Description
HK Chinese (655 HK) is an investment holding company whose main assets are investment and development properties in Singapore. The investment thesis is simple. HK Chinese has an effective 58.2% stake in OUE, a listed Singapore developer (ticker OUE SP). Just based on current share price of OUE, this stake is already worth HK4 per share, significantly above HK Chinese's share price of HK1.33. Assuming a 15% share placement discount for OUE's shares gets to HK3.2 per share. Adding conservative valuation of its other assets and subtracting net debt gets to NAV of HK4 per share. Applying a 30% holding company discount to this gets to fair value of HK 2.80 per share (110% upside).
Valuation
Detailed calculation is in attached spread sheet.
Why is the stock cheap?
We believe the stock is cheap because the Company is relatively unknown to the market due to no analyst coverage, low liquidity and a complicated holding company structure. HK Chinese owns its stake via a 100% owned subsidiary Lippo ASM Asia Property LP ("LAAP"), a property fund which through two other entities (Golden Concord and OUE Realty), owns an effective 58.2% of listed company OUE SP. (diagram below). There is no published info on LAAP, and HK Chinese accounts for its stake in OUE SP as associate income so HK Chinese's balance sheet does not reflect the capital structure of LAAP, and actual net debt at the LAAP level is unknown. We believe that for investors that have even heard of HK Chinese, the non-transparency at the intermediary level would have deterred them from investing, suspecting that LAAP must have a lot of debt. Hence, this presents an opportunity to invest in a significantly discounted stock for those that can unravel the true capital structure at the LAAP level. My checks so far (without trying to move the share price) have shown that most investors are not aware of the true assets within HK Chinese and how they are held.
Our Approach
An estimate of the total debt at LAAP can be made through piecing together filings undertaken by OUE SP from May 2006 to Oct 2010 of shareholder changes. Management of HK Chinese won't divulge the amount of debt at LAAP, but they admit that purchases of shares of OUE SP were financed by a combination of debt and equity, and proceeds from subsequent share placements of OUE shares were used to repay debt at the LAAP level. Typically, margin financing of 50% for a large block of shares is already considered aggressive, but for our debt estimate (to account for worst case), we conservatively estimate that LAAP was able to convince the banks to give them even higher leverage of 60-75% (given shareholder Lippo's relationship with banks).
The attached spreadsheet titled "LAAP NAV" shows the calculation to arrive at our estimate of LAAP's current debt level and NAV. Based on current market value of OUE shares, LAAP's is now worth SGD 1.7bn and our estimate of its total debt is SGD 620mil, i.e. a 37% debt to Market value of its OUE shares. Our estimate is not too far off and more conservative than something I learnt from a subsequent conversation with someone familiar with LAAP. The source remarked that "based on current shareprice of OUE, the debt/MV ratio at LAAP is comfortably below 30% (vs. our estimate of 37%), and even if the shareprice of OUE were to fall back to levels at the start of the year (down 80%), they would not be breaking any bank covenants"
Catalyst for stock re-rating
We believe that the catalyst for a re-rating of HK Chinese's stock would come when OUE and hence Hong Kong Chinese "marks-to-market" the value of its investment properties at its next annual report. One of its key assets Mandarin Orchard is still accounted for at cost and has potential for S$800mil+ of revaluation surplus given significant improvements in outlook for the hotels and retail sector in Singapore and strong results from the recently renovated luxury retail mall at Mandarin Orchard to come through. We suspect Management has not booked these revaluation gains yet due to management disagreement between the original two primary shareholders (Lippo and Ananda Krishnan) of OUE. The disagreement subsequently led to Lippo buying out Krishnan's stake in March 2010 (hence Lippo had an incentive to keep OUE's shareprice low prior to buying out its partner's stake). Now that the stake purchase has been completed, we suspect OUE will start booking more revaluation gains (coming primarily from the Mandarin Orchard asset). Conversations with Management of Hong Kong Chinese also suggests that there's more revaluation gains to come.
Catalyst
We believe that the catalyst for a re-rating of HK Chinese's stock would come when OUE and hence Hong Kong Chinese "marks-to-market" the value of its investment properties at its next annual report 3/30/2011. One of its key assets Mandarin Orchard is still accounted for at cost and has potential for S$800mil+ of revaluation surplus given significant improvements in outlook for the hotels and retail sector in Singapore and strong results from the recently renovated luxury retail mall at Mandarin Orchard to come through. We suspect Management has not booked these revaluation gains yet due to management disagreement between the original two primary shareholders (Lippo and Ananda Krishnan) of OUE. The disagreement subsequently led to Lippo buying out Krishnan's stake in March 2010 (hence Lippo had an incentive to keep OUE's shareprice low prior to buying out its partner's stake). Now that the stake purchase has been completed, we suspect OUE will start booking more revaluation gains (coming primarily from the Mandarin Orchard asset). Conversations with Management of Hong Kong Chinese also suggests that there's more revaluation gains to come.