Asia Standard International 0129
October 27, 2011 - 10:58am EST by
jcp21
2011 2012
Price: 1.32 EPS NR NR
Shares Out. (in M): 1,220 P/E NR NR
Market Cap (in $M): 1,610 P/FCF NR NR
Net Debt (in $M): -1,100 EBIT 478 500
TEV ($): 510 TEV/EBIT NR NR

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Description

1.6 billion HKD market cap, 5 billion in liquid securities, 282k GFA of office real estate in Hong Kong, 4 hotels generating ~200m HKD in EBITDA and 3.9 billion in debt.

The most accurate way to look at Asia Standard International (ASI) is to net out the debt against the office and hotel properties. The development prospects for the remaining 5 billion in dry powder are strong because:

-          Government (Hong Kong) land sales now favor smaller developers like ASI.

-          Going forward, ASI will be developing properties for the more sustainable domestic demand driven portion of the Hong Kong property market.

-          Unlike many developers, ASI does not need access to credit in order to develop projects.

-          The CEO owns 51% of the company and has a long history of generating shareholder value in strong and in weak property markets.

Assuming fair value is where an investor can earn a 40% return in a 0% asset return scenario, I calculate the fair value of the company is 3.5 billion, which represents 120% upside potential. Furthermore, there is a hidden currency-based call option that could yield a 10-30% return.

Financial Assets / Company History

ASI is sitting on 5 billion HKD in financial assets. To arrive at a shareholder value for those assets, I considered the following factors:

  1. 1.       The company’s track record of generating shareholder value

ASI has a long track record of generating shareholder value. From 2000 to fiscal year end 2011, the company generated the following:

-          +595 hotel rooms worth 330 million using 2000 rates (630 million based on 2011 rates).

-          +1.8 billion swing from 2.43 billion in net debt to 1.37 billion in net financial assets excluding the impact of 2 billion in new debt/equity.

-          +1.95 billion in pre-financing cash flow.

-          -1.9 billion backed out from appreciation of financial assets.

In total, the company generated 2.2 billion in shareholder value using its 2000 capital base which comes out to 220 million per year or a 14% yield on the current market cap. 800 million of the value was generated through property development at an average margin of 16%.

Unskilled property developers can ride a booming real estate market. For that reason, it is important to note that during the second half of the Hong Kong property market downturn (2000-2004) the company still generated property development margins of 4.4%.

The strong track record increases the probability that the large pool of financial assets will be used to generate new shareholder wealth.

  1. 2.       Asset management track record

Only recently has the company built up such a large pool of financial assets. In 2008, the company only had 106 million of financial assets and the number quickly grew to 700 million, 3 billion and 5 billion in 2009, 2010 and, 2011, respectively. Based on my estimate, the assets did take losses in the 2008-2009 market collapse in the range of 15-30% which was largely recovered in the 2009-2010 market rebound. Based on older annual reports, it appears as though the company invests primarily in a mixture of preferred stocks and bonds.

 

Hidden Call Option: Right now, 91% of the company’s financial assets are in non-HKD denominated assets. And, 78% of the company’s debt is HKD denominated. Furthermore, 100% of the company’s core land holdings are in Hong Kong. In the scenario where the Hong Kong dollar revalues towards its true fundamental value, (insert your own probability) the company’s financial assets would gain substantial value. In theory, a 10% gain on its current foreign denominated pool could generate 450 million HKD in additional value (~30% of market cap). Furthermore, the company’s hard assets would potentially go up in value at the same time. It is impossible to know with any precision how this event would impact shareholders as these gains would have to be realized at some point. Regardless, given the low likelihood of the HKD becoming even more overvalued, it represents low risk upside.

 

  1. 3.       The realistic prospects for this capital once it is converted into real estate

The government initiates land sales periodically. Currently, the government estimates that 52 residential sites will be sold which equates to 16,000 residential flats (178% increase over 2010/2011). Going forward, the plots will be smaller which is favorable for a mid-tier developer like ASI. The lots will serve the local market (priced in the 4,000 HKD per square foot range versus the high-end 30,000 HKD per square foot range), which is a more stable market to generate value. The shift allows ASI to avoid the more frothy China-driven portion of the residential property market. Due to political concerns, inflation and a general lack of investment options, ultra wealthy Chinese citizens purchase $4m+ condos in Hong Kong for the sole purpose of storing wealth. Clearly, a hard landing in China would damage this market and is one reason why Hong Kong property developer stocks are so volatile.

