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.
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.
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.
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 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
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 favourable 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
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
Stitch Fix is a fashion retailer in the sense that they take inventory, do merchandising, buy at wholesale price and sell at retail price. But that is about where the similarity with a traditional retailer ends.
Stitch Fix’s business model involves users submitting detailed body measurement data and style preferences which is then used to feed into the Stitch Fix machine learning model. Stitch Fix will combine algorithm recommendation and the wisdom of a human stylist to pick out 5 pieces of clothing and sent them to users in a box which is called a Fix. Users don’t know what clothes they are going to get until they receive it. So there is a surprise and delight element. Users will pick what they like and return what they don’t like.Continue reading
Bought a 1% position in Everyman Media, a boutique UK cinema chain, with an average price of GBP1.5.
I have been trying to buy this stock for over 2 months now but the liquidity is terrible and the price has gone up too much. Would have been a bigger position (3-5%) if liquidity is better.
For a detailed investment thesis, please see here – https://pembridgecap.com/?p=11077
Everyman Media is a boutique cinema operator in the UK which has been heavily impacted by COVID-19. I am buying into Everyman because I think cinema is going to be around for a long time especially the kind of cinema that also happens to be a restaurant. Continue reading
CD Projekt released a strategy update on its website on 30th Mar 2021.
In this strategy update, CD Projekt confirmed that its flywheel strategy to build game franchises – anchored in rich single-player AAA games and then create incremental game content and expansion into broader entertainment format. Continue reading
Just taking advantage of the share price volatility. Higher spread to offer price of USD 9 per share. 10% return for a very high certainty event that is likely to close in 3-4 months.
Added to existing Nintendo position @ JPY 58800 per share by ~1% position weight.
For the past 12 months, Nintendo is doing a great job in terms of updating Animal Crossing with new content and events. It shows that Nintendo is starting to get game as a service concept as an organisation.
In that backdrop, I added as the valuation looks attractive.
Tencent is a company that defies categorisation. It is so many things all at once – gaming, social network, fintech, media and cloud. At almost USD 700bn market capitalisation, it is the biggest company in China and one of the biggest companies globally. But I think it still has a very long growth runway ahead and likely to offer an excellent risk-adjusted return.
On a high level, my favourable outlook for Tencent is anchored on four parts:
1) WeChat is the equivalent of a modern-day digital utility in the sense that it is almost irreplaceable because it is both a utility app and a social networking app. The combination of utility-driven high switching cost and network effect creates an almost impregnable moat for the foreseeable future. It is currently under-monetised relative to the value created for its users. More importantly, WeChat continues to create new value for its users by expanding use cases on WeChat. For the next 5 years, WeChat’s advertising revenue growth rate will accelerate as its eCommerce ecosystems mature.
2) Tencent’s vertically created gaming business enjoys a very long growth runway as the video game is on a multi-decade march of gaining share of the entertainment budget.
3) Tencent’s corporate DNA, user-centric and bottom-up culture, is robust enough to deal with ever-changing technology changes and shifting consumer tastes.
4) Tencent has laid the seeds of future growth in Cloud, Fintech and enterprise software
For this blog, I just want to focus on the WeChat part of my investment thesis and I will write about other parts of the Tencent investment thesis separately.
WeChat
With 1bn of users, WeChat has transcended its inception as a messaging app and become a modern-day utility in digital life. People use WeChat to message, socialise, pay, read blogs, buy grocery and play games. In very practical terms, one cannot live life in China without WeChat just like one cannot live life without electricity in the modern era. No other social network, even Facebook, comes close to being as much a utility in people’s daily lives as WeChat does.
This means that WeChat’s risk of disruption by another social network is actually even lower than the like of Facebook and Instagram. In fact, WeChat will become more relevant to people’s lives by providing even more valuable services such as discovering restaurants, local services and financial services (payments, wealth management, personal loans).
Given WeChat’s importance in Chinese people’s lives, it is incredibly under-monetised. Tencent’s ~ RMB 80bn of advertising revenue is actually smaller than Bytedance’s advertising revenue. I think I am safe grounds if I say that advertising dollars follow user time spend. Below is a chart that maps ad spend to time spend. This data is from 3Q 2019 but it is still valid.
Tencent under index on its share of total ad revenue in China
Interestingly, Alibaba has the largest share of the advertising dollar with ~1/3 of the total China online ad spend. Bytedance’s ad revenue also saw a meteoric rise. Both Ali and Bytedance have the most mature and sophisticated monetisation infrastructure. Bytedance’s well-tuned algorithm can deliver unparalleled precision while Ali has the most comprehensive eCommerce marketplace.
Tencent is lacking behind in ad revenue because:
the creator of WeChat, Allen Zhang, is resistant to introducing commercial activities on WeChat in fear of dealing permanent damage to the ecosystem
for a very long time, Tencent lacks a coherent advertisement infrastructure (but that has been largely fixed now)
there was no proper medium to carry ads on WeChat
for a long time, games is in itself a strong enough growth driver
But all of the above are changing. And I believe that Tencent’s ad revenue will reaccelerate in the next 5 years and could reach RMB 200-300bn in the next 5 years.
