Value Investors Club / Hyundai Home Shopping Network Corp. (057050-KRX)

Description

HHSN is a growing, profitable, asset-light business which is being offered to investors for almost free, net of the cash an investments on the company's balance sheet.

Investment Thesis:

Asset-Light, Cash flow-Generating Business Model: Hyundai Home Shopping Network Corporation is a leading Korean home shopping company that operates an asset-light business model that generatessubstantial cash annually. The company takes limited inventory risk, primarily generating revenue via sales commissions. The company has limited capital expenditure needs and has generated positive free cash flow every year back to 2007.

Conservative, Profit-Focused Management: Hyundai Home Shopping Network Corporation is part of the Hyundai Department Store group. This group has traditionally focused on profitability over sales growth. As a result, Hyundai Home Shopping Network has historically enjoyed above industry average margins on the back of a lean cost structure. The company has also been conservative in their acquisition strategy. This fact is important given the company’s large cash balance.

Bargain Basement Valuation: Hyundai Home Shopping Network Corporation is currently attractively priced against its own history and on an absolute basis. Excluding the estimated fair value of cash and investments, the company is currently trading at 0.2x adjusted-EV/Sales and 1.7x adjusted-EV/EBITDA and has an estimated 16.2% free cashflow yield (ex. cash). I estimate an intrinsic value of KRW 173,250 (current upside of 40.3%).

Cash & Investments Represent 86.0% of Market Capitalization Protecting Downside: The estimated fair value of cash and investments of Hyundai Home Shopping Network represent a whopping 86.0% of current market capitalization. Even if the market assigns zero value to the underlying business, shares of Hyundai Home Shopping Network have limited downside.

Business Summary

HHSN markets and sells products to customers via television, their internet website (HyundaiHmall.com), their mobile app (Hmall), and a printed catalog. The company receives commissions for their sales such that the majority of revenue recognized is essentially “cost free” (aside from SG&A expenses). The company does have a number of private brands for which the company assumes inventory risks and sales of these goods have corresponding COGS expenses. However, these expenses pale in comparison to commissions received and, for this reason, the gross margins for the company are 90%+.

However, HHSN and the industry tracks their margins as a percent of “gross revenues”. Gross revenues represent total product sales for the company. Therefore, while gross revenues are not true “revenues” earned by HHSN, they are used as a guide to track product sales growth, product mix, and operating margins. The resulting “net revenues” are the commissions earned and are the true revenues for the company. The company’s revenues by segment are shown below:

The TV segment is, by far, the largest for the company and is also the most profitable. The television segment includes the sale of products on cable television (CATV), internet television (IPTV), and satellite television. The company earns average commissions on television product sales of 35.0-40.0%. The major costs for the company within this segment are the system operator (SO) commissions (commissions paid to the cable operators for use of a channel) and advertising and promotion costs. The margin for the television segment has declined the last several years as marketing expenses and SO commissions have grown faster than merchandise sales and product mix shifts have been margin dilutive. Historic profitability for this segment is shown above.

Industry Summary

Industry Background

Hyundai Home Shopping Network is one ofseven home shopping companies in Korea. A breakdown of market share by segment for the industry is shown below (seventh competitor not shown as they launched service in 2015):

Hyundai Home Shopping, CJ O Shopping, and GS Home Shopping are the industry leaders and have similar product portfolios. Lotte Home Shopping has drawn close to the big three but lacks in brand appeal and product range. Nongsusan Home Shopping and Home & Shopping are more recent entrants that focus on selling small business products and do not compete directly with their larger peers.

Another key player with a hand in the future health of the Korean home shopping industry is the Korean government. The government ultimately controls the number of participants in the industry through the licensing process. The government has been focused most recently on promoting small businesses through new licenses and I would expect any further entrants to be similarly focused and have minimal impact on the industry leaders.

Part of the reason that the publicly-traded Korean home shopping companies (outside of NSHS which focuses on the growing food segment) are trading at depressed multiples is uncertainty surrounding future revenue growth and profitability. A number of factors have contributed to these worries:

Korean domestic consumption has recently been tepid.
As the home shopping television industry matures, topline growth could be outpaced by SO commissions and promotional expenses which would continue to eat away at industry profitability.
Cable television subscriptions rates have potentially peaked with viewership giving way to the faster growing IPTV segment. IPTV viewers are thought to surf channels much less than traditional television viewers and are thus less likely stumble upon a home shopping channel.
Barriers to entry into the fast-growing mobile segment are low and competition from Korean and foreign websites is high. As a result, uncertainty about future mobile segment profitability is high.
Korean home shopping companies have yet to prove that foreign home shopping investments can be a meaningful earnings driver (outside of CJOS in China).

Why Now?

Despite the above issues, there is reason for optimism for the Hyundai Home Shopping. These include:

1) Expectations for the industry are currently very depressed. The operating margins for the industry have been declining over the previous five years and many investors have written them off as

dying businesses.

2) Several home shopping companies have been able to negotiate SO commissions downwards for the first time which should set them up to achieve increased profitability in 2016.

3) There were a number of one-off events that occurred in 2015 (MERs and product recalls) setting a low bar for Q-o-Q comparisons.

4) The company’s investment in its rental product subsidiary should continue to gain scale with the goal of reaching breakeven within the next several years.

5) As the growth in Mobile sales slow, there are plans to reduce marketing expenses in this segment and margins may expand as a result. With 70.0% of products sold through the mobile app being

company exclusives, it is feasible that this profitability could be sustainable.

Valuation Summary

I selected a group of publicly-traded peer companies consisting of: 1) other Korean home shopping companies, 2) other Korean retail companies, and 3) other international home shopping companies. This group should represent a reasonable collection of similar industry and geographic peers. Interestingly, HHSN’s historical operating margins, return metrics, and growth figures compare favorably to this peer group. I then calculated an adjusted enterprise value over time for each company by removing the balance sheet value of cash and investments. I then calculated the average adjusted-EV/Sales and adjusted-EV/EBITDA over the past ten years for each company. The results of this analysis are shown below:

Based on this analysis, I selected the average adjusted-EV/Sales and adjusted-EV/EBITDA multiples and applied them to HHSN’s core earnings (which excludes income from investments). A 1.0x EV/Sales multiple and a 6.9x adjusted-EV/EBITDA multiple do not appear unreasonable for this type of asset-light, cash flow-generating business. This valuation still appears conservative as compared to global home shopping peers (historically in the 8.0x-10.0x adjusted-EV/EBITDA range) and is in-line with the historical multiples of the overall Korean retail sector and the 6.5x adjusted-EV/EBITDA multiple that newly-public NSHS currently trades at. Taking the average of these approaches yields an estimated intrinsic value of KRW 173,250 (current upside of 40.3%).

Investment Risks

1) Macroeconomic risks

2) Regulatory risks

3) Competition

4) Secular decline in CATV subscription

5) Product risks

6) North Korea

7) Capital allocation disaster

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Value will out.

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			2016	2017
Price:	123,500.00	EPS	11038.4	12138
Shares Out. (in M):	12	P/E	11.2	10.2
Market Cap (in $M):	1,482K	P/FCF	13.8	12.6
Net Debt (in $M):	-758,200	EBIT	126,200	139,300
TEV (in $M):	723,800	TEV/EBIT	5.7	5.2