Pembridgecap

A Wealth Creation Journal

Live Portfolio Update – 2021 – #16 (Beijing Capital Land)

Investment Action: buy 3% position in Beijing Capital Land @HKD2.5 per share

Offer price: HKD 2.8

Current share price: HKD 2.5

Upside: 12%

Probability of success: 90%

Beijing Capital Land is a SOE real estate developer that is majority owned by the Beijing Capital Group which is in turn fully owned by Beijing SASAC (SASAC is the department that manages state own assets). And it is currently being privatised by Beijing Capital Group through a cash offer of HKD 2.8 per H share. In short, Beijing city government is buying the minority shareholders of Beijing Capital Land.

Beijing Capital Land was first listed in 2003 in HK stock exchange and its total return since IPO reflects the quality of the business. In 2020, Chinese government started to cap the leverage employed by real estate developers through three measures – 1) liability to asset ratio, 2) debt to equity ratio and 3) Cash to short term debt ratio. If the real estate developer is determined to be too leveraged according to the three metrics stated above, then the developer cannot increase total leverage. In essence this is very similar to the prudential regulation faced by banks. This sparked off a wave of either equity issuance, asset sales and/or price discount on new home projects to recoup cash in the Chinese real estate sector.

Unfortunately for Beijing Capital Land, it does not meet the debt to equity ratio and cash to short term debt ratio. Within this context, the parent company is privatizing Beijing Capital Land such that it would be in a better position to inject equity into the developer and meet the regulatory standard.

Despite the offer price of HKD 2.8 carrying a whopping 62% premium over the last trading price before announcement, the offer price implies a price to book ratio of 38%. So valuation also make sense for Beijing Capital Group

And the deal would require ~HKD 5.3bn of cash which Beijing Capital Group can easily finance out of its own balance sheet.

Live Portfolio Update – 2021 – #15 (Soho China)

Investment Action: Added 0.5% to Soho China @ HKD4.2 as the spread to offer price has widened to almost 20% since my first purchase a few weeks back.

There seems to be some delay in the deal due to the need to get approval from SAMR which is the Chinese regulator for market competition. Buying a few office buildings should not trigger any concerns but nonetheless, it is critical to get their seal of approval. Seems like a good opportunity to add.

Live Portfolio Update – 2021 – #13 (Soho China)

Bought a 3% position in Soho China at HKD 4.45. This is a simple merger arb and I see it as a better-than-cash investment opportunity.

Blackstone is making an all-cash offer for Soho China at HKD 5 per share which translates into an 11% upside from current share price of HKD 4.5.

Time to closure: I expect the deal to complete within 8 months which gives a pretty decent 15+% IRR. There is some risk that this deal could take longer

Probability of Success: 90%.

  • Blackstone is a reputable real estate PE firm and the founders of Soho China are very well-known figures within the Chinese business community. I think it is very unlikely for the deal to fall apart.
  • The price seems to be fair for both parties. Blackstone can see some upside from this transaction as there should be quite some room to improve rental income by improving occupancy rate and general recovery from COVID-19. And maybe there is a little upside from rerating from cap rate. The current cost of debt is ~5% and Blackstone could probably lower it once they gain control. Finally there should be some 2-3% of the like-for-like rental price growth annually
  • For Mr and Mrs Pan, this is a reasonable valuation for them to exit the business. Building office space seems to be a very structurally challenging business in China due to intense competition and the rise of shared working space. Soho China’s premium office space positioning has helped to insulate them from the most intense price competition.
  • Given that it seems like a fair deal, then both sides should be motivated to close this transaction.
  • I don’t see material regulatory issues as Soho China’s market share is low and office space is not a sensitive sector
  • There is a general risk of unanticipated events happening and I am not too intimate with the parties involved

While the probability of failure is low at 10%, the downside from the deal not going through is very high at over 50% using the pre-announcement share price of HKD 2-3.

All things considered, I am only committing 3% capital as I would not consider Soho China a favorable long-term investment in the case of deal failure.

Live Portfolio Update – 2021 – #12 (Kuaishou)

Bought a 3% position in Kuaishou at an average price of HKD 193 per share.

I believe that short video platform is a structurally good business with an excellent LTV / CAC ratio. Kuaishou is the second-largest short video platform in China behind Douyin (TikTok). Unlike long video platforms like Netflix, short video platforms have very little content cost due to a high degree of UGC and PUGC content. On the monetization side, short video platforms can make money by 1) ads, 2) live-streaming, and 3) eCommerce. In the future, I believe short video platforms can explore even more monetization opportunities through gaming and local services.

Short video platform’s favourable LTV / CAC ratio stems from 1) user behaviour, 2) product format and 3) AI-first product

Even though Kuaishou is behind Douyin in China, I believe Kuaishou’s China business is more like a community of KoL and users whereas Douyin treats KoL as commodity content suppliers. User experience on Kuaishou is more akin to going to a music festival where the music fans go there to see their favourite band whereas the Douyin user experience is similar to listening to a very smart radio programme that only plays music that you like.

