Tuesday, February 27, 2007

Something Else

South Africa isn't like Africa at all!

And I won't fault anyone for mistaking Cape Town for any U.S. or European coastal city. The scenery is breathtaking and the weather is excellent. Cities are highly developed and highways and airways are equally impressive. Dining, and especially wines, are surprisingly affordable. Meat is generally excellently done whilst seafood is only average and lacks variety, a surprise given the long coastline of South Africa. Caucasian girls there are real beauties too probably due to their European origin. If not for the high crime rate (I saw electric fences in some homes!) South Africa could really make an excellent vacation home for many.

Maybe I haven't joined a group tour for a long time, I found out at favorite tourist spots and restaurants that I was no longer surrounded by other HK groups but Chinese ones. Many merchants also spoke simple mandarin to us obviously not knowing the difference. Small chats with the Chinese revealed that the tour had cost them $18,000 each, which wasn't cheap even in HK standard, but many travelled with their parents or kids. And on my return flight I was further bemused by those Chinese ladies at the back of the plane who were buying so enthusiastically from the duty-free shop catalogue! The serving flight attendant ended up bringing a large bag of merchandise for them to pick from! My further grown respect for our country men!

Saturday, February 17, 2007

Something Else

This year is the 1st 'payback' year for me, after having received red packets for so long. I sure miss the days when I was part of the special task force in 'storming' every office and cubicle in the company! But giving out those packets this year really does give me a different kind of pleasure. And family reunion is another thing which one can only grow to appreciate.

I'll be away to South Africa for 10 days and so there'll probably be no new post until March. Have a happy holiday and hope everyone is charged up for next year's challenges!

Friday, February 16, 2007

HK & China Gas (3): Take a Wild Guess?

Like PCCW, HK & China Gas, finally beginning to live up to its name serving China now, has a valuation that seems mind boggling, yet there has been a share repurchase programme, two privatization attempts (on Henderson Investment) and direct purchases by Mr. Lee, who's not known for buying high.

The business model of HKCG is about the simplest among all HK stocks, that of building pipelines and selling gas and equipment. It's a natural monopoly and there's no profit arrangement like the power companies, although it too faces political and public expectation to keep fees reasonable. As HK has become a mature city with limited population growth, it has diversified into property development and China, where major cities are moving toward using natural gas after PetroChina's west-to-east gas pipeline has commissioned operation.

HKCG has a market capitalization of about $97b, or $100b for simplicity. On average it made some $3b from selling gas in HK, fairly consistent. Future profits may become slightly higher after natural gas is increasingly used to replace coal (naphtha) in production of gas. Historical p/e before 2003 was between 15-18x (I chose pre-2003 as afterward property profit became part of recurring profit) and I'd arbitrarily give a 16x which is slightly higher than what I assigned to PCCW. This works out to be $48b or roughly half of HKCG's capitalization.

The question then becomes should the HK properties and China business worth as much as, or even more than, the HK gas business?

On the face of it the valuation is stretched as the HK operation has 140 years of history where HKCG only started investing in China since 2000. Segmental information in 2005 annual report showed China business took up a quarter of assets and contributed 3% of earnings before tax (increased to 7% in 2006 interim). Either way one looks at it it doesn't suggest a 50/50 split in valuation.

On the other hand the China market is huge as any China city, even 2nd-tier ones, can provide as big a market as HK. HKCG has laid pipelines in 34 cities, mostly in the Eastern region and Shandong, the receiving end of the giant gas pipeline. Once the supply issue is taken care of (it seems steady supply of gas is a problem now as demand is greater than anticipated) businesses should thrive, maybe exponentially.

However the China gas market is primitive both in terms of development and regulations. It's an open market and most cities would welcome anyone with the capital and skills to assume the responsibilities for laying and running the pipelines, in return for a share in the profit. So far a national operator with sufficient scale has yet to emerge but looking at the competitors so far, HKCG should have a higher chance mostly due to its reputation and financial capability.

Imagination can go very far, sometimes dangerously too far, so I try an educated guess as to how far we are now.

According to the 2005 annual report the China business had a NAV of $6.8b. Since earnings have yet to come one can only use p/b as a reference. After checking out Panva (I'll go into the Panva/HKGC deal later), Zhengzhou, Xinao, and China Gas, the p/b is from 2.3x to 3x. So at most HKCG can warrant a 3x p/b for its China business, although the ratio should actually be lower as HKCG can't grow as fast with the HK business dragging at its back (and so came the spin-off deal with Panva).

I worked out that the property interests had a book value of $6b (don't ask me how as it's a very rough guess too) Since these projects were either acquired at a low price (IFC centre and Grand Promenade) or self-owned site redevelopment (that in Ma Tau Kok), I'll give it a generous 2x p/b valuation so $12b in total.

