Sunday, February 16, 2014

Nam Tai: A net-net with multi-bagger upside

Nam Tai Electronic (NTE) is a contract electronics manufacturer with factories located in China. It has a market cap of $270m and no debt. It's been in business for 40 years and listed on NYSE since 2003. It business has changed and gone through many phases. Currently it assembles LCD modules (LCM), with Apple as the primary customer. It has always been profitable and has never lost a single dime in the last 10 years. However, it has warned investors in the recent years competition is intense and its contracts could end abruptly. On Jan 27, it confirmed it would receive no more orders and all production would be terminated for good in April. It also confirmed it would exit its existing lines of business completely.

Investment thesis

NTE is a net-net with a hidden asset worth multiple of its existing market cap. Its management is competent and aligns with shareholders. Catalyst is already in place. The management has committed to realise its value.

Downside

At the time of writing, NTE is trading at around $6. Current assets less all liabilities is $300m ($6.65 per share) and book value is $360m ($8.10 per share). In other words, NTE is trading at 10% below NCAV and 25% below BV. And most of the current assets is cash.

The number one risk investing in any company with any China connection is fraud. In the case of NTE, this risk is virtually zero. Every evidence indicates it's a legitimate business run by a legitimate businessman: Its primary customer is Apple. It sells real electronic components and receives real cash. In the last 5 years, it distributed $58m dividends in total with an average payout ratio of 70%. There was no capital raising nor debt.

Or we can look at it from the history perspective. Nam Tai was founded by Hong Kong entrepreneur Koo Ming-kown (as in Chinese tradition, the surname goes first; so, "Koo" is the surname). He is currently NTE's Chairman and CFO and holds 11.7% of NTE. Another director Peter R Kellogg holds 14.4%.

NTE's history shows Koo is an opportunist and capital allocator. NTE's business has gone through 3 major transformations in the last 4 decades. NTE started as a distributor of Japan-made calculators. At its peak, about half of the calculators used in Hong Kong were imported by NTE. In 1979, taking advantage of China's economic reform, Koo expanded the business into China and started manufacturing his own brand of calculators in China. Later, around 1985, economic environment became harsh and NTE's business went downhill. With its existing relationship with Japanese manufacturers, Koo seized the opportunity to transform the business again to export electronic components and raw materials from China back to Japan.

Upside

One of NTE's factories locates in Bao'an, Shenzhen, China. NTE now intends to redevelop this land into a commercial complex and become a property developer and manager.

A quick discussion of the economic backdrop of this region is warranted here.

In 2010, Chinese central government extended the Shenzhen Special Economic Zone (SEZ) to include Bao'an and Longgang. Besides, Qianhai, the bay area in Nanshan, is earmarked to be turned into an international financial services centre. It is China's ambition to have its currency RMB playing a more significant role in global finance. 

Expansion of Shenzhen SEZ (Source: China Daily News)

NTE's factory is 7km from Bao'an CBD, 12km from Qianhai CBD and 10km from Shenzhen's international airport. Local government has recently been rezoned the region from industrial use to commercial use.

"A" is NTE's site. Left box is Shenzhen's international airport. Middle box is Bao'an CBD. Right box is Qianhai district.
(Source: NTE new releases, Google Map)

In China, like Singapore and Hong Kong, lands are not bought. Instead, land use rights are leased. The total historical cost of land use rights is stated at $10m on NTE's balance sheet. Bao'an site makes up probably less than half of that. i.e. it makes up less than 1.5% of the its book value. In other words, it's not material.

NTE's site has a land area of of 52,600 sqm. It can accommodate a business complex with a plot ratio of ~6. That means, after redevelopment, it will have a 300,000 sqm gross floor area (GFA). How much is this land parcel worth now after the rezoning?

NTE's Bao'an site (Source: NTE new releases, Google Map)

We can look at comparable land sales (or more correctly, auctions of land use rights). Two parcels of land in Qianhai with plot ratio 6.5 & 7.8 (T201-0077 & T201-0075) were auctioned in July 2013 and sold for ~$2,700 per sqm (GFA). Sale prices were ~50% higher than the opening prices. But that's Qianhai, the red hot region in recent months. How about Bao'an? Two parcels of land in Bao'an CBD with plot ratio 6.0 and 8.1 (A004-0154, A002-0046) are currently listed with opening prices at around $2,100 per sqm. Two years ago, a parcel of land a couple of kms outside CBD (A002-0042) was sold for $1,600 per sqm in Jun 2012.