I think both Kuaishou and Douyin would do well and continue to take time share in China.

That said, an investment in Kuaishou is very risky and many things can go wrong – competition, execution, new verticals didnt work out, international growth sizzle out. But the upside more than compensates for the downside at the current valuation.

I think Kuaishou could make a net profit of RMB 50-100bn in 2025 in base case and probably still have a respectable growth of 20+%. Hence the valuation feels reasonable to me.

I might write a full post on Kuaishou at some point in the future.

51Job Privatisation Deal Update

When I initiated the position in 51Jobs (see previous post here), I expect the deal would likely close within 3-6 months. And now 8 months have passed by and the deal is still work-in-progress. So much for my forecasting skill!

But I did get something right when I wrote that:

My guess is that mgmt team will join them in the privatisation deal at some point and hence they only have to buy 50% of the shares outstanding.

That finally happened on 4th May 2021. 51Job announced that the CEO, who owns 17.6% of the shares outstanding, would join the buyer consortium together with another PE fund – Ocean Link. Let just say that Ocean Link as a PE fund is not new to this privatization game.

https://ir.51job.com/ir/php/2021/PreRelease20210504.php?0504

Currently, there is still a 9% spread available based on the current share price. I think the risk-reward is extremely good from here since the management participation in the deal increased the probability of success significantly.

If I have to make a guess here, the buyer group needs to convince Recruit Holding to either join the buyer consortium or sell out. Once the buyer consortium can reach some kind of agreement with Recruit, then the deal is a done deal. See this Nikkei Asia article here.

While these privatization deals generate small profits in the bigger scheme of things, I enjoy the analytical process of guessing the probability of success.

Nintendo Investment Update – The End of the Beginning

Nintendo reported, in my view, excellent results for the Fiscal Year (FY) 2021 and it is a real pleasure to be a business owner (and customer) in this fantastic business.

My core investment thesis for Nintendo remains the same: Nintendo Switch is a sustainable gaming platform because it is anchored by Nintendo’s world-class games and supported by a mix of long life-cycle games and new games by both Nintendo and third-party game developers. Nintendo Switch is in a positive feedback loop now where its large install base is attracting more third-party game developers which in turn attract more Switch buyers. If my assumption that the Switch gaming platform would defy the previous console lifecycle of peaking in year 5 and ending in year 7, then I assess Nintendo’s intrinsic value with the following factors: 1) Switch install base, 2) software revenue per install base, and 3) gamer engagement with Switch platform. Continue reading

Live Portfolio Update – 2021 – #11 (Tandy Leather Factory)

Investment action: add ~1.3% to Tandy Leather and make it a 3% position. Bought at an average price of USD 4.2

I first purchased Tandy Leather Factory shares in Dec 2019 and it has been a bumpy ride since then. They are still mired in the accounting restatement crisis while being hit by COVID-19. This resulted in delisting and now still trading on the OTC market.

They finally announced a final bit of positive news on 21 Apr 2021. See link here

Tandy Leather announced that its sales for 1Q 2021 is USD 21.3m & have a net cash position of USD 10m. This is a very favorable quarterly revenue trend coming out from covid-19. Generally speaking, Tandy managed the COVID situation well and grew its eCommerce operation significantly.

Strong revenue recovery implies a few things:

  • Healthy demand for leathercraft
  • Strength of online channel and specialty retail category such as leathercraft is very well suited to eCommerce

What I don’t know is how much revenue is driven by retail vs wholesale activity

There is a scenario that Tandy use online as an efficient sales channel to expand the reach and only use stores for customer service. In this scenario, we could see higher organic growth even post-pandemic.

But the risks are still clearly there. 1) financial restatement still not done yet & 2) two CFO resignations within one year

However, given that Tandy was able to execute a USD 1m share buyback in Jan 2021 and still maintain a sizable cash balance. Plus they actually survived COVID. The risk of fraud is reduced.

Based on q1 numbers, it seems like Tandy could be doing 80-85m annual revenue in 2021. assuming 7.5% net margin (historical margin is 5-10%), then Tandy could be making 6-8m of net profit this year. The current market cap is USD 36m with 10m of net cash, the implied earning multiple is 6x. Hopefully, once restatement is done, we could see substantially higher share buyback activity

Live Portfolio Update – 2021 – #10 (Avanza)

Investment Action: Sold all Avanza shares @ SEK 304 which is roughly a 3% position now

Despite a set of very strong Q1 2021 results, I am going to sell Avanza shares and very unfortunately no longer be part of Avanza’s growth journey from here. I sold a large chunk of the Avanza investment in Oct 2020 at around SEK 185 and clearly my ability to time the market is terrible because Avanza shares trade around SEK 300.

The main reason for selling is the same as before: Avanza’s earning is cyclically high due to higher than usual trading activity from its customers (mostly retail customers). Continue reading

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