Adding up the pieces I got $48b + $20.4b + $12b + $3b (securities investment on book) and $83.4b in total. This is 87% of the current market price. The 'imagination' premium is only 15% which is lower than I initially thought. And it may not even exist as the disclosure of HKGC is really inadequate and obscures any serious attempt of analysis. I wouldn't fault Mr. Lee for it though as he has been trying to buy up the company.

HKCG appears to be fairly priced now and is worth a second look when it 2006 results are out.

DISCLOSURE: I don't hold 3 at time of writing.

Tuesday, February 13, 2007

PCCW (8): Now is the Time?

Now or i-Cable, PCCW Mobile or CSL, 0060 IDD or another carrier, there's a lot of reasons not to pick PCCW. Now is cumbersome to install, PCCW Mobile is Sunday in disguise, 0060 is costly. To many the time to buy PCCW is never. But there's also apparently sophisticated people foolish enough to chase for its assets, or even offer to buy shares at $6. So who's dumb and who's dumber? Now share price is back to around $4.6, a level where it's been stuck since 2003 when it was in much worse shape. I'm curious to know if there's something special inside PCCW which can only be seen by the 'gweilo'.

You may not like PCCW overpaying for the English Premier League broadcasting right, or Now and PCCW Mobile never making a profit, or IDD keep losing customers, I thought about these too. But they actully matter less in the bigger financial picture. A look at PCCW's turnover breakdown will help understand why PCCW isn't gonna screwed in any significant way.

(excluding PCPD)
Telephone & broadband & services $7.5b (IDD $1.1b) -> PCCW solutions $737m -> Mobile $585m -> Others $364m -> NOW $303m

No matter how PCCW pretends otherwise it is still the same old fixed line behemoth with a 68% market share in HK, reaching 2.6m household and businesses. And it's proven resilient against challengers in all fronts. It isn't growing but ain't going down either. Telecom revenue (excluding PCPD) is over $16b with an EBITDA of $6.5b and operating margin even showed improvement in 2006 1st half. This cash generating ability and market penetration is certainly attractive to an outside buyer.

You may ask 'what about all that haunting debt incurred from the takeover of HKT back at year 2000'? Good question, and to answer, net debt was halved from $41b in 2001 to $20b in 2006 interim (I'll stick to management's figure although I calculated $18b), but still overwhelming against net assets of only $3.1b (or only $750m if MI is taken out!). Normal capital expenditure in an year appears to be in the region of $2b, but PCCW is buying new assets too, recently spending ~$1.5b on EPL license and last year ~$1.6b on REACH undersea cable right. It is possible that ~$4b can be used to repaid debt each year and in 5 years all debt will be gone. As debt is progressively repaid PCCW's bond rating will improve and this will reduce future interest cost too. This scenario is however with the shaky belief that the management can keep their composure and confidence in check and won't try to pull another stunt to impress.

One peculiar feature about PCCW is its high profit tax rate, at ~37% of income over the last 2 years. And taxes were paid too during loss making years in 2002 and 2003. The explanation in the 2005 annual report was that certain expenses ($348m) were not deductible and some tax losses ($444m) were not allowed to offset profit. I guess it's the interest associated with the HKT acquisition debt that contributed to the bulk of the non-deductible expenses and that taxes losses were from Sunday, NOW, and other new ventures PCCW undertook in these few years. This can be a bad thing now but a good thing for the future, because future interest savings (from paying down acquisition debt) will translate 100% to bottomline improvement. Similarly, any turnaround of the new businesses will enjoy tax advantage.

Profit excluding PCPD should be roughly $1.25b. Add back amortization of $200m (which was mostly trademark) and optimistically assume* $200m interest saving and $200m savings from merging Sunday operation, we have 2007 profit of $1.85b. P/E works out to be ~15x excluding the market value of PCPD, which is about fair for a pseudo utility. Profits will grow marginally for the years afterward but if NOW and PCCW Mobile can trim their losses it'd be a major plus. On the contrary if there's no improvement these can be sold off so there's no further drain on resources.

A takeover is always a possibility, as it's in the blood of Richard Li, like father like son. Francis Leung's deal was at $6 and I gathered from press that the competitive bids worked out to be roughly the same** too. There may not be a lot of upside but I'm confident downside is really limited since PCCW today is a much stronger company than it was a few years ago, but its share price has only gone sideway. It may actually be a good defensive play in a correction with a 4% yield.

* $3b repayment x average yield of 6.5% / Sunday cost saving is more or less a guess
** market rumoured USD7.3b x 7.8 for telecom assets less $2b net debt plus market value of 62% interest in PCPD work out to be ~$6 a share

DISCLOSURE: I don't hold 8 at time of writing.

Tuesday, February 06, 2007

Something Else

Most of you have heard about the funny notion in China now that your luck in stocks will improve if you eat more beef. Well thank god I'm a beef lover already. We can laugh it off but weird things do happen when the temperature of the market gets past a certain degree. I've got a few more funny anetotes, of international flavor and across history, from a book* about past financial bubbles to share.