 

The government has an interest in providing more housing to keep pace with demand. Officials have identified 6.5 m sq ft floor area of commercial / business sites for potential land sales in 2011/2012. For example, in Wong Chuk Hang, Island South, the government is transitioning an industrial area into a decentralized office hub. Longer-term the government has development plans out to 2020. Clearly, significant development potential remains in Hong Kong for ASI. And, the company has a history of disciplined development projects that generate shareholder wealth.

 

One problematic aspect of the company’s development pipeline is its 50% interest in a residential/commercial project in Beijing (2 million GFA). Although the project will not be completed until 2013, putting capital to work in China’s property market is very risky. The risk is mitigated, to a degree, by the company’s long and successful development track record in China.

Assets That Net Out the Debt

 ASI owns the following office properties (and has since the 90s):

-          Asia Standard Tower – 100% interest, 133,000 GFA

-          Asia Orient Tower – 100% interest, 114,000 GFA

-          Goldmark – 33% interest, 106,000 GFA

In total, the assets generated 74 million HKD in income in FY 2011. Using a 7% cap rate (versus an actual market cap rate of 4%) gives an implied value of 1.1 billion. Hong Kong properties currently trade at low cap rates due to expectations for appreciation, high inflation and low U.S. interest rates. And, leasing rates continue to climb as financial services firms scramble to fill the limited remaining office space. If the company wanted to liquidate its office buildings, it could generate billions in value.  According to the Economic Property Research Centre, recent office property sales ranged from $11,010 to $25,129 HKDpsf). Using the low end of the range implies all three offices could be liquidated for gross proceeds of 3.1 billion HKD (100% greater than ASI’s current market cap).

Hotel Properties

Asia Standard Hotel (ASH) is a dramatically undervalued asset in which ASI has a 70% stake. The Hong Kong hotel market is extremely robust, as a combination of limited supply and secular demand growth from mainland China has sustained high room rates and low vacancy rates. In 2011, the four hotel properties generated 194 million HKD in EBITDA. Using a below average 9x multiple gives an asset value of 1.75 billion (hotel multiples bottomed at 10x, excluding the SARS epidemic where the multiples bottomed at 5x before rebounding, and are now in the 13-15x range). ASI’s 70% stake is worth 1.2 billion.

As a standalone investment, ASH could yield a 150%+ return:

-          1.8 billion HKD in hotel value

-          968 billion HKD in debt

-          1.7 billion HKD in financial assets

-          Total: 2.5 billion or 1.62 per share (165% upside)

Valuation

Assets Net Out Debt

Since the investment properties will likely never be sold unless ASI liquidates 100% of its assets, the primary value the assets bring to shareholders is additional low cost debt capacity. Right now, the company has 3.9 billion HKD in debt, carrying a total annual cost of only 77.9 million HKD (2% average variable interest rate hedged using swaps with 40% maturing within a year and 44% maturing between 5-15 years). A big reason the average interest rate is so low is because the debt is secured by existing property assets. So from a shareholder value perspective, it makes sense to net out existing property against outstanding debt. And, the office and hotel properties generate 268 million HKD in EBITDA or 3.4x coverage.

Financial Assets

Evaluating the remaining 5 billion HKD in investment assets is the key to determining a fair value for ASI stock. Given the very wide range of possible outcomes, it seems reasonable to focus on what value gives a future investor a fair risk/reward. The ceiling for any reasonable valuation is clearly 5 billion. If management, for example, executes a massive 5 billion special dividend, an investor could rationally pay that amount.  The more likely outcome is that the assets will be used for real estate development over the next 3-5 years. Given the uncertainty in China and the global economy, a reasonable best case upside for the assets should be no more than 5 billion (at least with the company’s current asset position).

Unknowns: 1) the timing of the investment is uncertain; 2) the market value of the financial assets upon liquidation is uncertain due the market fluctuations; 3) the quality of future investments is uncertain. In contrast to 5 billion going to build Marriot hotels where the future value is more certain, ASI has no brand or inherent competitive advantage other than a massive amount of dry powder and experienced property developers.

