download the app and book a cab without much trouble. The driver called me half an hour before the time I needed the taxi, and he was at our gate in time. His car was brand new; like any new car owner in Vadodara, he had not even taken the plastic wrapping off the seats. The aircon worked even in the blazing heat of Vadodara summer, where outside temperature was 43 degrees. When I reached my destination, the bill was about a hundred rupees. An auto rikshaw would have charged only slightly less, and that too after minutes of haggling. I was so overjoyed I wanted to hug the driver. 

I had about one hour's work and after this amazing experience, I didn't want to go back home in a rikshaw, so I decided to pay one rupee a minute waiting charge and hold my Olacab. 

But... do the economics make sense?

The Future of taxis in India? (Bhavish Aggarwal, CEO and co-founder of Ola in front of an Olacab)

On the way back, what I learned from the driver really amazed me. 

In the last six months, three taxi calling services have launched in Vadodara, and Uber is expected to launch soon. When Olacabs launched their services in the city, they had one hundred and fifty cabs on contract. For the first six months, they gave one thousand rupees per day to each driver as a handout, irrespective of the fares they got. For the first six months, in Vadodara alone, they burned twenty seven million rupees. Later, they changed that to four hundred rupees after every ten rides and seventy drivers from the original of one fifty . My driver told me he usually gets more than ten rides in a day. So as I write, the company is still burning close to one million rupees a month in Vadodara alone. 

In addition, the company also spent money on promotion to the consumers: a bonus of rupees fifty to hundred upon downloading the app, fifty rupees off on the first ride, etc. I learned through online articles and blog posts that in bigger cities, their handouts to drivers are even larger and could be as high as two thousand rupees per day. 

So, how much money could they have burned to date? Probably only the insiders and existing investors are privy to this figure, but given that they have launched services in eighty eight cities now, a simplistic back-of-the envelope calculation would suggest about three billion rupees (US$46 million) only in handouts to drivers, taking Vadodara as the average! If anything, this figure is likely to be an underestimate, since their payments to the drivers are higher in the metros and bigger cities. 

Small change

That might look like a staggering sum to spend before even realizing any revenue from the cabs. However, it is only a small change considering the amount that the company has raised from the investors and the US$2.4billion valuation that it fetched from its latest round of funding. I have my own views on this valuation; I think it could be significantly overvalued, but exploring that should be the topic for a separate post. (Meanwhile, people interested on this topic should take a look at Prof. Aswath Damodaran's excellent blog post on valuation of Uber.) 

Why is Olacabs in such a tearing hurry to expand, one may ask? The only answer could be that they are in a land-grab mode, and want to preempt the rivals, especially the bigger and better funded Uber. I believe with its current expansion spree, it could be years before Olacabs makes money. And I do wish them luck and hope that they succeed, because I love what they are doing to the taxi scene in India.

In the mean time, consumer is the real winner. As long as I was in India, I gave auto rikshaws a break, and traveled everywhere by Olacabs. I also took an Olacab on the way back to the airport. It cost me only a hundred and forty rupees.  

Before leaving India, I did two things. One, I bought my father a smartphone. I ordered it on flipkart; it cost me twenty percent cheaper than buying from the local phone dealer. Two, I downloaded Olacabs app on his new smartphone. 

Thursday, November 6, 2014

BILT Paper perpetuals with 12.3% yield offers good investment opportunity

Disclosure: We own this instrument in our portfolio.

BILT Paper, the subsidiary of Ballarpur Industries, India's largest manufacturer of paper, has a US$ denominated perpetual bond that offers 12.3% yield based on Bloomberg offers (coupon: 9.75%, Price: 92.5 cents. Bloomberg ticker: BILTIN 9 3/4 08/28/49 Corp, ISIN: USN08328AA95).

The discussion below summarizes the events that led to a distress in the bonds and argues that the situation is now on a mend, resulting in a potential investment opportunity for buy-and-hold investors looking for yield. 