Early 18th century France - "gold mania" during Mississippi Company Bubble

MC was set up and given trading privileges by the French Government to pursue gold deposits presumed to exist in Louisiana of America (when there was no evidence of the gold). Shares were offered to the public who went crazy for it. The proceeds however went not to the search for gold but to the government for repaying its debt!

"So determined were some women purchasers that, in an interesting modern touch, they offered themselves for the right to buy shares." [I wonder how redemption and interest payment work?]
"To restore confidence and assure noteholders and investors that a goodly supply of [gold] would be forthcoming, a battalion of Paris [street beggars] were recruited, and the members were equipped with shovels and marched through the streets of Paris as though on the way to mine the [gold] in Louisiana. It was thought distressing when, in the next weeks, many of them were seen [in town] back to their old [selves]"

Early 18th century Britain - "concept company" mania during South Sea Company bubble

SSC ran a very similar theme to MC so I'll spare introduction. But it was the imitators who had outdone SSC founders in promoting companies with pure creativity and imagination. Some noble themes included:

"a company to build and market a typewriter - a company considerably ahead of its time." [it wasn't until more than 100 years later at 1868 when typewriters were invented]
"a project for a subtle machine gun that could fire both round and square bullets, depending on whether the enemy was a Christian or a Turk."
"a company to erect houses or hospitals for taking in and maintaining illegitimate children" [would they take mistresses too?]
"a company for carrying on an undertaking of great advantage, but nobody to know what it is [yet]" [this one sure sounds like the 'I have a dream' IPO campaign of Tom.com]

Early 20th century America - during Florida real estate boom

"beachfront lots could, by a flexible approach to [measurement], be 10 or 15 miles from the water."
"a subdivision said to be near Jacksonville was approximately 65 miles away." [we all know these well as we're told new properties anywhere in Hong Kong are all only 20 minutes away from Central]

Late 20th century Japan - beginning of end of Tokyo stock market boom where index dropped by nearly a quarter

"a leading investment house concerned with Japan reported that there was talk of changing the accounting rules, so that an institution that loses money in stocks can keep that fact confidential".

Early 21st century China - beef = bull???

* John Kenneth Galbraith, "A Short History of Financial Euphoria"

Friday, February 02, 2007

Money can't buy Benz, nor its Dealer

I read from the 'Investor's Dairy' weeks ago that in China now, people have to wait 9 months for a Mercedes Benz. And it said the last time when we Hongkies needed to wait that long for a car, it was the pre-handover 1997. It was also the days of the 'big fly' when Mercedes Benz were frequent flyer.

What's surprising is that it may take you just as long to buy enough shares in the China Mercedes dealer Lei Shing Hong (238)!

The allure of the Mercedes brand needs no introduction. Hong Kong has the highest Mercedes 'density' in the world, but I think in time that'll pale compared to a major Chinese city like Shanghai or Beijing. And unlike a Rolex, a Mercedes can't be bought here in HK and carried across border (or more accurately not anymore) so it must be bought via dealers of LSH.

LSH hold a 49% interest in the Mercedes Benz distribution company in China/HK, Taiwan and Korea. It also runs Mercedes dealerships in the Northern and Eastern China, HK, Taiwan, Korea (where it distributes Porsche as well) and Vietman. LSH also distributes Caterpillar heavy equipment in Eastern China and Taiwan.

China/HK business contributed 77% of turnover while sales from automobiles (70%) and Caterpillar equipment (17%) contributed the bulk of turnover. LSH is a growth story of both luxury consumption and construction in China.

Automobile dealership can be a risky business with slow moving inventory tying up working capital, not the case with Mercedes Benz in China. And in worst case old stocks can be cleared with ease at a 10-15% discount, leaving LSH more or less unscratched.

Indeed, profit grew for 5 straight years, though mildly, and turnover only had a dip in 2004. 2006 interim reported 37% growth in turnover to $9b and 52% growth in profit to $170m. I expect 2006 profit to be a little more than $300m.

Maybe business was simply too easy, management found amusement in dangling stocks and foreign currencies and got burnt in 2005 losing close to $90m. LSH still made $252m that year.

LSH also spent some cash in building properties too. This one they had better luck and projects sold in the last 2 years made good profits. But I'd appreciate more if the management spent that cash to pay dividends or pay down its debt. At 2006 interim LSH held $1.6b cash and had $2.8b debt. Interest for half year was $95m. Dividends were unchanged for 5 years at only 3 cents.

With a market capitalization of $3.6b and NAV of $5.5b, LSH is a good bet on China premium auto. But liquidity of the shares is non-existent and it makes you wonder where the shares have gone. LSH is perhaps even harder to buy than a Mercedes.

DISCLOSURE: I don't hold 238 at time of writing.

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