On a high level, I believe the growth of WeChat’s e-commerce ecosystem will drive Tencent’s ad revenue. But why is Tencent able to crack eCommerce this time around? Tencent made a go at eCommerce in 2014 which did not go well. They end up selling their eCommerce business to JD.com. So what has changed?
Since 2014, China’s eCommerce infrastructure has grown significantly where the payment and logistics are becoming APIs that anyone can plug-in and start an online business. A vast ecosystem of service providers such as Youzan and Baozun has surfaced to provide software and operational competences to run an online eCommerce business. Most importantly, Chinese merchants have accepted eCommerce as the default way to do business and the majority have decent know-how when it comes to running an eCommerce business.
So it is in this context that Tencent decides to have another go at eCommerce and this time through WeChat and more specifically WeChat mini program (MP).
Merchants will be able to set up shop using WeChat MP to market and sell their products. WeChat MP has a built-in payment API (WeChat pay), a logistics API link and other useful modules such as live streaming and eCommerce software. This means that WeChat is a closed-loop transaction platform just like Taobao!
And this is VERY important. For a very long time, merchants have advertised on Tencent properties but the transaction is typically completed either on Ali or JD or PDD. As merchants now have the option of directing transaction to WeChat MP, merchants will be able to acquire customers, complete transaction and provide aftersales service within WeChat. This ability to close the transaction within Tencent’s walled garden has two huge implications for its advertising business.
1) Tencent can finally provide a true performance advertising product which means merchants can measure their RoI with incredible precision. We have seen many times that the ability to demonstrate a clear marketing RoI is an excellent way to persuade merchants to shift their advertising budget. Facebook is a good example here.
2) Tencent will be able to collect better data and, with its improved advertising infrastructure, it can finally be able to match its peers in terms of precision and accuracy. Here there is a very fine line to draw between protecting user privacy and advertising efficiency. I trust that Tencent will approach this balance with an abundance of prudence. I think it would be naïve to believe that there is no loss of user privacy but I think it will be moderate.
One of the biggest challenge in terms of growing ad revenue on WeChat has been this: how to show users more ads while not completely destroying their user experience. Just imagine how annoying it would be if you keep seeing ads while messaging your friends. So WeChat has to create a completely independent public domain for commercial activities while keeping the core messaging user experience simple and pleasant within the private domain.
The introduction of WeChat MP and WeChat Video Account solves this problem quite well. But the deliberate separation created by WeChat MP means that discoverability is a big issue for merchants. How can merchants reach users on WeChat if they are only given a very limited opportunity to market themselves? WeChat has come up with two partial solutions. 1) they are trying to make the search within WeChat much more powerful. At the moment WeChat search capability is very limited as it cannot search for content within MPs very well. 2) the creation of a short video product within WeChat, known as WeChat Video Account, where users can watch short videos in a feed style. I suspect this would be an important portal for merchants to acquire users in the future.
In the long term, there is a question about how much activity can WeChat carry within a single app without breaking the user experience? Is WeChat trying to do too much? I think at some point in the future, it will be a big problem for WeChat. But at this point, I think the early evidence suggests that WeChat can support a vibrant commercial community on its app.
Tencent reported that WeChat generated RMB 1.6trn of GMV in 2020 with over 100% YoY growth. It also reported a 400m DAU for WeChat MP. WeChat has 1bn users and let’s assume 50% of them end up buying things on WeChat and assume an ARPU of RMB 10k which is in line with major eCommerce platforms in China. It is not inconceivable that WeChat can do RMB 5trn of GMV by 2025. If we assume a 5% take rate on RMB 5trn GMV, it translates into RMB 250bn of revenue for Tencent which is incremental to its current base of RMB 80bn revenue.
Bought Sogou shares @ USD 8.25 per ADR. 6% position.
This is a merger arb with 8% spread over 5 months. While I focus on finding long term investments in high-quality businesses, I just cannot resist myself when short-term investment opportunity with good risk-reward arise.
Tencent is privatising Sogou with an offer price of USD 9 per ADR. This deal has reached a definitive merger agreement in Sep 2020 and hence the spread completely disappeared.
In Dec 2020, Sogou announced that they amended the merger termination date from 29/03/2021 to 29/07/2021 due to the need for antiregulatory filing and subsequent clearance from Chinese regulators.
“In late November 2020, THL and Parent made an antitrust filing with relevant PRC regulatory authorities in connection with the Sohu Share Purchase and the Merger. Considering the time needed for the clearance of such filing, the parties decided to extend the termination date under the Sohu Share Purchase Agreement and the Merger Agreement. On December 1, 2020, (i) Sohu.com, Sohu Search, and Parent executed an Amendment No. 1 to Share Purchase Agreement, to extend the termination date under the Sohu Share Purchase Agreement from March 29, 2021 to July 31, 2021, and (ii) the Company, THL, Parent and TML executed an Amendment No. 1 to Agreement and Plan of Merger, to extend the termination date under the Merger Agreement from March 29, 2021 to July 31, 2021.”
I am confident that Sogou deal will get approved by Chinese regulators because:
1. Tencent is not dominant in search
2. Sogou is very important to WeChat commerce ecosystem that Tencent will go out of its way to make Sogou deal happen
I expect them to get approval before 29/07/2021 and hence the expected time to completion of 5 months.