Largest Paper Company in India and Malaysia...
Member of the Gautam Thapar led Avantha Group, Ballarpur Industries is the manufacturer of writing & printing paper in India and Malaysia, with a market share of 25% and 30% respectively. BILT Paper BV is the subsidiary of Ballarpur Industries that owns the pulp and paper manufacturing and forestry assets (where as rest of the more 'consumer' businesses such as specialty paper, branded stationery and hygiene business are owned directly by Ballarpur Industries). The group is the only vertically integrated manufacturer in India, controlling the entire chain from plantations to pulp to paper. It also has captive power plants at all its locations.

Ballarpur Industries is listed in India (TIcker: BILT IN) and BILT Paper also intends to get listed in an overseas stock exchange (likely Singapore).

...with ambitious expansion plans...
Malaysian operations were acquired in 2007. Following the financial crisis, BILT Paper went on a massive expansion spree. It increased the paper capacity from 780,000 tons to 1million tons and expanded the pulp capacity from 462,00 tons to 752,000 tons. The expansion aimed to increase vertical integration and reduce costs.

...but poor execution...
However, the execution was bad. The expansions were delayed, there were cost overruns, Indian rupee tanked and the cost (and value) of its US$ debt sky-rocketed. Its balance sheet took further toll when it bought two captive power plant units from Avantha Power for US$103mm. With economic slowdown India in 2013, paper prices also suffered, affecting the profitability. Plans to list BILT Paper were indefinitely postponed.

...resulting in stretched balance sheet...
Though BILT Paper is not listed, it has published its annual report for 2013 (presumably because it is preparing for an IPO). The following analysis is based on its June 2013 Annual Report. (FY14 annual report is not available yet. My guess is that FY14 balance sheet is slightly worse)

BILT Paper had FY13 revenues of US$722mm and EBITDA of US$98mm. Interest payment, including the distribution on perpetuals, was US$68mm. That results in interest coverage of 1.44.

Unlike the company's auditors, I do not see perpetuals as an equity (it requires servicing and though coupon deferrals are possible, it is construed almost like an event of default). Assuming that perpetuals is a debt, the company has total equity (Book Value) of US$509mm and net debt of US$870mm. That translates to a gearing (net debt to equity) of 1.7x and Debt to EBITDA of 8.7x. These are highly stretched debt levels - Debt to EBITDA of 3-4x are considered more 'normal.'

...and rumors of a likely default
In 2H 2013, when the rumors were rife that BILT Paper is going to default on the coupon payments, the bonds hit a low of 60cents to a dollar. Later, the rating agency Fitch downgraded the perpetuals to B+.   

Though the bonds have since recovered and now at 92.5 cents, are well above their distressed levels, but we believe they still offer an attractive risk-reward. 

1. Capex has peaked: Between 2010 to 2013, BILT Paper embarked upon a massive capex of over US$400mm. With the pulp mill in Sabah commissioned in FY13 and in India earlier this year, the last leg of capex is finally over, and the the Chairman Mr. Thapar declared so in his address to shareholders in FY13 annual report. Going forward, I expect only the maintenance capex of about US$20-30mm per year. BILT Paper should generate positive cashflow, which should go towards reducing the debt and improving the balance sheet.

2. Profitability to improve going forward: With the new pulp mills stabilized and operating optimally, BILT Paper would be totally self-reliant on pulp. Vertical integration should reduce pulp costs and improve the profitability going forward, which will be further enhanced as its plantation in Sabah is also expanded.

3. Investment by IFC improves the balance sheet and credit profile: Last month, IFC announced plans to invest US$100million in equity and provide up to US$150mm in loans to BILT Paper. The equity investment has already come through giving IFC a 14.3% stake, according to the announcement on 4th November (IFC's investment puts the equity value of BILT Paper  at US$600mm). BILT's press release earlier mentioned that IFC loan would be used to refinance some of the highest cost debt. The effect is to increase the equity, reduce the debt and gearing and the finance costs. Having IFC as an equity and debt investor in the company provides comfort for other investors. This could improve chances of BILT Paper's successful IPO and also open up other sources of funds.