So, if NTE's land can command $1,000 per sqm, it will be worth $300m. If it can command $2,000 per sqm, we arrive at a more aggressive value of $600m. Adding this back to the book value, we are looking at a value of $14 to $21 per share.

Alternatively, we can look at cash flow. NTE has commenced 3 feasibility studies for the project from 3 different consulting firms. The recommendations centre arround building a mix-use complex consisting of a hotel, offices, R&D offices, retail space and residential apartments, and some combinations of these. With assumed rental charges in the range of $0.8 to $3.0 per sqm per month (if you consider the current rental market in the area, these rental rates are very reasonable), the expected net rental cash flow will be in the vicinity of $50m per annual. If you apply a very conservative 10% capitalisation rate, the complex will be worth $500m (in 3-4 years). Apply a more aggressive cap rate of 7%, you will get $700m. i.e. We are looking at $11 to $16 per share. Here, we haven't added back the book value because the development will consume cash. However, it is almost a certainty NTE will mortgage the land to fund the development. There will be un-utilised asset value not accounted for here.

Why is it cheap?

The main give-away is the 11% drop on Jan 27th when NTE announced it would cease all manufacturing and committed itself to develop its lands. Its existing shareholder base sees it as a electronic manufacturer with good dividends, not a property developer that won't be able to distribute in the next few years and needs to lever up the balance sheet.

Second, value investors who screen for cigarbutts will shun the stock with its China connection.

Third, its small $270m market cap is pretty much not on most fund managers' radar.

Risks

Koo is 70 this year. NTE is his company. Without him, the direction of the company is completely unknown.

Second, my contact in China who is familiar with its business environment and property laws told me there is a real chance the local government will not approve NTE's redevelopment plan. Typically, the local government will have a lot of financial incentive to take back the lands and then auction them off. It will pocket the hefty profits while the original property owners will only be compensated for what the lands were original designated for. e.g. Another industrial land in a nearby region. Besides, the local government favours established larger developers and give them significant advantage.

However, the feasibility studies indicate the local government is "supportive" of NTE's project. One possible explanation is NTE's project fits well in the government's overall agenda. They want to fast track the redevelopment of the entire industrial region. There are rivalries between different SEZs. They are willing to give up a very small value in the overall scheme of things in order to get a pioneer to create a showcase. In addition, Koo's 3 decades of business relationship will the local government should also count. Undoubtedly, we have to trust Koo's experience and judgment here.

But even if the project is rejected by the government, what do we lose? We are still holding onto $1 worth of asset value that we have paid only 75 cents for it.

Third, if the redevelopment goes ahead, we won't see any cash flow for 3-4 years and NTE will lever up its balance sheet. Besides, China's grand policy plan for the Qianhai and Bao'an will take years to materialise. So, you need a 5+ years time horizon to invest in NTE.

Fourth, I've said for years China will slow down in the coming decades. We now start to see this effect on Australia's mining sector and its currency. In addition, China's huge debts in its shadow banking system is destabilising its economy. The chance of a catastrophic collapse of its economy or property market is remote but possible. This can derail the planned economic development of the region for 5 to 10 years. Or more.


Closing thoughts

One way to look at this investment is, it is buying a property development project at a discount. Another way to look at it is, the property development project has tremendous option value. We are effectively getting paid to hold this option.

How often do we see management of companies operating in deteriorated business environments hanging onto their status quo, knowingly to lose money years in years out, hoping to "turn around" the businesses? When the market sees NTE's exit from its existing business a negative, we should see it a strong positive. Koo refuses to continue to operate a business that will no longer earn its cost of capital. It is Koo's brilliance to turn hindrance into opportunity. We have seen it happened before multiple times in NTE's history. Buying NTE is to bet that he will do it again. But strangely, this bet costs us nothing.

Resources

*I didn't discover NTE myself. The credit goes to Batbeer2 who published an investment case on Gurufocus in July 2013. I also owe Batbeer2 a thank you for flushing out some of the details.

(Disclosure: Long NTE & AAPL)

18 comments:

  1. Hi John,

    Thanks for a nice writeup. I have NTE on my research-list but haven't looked into it yet. Looks interesting. Noticed that the Kahn Brothers recently sold of a decent chunk of their holdings, what is your view on this?