So, an investor has at most (given the current information) 4.10 per share in upside (5 billion). In order to determine the price range where a future investor gets a fair risk/reward ratio, it is important analyze how low the stock could go. During the financial crisis in 2008, the stock bottomed at 0.40. Sellers at those levels were looking at a company with 1 billion HKD in net debt. A more realistic downside assessment probably puts the stock in 0.70-0.90 to account for the additional asset protection. At 2.90 per share, an investor has 40% near-term upside, 100-200% long-term upside with 70% downside. With a 2.90 price target, investors at today’s price have 120% upside. 


Risks

-          The Hong Kong property market is very volatile and ASI’s assets could lose value.

-          The company’s assets are invested in public market securities that could lose value in an economic downturn.

-          The Chinese economy could fall into a recession which would a) put pressure on the company’s hotel business b) create a difficult environment for developing real estate both in Hong Kong and in China.

Disclosure: I am long ASI and ASH

 

Catalyst

Catalysts:

-          Either a stabilization or recovery in the Hong Kong property market.

-          A soft landing in China.

-          Successful sale of remaining residential development (Westminster Terrace) which would bring in ~400 million HKD in revenue or ~235 million HKD in additional operating earnings (15% of market cap).

-          Successful pipeline development.

-          HKD revaluation.

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    Description

    1.6 billion HKD market cap, 5 billion in liquid securities, 282k GFA of office real estate in Hong Kong, 4 hotels generating ~200m HKD in EBITDA and 3.9 billion in debt.

    The most accurate way to look at Asia Standard International (ASI) is to net out the debt against the office and hotel properties. The development prospects for the remaining 5 billion in dry powder are strong because:

    -          Government (Hong Kong) land sales now favor smaller developers like ASI.

    -          Going forward, ASI will be developing properties for the more sustainable domestic demand driven portion of the Hong Kong property market.

    -          Unlike many developers, ASI does not need access to credit in order to develop projects.

    -          The CEO owns 51% of the company and has a long history of generating shareholder value in strong and in weak property markets.

    Assuming fair value is where an investor can earn a 40% return in a 0% asset return scenario, I calculate the fair value of the company is 3.5 billion, which represents 120% upside potential. Furthermore, there is a hidden currency-based call option that could yield a 10-30% return.

    Financial Assets / Company History

    ASI is sitting on 5 billion HKD in financial assets. To arrive at a shareholder value for those assets, I considered the following factors:

    1. 1.       The company’s track record of generating shareholder value

    ASI has a long track record of generating shareholder value. From 2000 to fiscal year end 2011, the company generated the following:

    -          +595 hotel rooms worth 330 million using 2000 rates (630 million based on 2011 rates).

    -          +1.8 billion swing from 2.43 billion in net debt to 1.37 billion in net financial assets excluding the impact of 2 billion in new debt/equity.

    -          +1.95 billion in pre-financing cash flow.

    -          -1.9 billion backed out from appreciation of financial assets.

    In total, the company generated 2.2 billion in shareholder value using its 2000 capital base which comes out to 220 million per year or a 14% yield on the current market cap. 800 million of the value was generated through property development at an average margin of 16%.

    Unskilled property developers can ride a booming real estate market. For that reason, it is important to note that during the second half of the Hong Kong property market downturn (2000-2004) the company still generated property development margins of 4.4%.

    The strong track record increases the probability that the large pool of financial assets will be used to generate new shareholder wealth.

    1. 2.       Asset management track record

    Only recently has the company built up such a large pool of financial assets. In 2008, the company only had 106 million of financial assets and the number quickly grew to 700 million, 3 billion and 5 billion in 2009, 2010 and, 2011, respectively. Based on my estimate, the assets did take losses in the 2008-2009 market collapse in the range of 15-30% which was largely recovered in the 2009-2010 market rebound. Based on older annual reports, it appears as though the company invests primarily in a mixture of preferred stocks and bonds.