4. Yield pick-up if the bonds are called: There is a likelihood that the perpetuals will be called at the next call date. Perpetuals come with a step-up clause in the coupons. At the next call date in 2016, the coupon steps up to 5yr US Treasury note + 8.57%. For instance, the current yield on 5yr US Treasury note of 1.63% would put the new coupon at 10.3% (and will fluctuate according to yield on Treasury note at each coupon date). Between now and 2016, the Treasury yield is likely to only increase, resulting in even higher coupons and creating even more incentive for the company to call the bonds. If the bonds are called, the yield to next call works out to 14.75%

If they are not called in 2016, the next call date after 2016 is in 2021, when the coupon steps up by another 1%.

1. Interest rates: Almost all of BILT Paper's debt is floating. Inability to quickly deleverage before the rates start rising could stress the cashflow .

2. Macro slowdown: Paper prices are highly susceptible to economic slowdown, as witnessed in India last year. Declining paper prices could put pressure on profitability.

3. Corporate Governance: Decision to acquire captive power plant from Avantha Group when BILT Paper's balance sheet was already stretched, was untimely and creates corporate governance red flags in my opinion. Similar transactions in future may create unexpected capex outlay and jeopardize the balance sheet.

We own BILT Paper perpetuals in our portfolio. With improving macro conditions in India, increased access to funding by the company and a lack of capex, I believe that with 12.3% yield, the bonds offer excellent investment opportunity for buy-and-hold investors seeking yield (Minimum ticket for the bonds is US$200,000 in face value).

Sunday, November 2, 2014

"It is my company:" Corporate Governance From the Perspective of an Asian Entrepreneur

Asian companies are different from their developed market counterparts: majority of them, even the very large ones (when not government owned), are controlled by a single owner-entrepreneur, or at best a family. They may have sold the shares to investors, but few of these entrepreneurs like to cede control. 

Over my 11+ year career as an equity research analyst and fund manager, I have met over thousand listed Asian companies, many of them multiple times. Armed with MBA, CFA and with hubris gathered from years of investing experience, I have nodded my head in disgust at lazy balance sheets, wasteful capital allocation, general disregard for corporate finance principles and poor corporate governance. On numerous occasions I have given unsolicited advice to CFOs, CEOs, and the big bosses, on how to run their companies, at least the financial side of it.

Today, I'm going to turn the tables, and think from their perspective, the perspective of an Asian Entrepreneur. The typical profile I have in mind is not the savvy founder high-tech internet enterprises listed in the US; that forms just a very small universe. Typical profile is a first generation entrepreneur, often without a college degree, zero knowledge of high finance, but a gut for business, risen typically from a trader to a manufacturer, a self-made man.

So here it goes, in his own words.

It was my company
I used the entire savings that I had, borrowed money from relatives to start my business. Initial years were tough. Banks denied me loans. I used my house as a security for the loan, and when that was not enough, my wife's jewelery. As the business grew, profits came in, but I didn't see much of that. I ploughed nearly everything I earned back into the business. Banks were less reluctant to lend money now, but I still had to beg and they still charged very high rates.

Then, two sleek guys in smart black suit, cuff-linked shirts and glimmering ties paid me a visit. With their shining faces, intent look in their eyes and gelled hair, they looked like clones. They were investment bankers, they said, not bankers. Apparently there is a difference, I was about to find out.

We will raise money for you, they said.

You will give me money? I asked.

No, they said. Mr. Market will give you.

How much will it cost? I asked.

Nothing, they said.

No interest? I asked.

No interest. And no repayment, imagine. This is called equity. 

I took them to dinner. They paid for it, and I knew they were different from bankers. Over drinks they told me, they will help me sell a part of my business.

But it is my company, I said.

It will still remain your company. The other guys -- so called investors -- will just get a piece of paper. They'll get tired of it in one, three, or at most six months. Then they'll trade that piece of paper among themselves. Some of them may request to meet you periodically, but you can always hire someone to do it for you.

It is still my company 
So I did what the investment bankers said. We were just making cheap batteries, but a bunch of their nerds wrote up some crap about how we were the next e-vehicle play (whatever that means), and these investors couldn't have enough of my paper. I got more money than I needed.

