Saturday, 15 November 2014

Keck Seng

Keck Seng is a real estate investor and developer with properties located in the US, Macau, Vietnam, Japan, Singapore, Canada and China. The origins of the company trace back to an entrepreneur by the name of Ho Yeow Koon, who founded the company in Singapore in the 1940s. The business is now controlled by his sons who took over ownership/management after his passing. To be clear there are two listed Keck Sengs - one in HK and one in KL - and the one discussed here is the HK listed co (HK:184). There is a connection between the two companies to the extent that the sons control and manage both businesses and the two companies invested jointly in two hotels in Canada, while new property investments are made by the HK company. The KL listed entity also owns plantations and other real estate investments.

The below is roughly how the valuation looks and as it’s a holding company I’m going for SOTP. There is a substantial discount to equity value, which might not surprise you much as it’s a SE Asian family controlled, holding company that invests in real estate (some trade at 40%+ discount, even the larger ones) but in the case of Keck Seng I think this is unwarranted, while the financials have actually been quite healthy historically as well. The company compounded book value around 10% over the last decade, free cash flow at 11% while pre-tax ROIC (ex cash) averaged in the mid teens.

United States – 47% of GAV
W San Francisco
  • Acquired in 2009 in the middle of the property downturn from Starwood, which was going through a deleveraging process
  • Paid $90m for a 404 room hotel ($222k/key) and a remarkable 15.1% cap rate ($13.6m NOI in 2008)
  • As a comparison, in the first full consolidated year net profit after tax was HK$17m ($2m), while mostly recently in 2013 it reached HK$43m (c. $5.6m)
  • Valuation: I’m using the average of (i) recent SF hotel transactions per key (avg of $350k/key) and (ii) cap rate of 8.5% (taking some discount to recent transactions) on 2013 free cash flow
Sofitel New York
  • The company recently closed the acquisition of the Sofitel New York (midtown Manhattan) for $265m or 5% cap rate based on 2013 NOI of $13.5m. The hotel has 398 rooms ($666k/key)
  • Before you jump to the conclusion that the 5% cap rate is high and some foreign investors paid crazy prices for a trophy asset consider that (i) asset is in prime location (ii) while not a bargain like the SF W, this rate is in line with recent Manhattan hotel transactions (iii) they’ll get recurring cash flow (iv) 70% cash financed so no real impact on leverage/balance sheet and (v) instead of repatriating cash from the W (and paying taxes…) they could use it to buy property in the US
  • As a fun fact the transaction equalled their market cap at the time (which happened to equal the cash pile on the balance sheet)
  • Valuation: transaction price
Macau – 34% of GAV
This is where the juicy stuff is in my opinion. The company has been involved with Macau for decades, mostly in residential and have been behind projects such as Ocean Gardens in Taipa, near the new casino developments on the Cotai Strip.

The interesting part here is that HK accounting allows the company to a hold a large chunk of their Macau assets at cost, which given the increase in property prices is nowhere near reality. You can find more details on Macau property price statistics here. KS’ property sales in Macau have slowed down since 2012 (none in H1 2014) as mgmt. is waiting for the completion of the bridge connecting Macau with HK (expected in 2016), public transport in Macau in 2015 and new casino developments.

As I noted in my post on RexLot I’ve no illusions about the Chinese government not going after excessive gambling and spending (this is a fact), however as (i) Macau has limited land supply similar to HK (ii) other trades develop such as conventions, family etc and (iii) healthy interest from mainland Chinese (though not the super rich but more geared towards well-off middle class visitors) property should continue to do well over the long term. There’ll be bumps for sure but KS will likely be less impacted as the majority of Macau assets are carried on their book at cost and any sale should be substantially profitable and result in better reflection of true value.