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    Replies
    1. Yes, I'm aware of their transaction. I can only speculate.

      They bought their stake in Feb 2013. I guess their thesis was "a well-run manufacturer with good upside of more LCM contracts and asset backing." But their thesis is now broken.

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    2. Hi Jonas,

      Btw, what are your high conviction ideas in Europe?

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  2. Fair enough. I don't have that many high conviction ideas in Europe at the moment for the right price. Rella Holding would probably be the one although it is up a bit since I bought it. A good analysis on seeking alpha. http://seekingalpha.com/article/1995471-rella-holding-double-share-buybacks-are-creating-shareholder-value

    Otherwise I have been buying mostly American net-nets the past 6 months. I think PRLS is a really interesting story. Probably not a huge upside, but a lot bigger than the downside.

    Thanks for a great blog! I've been subscribing it for a while but not looked into it too much, that will change now :)

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    Replies
    1. Thanks. I'll take a look at PRLS.

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    2. A link to my own writeup on PRLS. It is in Swedish unfortunately. But through google translate you probably can get a quick glimps into the stock and get a feeling for the case. http://vardebyran.wordpress.com/2014/01/17/analys-av-peerless-systems/

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  3. Btw, when we are on the subject on chinese net-nets. Do you have a view on DSWL? Looks interesting, in many ways some similarities w/ nam tai. Also probably not a scam like many of the other chinese net-nets. Long history of dividends, no debt at all, insiders are decent owners, public since 1995. DSWL also have a negative enterprise value.

    ReplyDelete
    Replies
    1. Interesting. I noticed I took a brief look at it in 2011 but passed. My own note said "bleeding money; no moat".

      But now look at it again, its FCF is actually positive, 5yrs averaged at ~$6m. Not sure what I was thinking 2 years ago...

      It's really dirt cheap. The market values it at net cash. The business is essentially free.

      Need to spend some time to think about the upside. Thanks for bringing this up.

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    2. No wonder it sounds so familiar. Michael Burry invested in DSWL in 90s.

      Looks like business will continue to deteriorate and the endgame is either a liquidation or a reallocation of capital into something else.

      Wondering if there is any hidden value in the properties. Need more investigation.

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    3. Was a writeup on SA, think the author was quite positive to the real estate leases, think they were good until 2050. Yeah read that about Burry as well, fun to potentially invest in the same company a living legend once was in. At least says that he had no worry for fraud 20 years ago. But of course no guarantee, a lot can happen in a way shorter time.

      If you want to continue discussing net-nets or DSWL feel free to send me an e-mail at vardebyran-a-gmail.com.




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  4. The multibagger stocks can be a great idea to make money. There are a number of multibagger stocks that have gained high popularity in making money.

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  5. (India) We have gone through a few Indian companies which began foraying into developing land, primarily because of how rapidly land prices moved north and there was more value in the land than in the operating business. Raymond and Godrej properties come to mind.
    The hurdle they tend to face is legalities and bureaucracies; development takes a long time and the 'value' takes too long a time to realize. Furthermore, owners -large shareholders- of businesses, upon seeing the value in their land parcels tend to become greedy.
    Luckily, China is more adept at making things happen for the sake of progress, but we also have a potential credit bubble in that country.
    All the best.

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    Replies
    1. with a dividend of 2%, waiting is not so awful, especially if the upside is for the investment to triple over 4 years. Given that the stock is selling at a P/B of 0.5 WITHOUT the land assets, I think this is a no brainer investment.

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  6. Hi Tirath,

    Thanks for comment. Those are all very real risks.

    Btw, I always wanted to take a look in India. Is the market less crowded than, say, United States? Any suggestion where to get started?

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  7. it looks up 15% in after hours at $7.30 with 29k volume, very odd...is something brewing?

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    Replies
    1. No idea. I never pay attention to technicals.

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    2. Maybe this?

      http://finance.sina.com.cn/stock/hkstock/hkstocknews/20140405/115018720945.shtml

      Hong Kong Stock Exchange may set up a branch at Qianhai.

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  8. Any updates. The thesis appear unchanged. No meaningful news since the first report. Yet the stock price continues to go down - most recently to $3.85 per share. Time to get greedy?

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