And I enjoy meeting my investors, mostly young kids in suit and tie full of themselves. I humor them, pretend that I listen to them, take them to a tour of my plant. When they ask all sorts of bookish financial questions, I turn to the guy I hired and gave him the fancy title of CFO.

They're worried about corporate governance, my CFO said once.

What corporate governance? I asked.

They want to see minority interest protection -- audit committee, compensation committee, more independent directors, things like that.

That only opened up more job opportunities for my relatives, friends and people I wanted to oblige. One independent director is a government official I needed on my side, another is my brother-in-law. The audit committee head is my brother; he just uses a different surname.

When I want to take some money out, my accountant shows me the way. One year I used M&A, another year I over-invoiced capex. Every year I give myself and my cronies stock options.

For now, I'm enjoying this game. If I get tired, I'll just have to show some bad numbers, poor corporate governance, and privatize the whole thing at throwaway prices.

They think they own a part of my company; of course they're dreaming. I let them, and go back and do what I want. It is, after all, still my company.    


Monday, June 23, 2014

Should you still be invested in bonds?

Now that the interest rates are going up globally, should you continue to invest in bonds? The answer depends not only on what bond yields you are getting and where you live, but also on whether you own your property or not. How? Read on...


Beating inflation

The point of investing is to make your money to work for you. At a bare minimum, you want to ensure that the value of your capital does not erode over time. I hope to achieve that for my savings by investing primarily in stocks. However, I also have a smallish bond portfolio.

By above logic, I should be buying bonds only if I believe that the returns on my bond portfolio will beat inflation. Since I live in Hong Kong, I will elaborate using Hong Kong as an example.

Since 1981 (earliest the data is publicly available), inflation in Hong Kong has averaged 4.6% (year-on-year basis, monthly data). So I should be happy if the current yield on my bond portfolio is well above this average. (in US$. There's an underlying assumption that HK$ will maintain its peg to US$, at least for the near future).

Okay. Simple enough? Hardly. There are obvious holes in the thesis.

Illusion of averages

4.6% average does not guarantee that the inflation in the near future will not exceed the returns I am getting from my bonds. Hong Kong has a history of very volatile inflation rates, reaching a high of +16% in October'81 and a low of -6.1% in  August'99. It stayed above 4.6% for prolonged periods from 1981 to 1984, and then again in the pre-handover euphoric years of 1988 to 1996, falling below 4.6% only after the Asian crisis, as the chart below shows.


Monday, June 9, 2014

A Little bit of 'Samatva'

-Balance, sameness, an evenness of mind, equipoise

I first came across this word at the weekly Gita classes at the Chinmaya Mission in Hong Kong. In verse 48, Chapter 2 of Gita, Krishna urges Arjun to perform actions while remaining ‘balanced.’ Actually, Sri Krishna was asking for a lot more – he wanted Arjun to ‘perform actions abandoning attachment, remaining the same to success and failure alike.’ But then Arjun was a much more ‘evolved’ disciple. For me, ‘balance’ is a good start. 

Control over time
Today marks the first anniversary of my being officially unemployed. When pressed for a reason in my exit interview, I mumbled something about wanting to leave at a high point, but mostly, I wanted to take control of my time, as this post explains.

So, what have I been up to since then? Mostly, I traveled a lot. Of the last 365 days, I was on vacation for 94 days. Besides traveling I read a lot (no, not about finance or investments or self-improvement, but mostly fiction), and attempted to write a book (and still attempting to sell it). I also set up my own fund, “Samatva Opportunities Fund.”

And finally, this blog. 

I have been thinking about blogging for at least last six months, and I would still not have put my words on paper, were it not for this excellent blog article that I came across a few days ago, A guide to young people: What to do with your life. A must read for parents of teenage children, but sensible advice for just about anybody. For one, spurred me to stop procrastinating  -- my wife wouldn't agree to such a sweeping statement -- but at least, I've made a start.

What do I intend to write about? Just about anything I wish to chew on. Everyday finance. Things that I’m figuring out. Notable posts I find on the blogosphere, and some other things I don’t know yet. How often? I don’t know. Whenever inspiration strikes.

See you soon. Until then…...stay ‘Samatva!’