Properties held for sale
  • Three buckets of properties with gross area of 412,500 sq. ft., which I’m valuing at 3 year average historical transaction prices
  • Ocean Industrial (industrial property) with 22,900 sq. ft. at HK$2,600/sq. ft.
  • Ocean Gardens (60 residential units) 163,000 sq. ft. at HK$5,000/sq. ft.
  • Lot W (2x tower blocks of 40 residential units) 113,000 sq. ft. each at HK$6,200/sq. ft. (this is at a premium given that these are whole tower blocks with full serviced apartments and would command a higher price in a transaction)
  • Valuation: pro-rata value of the above c. HK$1.6bn. To note these assets are carried on KS’ books at HK$280m
Properties held for investment
  • Three properties consisting of two offices (Luso Bank and Ocean Tower) and one commercial building (Ocean Plaza)
  • Valuation: pro-rata value of around HK$670m (based on recent transactions), which is not too far from the company’s reported figure of HK$703m in their H1’14 financials
Vietnam – 12% of GAV
  • Two properties in Ho Chi Minh City (i) 64% stake in Sheraton (485 room hotel, including a casino, which is quite rare for Vietnam) and 25% stake in the Caravelle hotel, which was opened in 1959
  • Now Vietnam had/has it’s own peculiar situation with state involvement and bad debt in the system (Moody’s estimates NPLs are around 10-15% of total stock vs 5% official figures) that has been fuelling a property bubble, in addition to increase in supply of hotel rooms, which pushed prices down
  • Even under these circumstances the Sheraton continued to perform well and based on this experience it should continue to do OK, as well as with the government potentially opening up gambling to locals
  • Valuation: I’ve the least confidence in valuing these assets so I’m taking a large discount vs numbers I came across from other sources. I’m using a 17% cap rate to value the Sheraton and 8x P/E on the Caravelle, which gets to around HK$830m
One thing to note about the Vietnamese operations is that up until now KS faced a US$55m (HK$420m) lawsuit, which was brought by one gambler whom, following an error in a slot machine, supposedly won $55m. Initially in 2013 the judge voted in his favour, however following some “mysterious” events this was withdrawn at the beginning of the year and thus the overhang from the stock is removed.

Other (Japan, Singapore, Canada and China) – 6% of GAV
  • The other bucket includes (i) Best Western hotel in Osaka (ii) 5 residential units in Singapore’s Ocean Park (iii) two hotels in Canada and (iv) Holiday Inn Wuhan
  • Valuation: around HK$410m; mix of book and recent market transactions

Based on what I deem to be relatively conservative assumptions the gross asset value of the portfolio is HK$6.7bn and taking into account net debt of HK$680m (PF for the Sofitel transaction) and 20% holding discount/tax (based on weighted avg of the countries’ capital gains tax where KS operates; and a discount/tax should be applied to holding companies anyway) I get to c. HK$4.8bn (HK$14 per share) equity value vs market cap of HK$2.4bn (HK$7.1 per share) or an almost 100% upside. Kick in a 10% free cash flow yield, further growth in cash generation and a 2-3% dividend yield and it looks like an interesting story. As Macau sales resume, it should shed light on the true valuation of the properties and help the market value reflect intrinsic value better.

Looking at downside scenarios, if you assume that real estate valuations/prices in Macau go back to 2009/2010 levels, total portfolio equity value drops to HK$3.6bn (48% upside) and if you further assume that the valuation of Vietnam goes to 0 your upside is reduced to 22%. Assuming the portfolio is only worth what it’s carried on the books (HK$3.2bn; ex minorities) you’d still be picking up the company at 0.7x book. Should the stock trade down to it’s historical valuation of 0.5x book you’d get to a share price of HK$5, or HK$2 downside vs upside of HK$7 per share to my estimate.

With any controlled companies you can get mistreated by shareholders (money channelling out of the company, buying out substantially undervalued assets, stupid acquisitions, crony investments etc). While I’ve no better insight than you do, looking at past actions they seemed to have made rational capital allocation decisions and I think the shares are priced attractively from risk/reward perspective. Should things start to go bad corporate governance wise the stock is listed in HK with relatively strong minority shareholder protection in the region. Mind you the shares are quite illiquid so position sizing is key.

For further research, please see an article from Barron's on Keck Seng from this week.