     

    Hidden Call Option: Right now, 91% of the company’s financial assets are in non-HKD denominated assets. And, 78% of the company’s debt is HKD denominated. Furthermore, 100% of the company’s core land holdings are in Hong Kong. In the scenario where the Hong Kong dollar revalues towards its true fundamental value, (insert your own probability) the company’s financial assets would gain substantial value. In theory, a 10% gain on its current foreign denominated pool could generate 450 million HKD in additional value (~30% of market cap). Furthermore, the company’s hard assets would potentially go up in value at the same time. It is impossible to know with any precision how this event would impact shareholders as these gains would have to be realized at some point. Regardless, given the low likelihood of the HKD becoming even more overvalued, it represents low risk upside.

     

    1. 3.       The realistic prospects for this capital once it is converted into real estate

    The government initiates land sales periodically. Currently, the government estimates that 52 residential sites will be sold which equates to 16,000 residential flats (178% increase over 2010/2011). Going forward, the plots will be smaller which is favorable for a mid-tier developer like ASI. The lots will serve the local market (priced in the 4,000 HKD per square foot range versus the high-end 30,000 HKD per square foot range), which is a more stable market to generate value. The shift allows ASI to avoid the more frothy China-driven portion of the residential property market. Due to political concerns, inflation and a general lack of investment options, ultra wealthy Chinese citizens purchase $4m+ condos in Hong Kong for the sole purpose of storing wealth. Clearly, a hard landing in China would damage this market and is one reason why Hong Kong property developer stocks are so volatile.

     

    The government has an interest in providing more housing to keep pace with demand. Officials have identified 6.5 m sq ft floor area of commercial / business sites for potential land sales in 2011/2012. For example, in Wong Chuk Hang, Island South, the government is transitioning an industrial area into a decentralized office hub. Longer-term the government has development plans out to 2020. Clearly, significant development potential remains in Hong Kong for ASI. And, the company has a history of disciplined development projects that generate shareholder wealth.

     

    One problematic aspect of the company’s development pipeline is its 50% interest in a residential/commercial project in Beijing (2 million GFA). Although the project will not be completed until 2013, putting capital to work in China’s property market is very risky. The risk is mitigated, to a degree, by the company’s long and successful development track record in China.

    Assets That Net Out the Debt

     ASI owns the following office properties (and has since the 90s):

    -          Asia Standard Tower – 100% interest, 133,000 GFA

    -          Asia Orient Tower – 100% interest, 114,000 GFA

    -          Goldmark – 33% interest, 106,000 GFA

    In total, the assets generated 74 million HKD in income in FY 2011. Using a 7% cap rate (versus an actual market cap rate of 4%) gives an implied value of 1.1 billion. Hong Kong properties currently trade at low cap rates due to expectations for appreciation, high inflation and low U.S. interest rates. And, leasing rates continue to climb as financial services firms scramble to fill the limited remaining office space. If the company wanted to liquidate its office buildings, it could generate billions in value.  According to the Economic Property Research Centre, recent office property sales ranged from $11,010 to $25,129 HKDpsf). Using the low end of the range implies all three offices could be liquidated for gross proceeds of 3.1 billion HKD (100% greater than ASI’s current market cap).

    Hotel Properties

    Asia Standard Hotel (ASH) is a dramatically undervalued asset in which ASI has a 70% stake. The Hong Kong hotel market is extremely robust, as a combination of limited supply and secular demand growth from mainland China has sustained high room rates and low vacancy rates. In 2011, the four hotel properties generated 194 million HKD in EBITDA. Using a below average 9x multiple gives an asset value of 1.75 billion (hotel multiples bottomed at 10x, excluding the SARS epidemic where the multiples bottomed at 5x before rebounding, and are now in the 13-15x range). ASI’s 70% stake is worth 1.2 billion.

    As a standalone investment, ASH could yield a 150%+ return:

    -          1.8 billion HKD in hotel value

    -          968 billion HKD in debt

    -          1.7 billion HKD in financial assets

    -          Total: 2.5 billion or 1.62 per share (165% upside)

    Valuation

    Assets Net Out Debt

    Since the investment properties will likely never be sold unless ASI liquidates 100% of its assets, the primary value the assets bring to shareholders is additional low cost debt capacity. Right now, the company has 3.9 billion HKD in debt, carrying a total annual cost of only 77.9 million HKD (2% average variable interest rate hedged using swaps with 40% maturing within a year and 44% maturing between 5-15 years). A big reason the average interest rate is so low is because the debt is secured by existing property assets. So from a shareholder value perspective, it makes sense to net out existing property against outstanding debt. And, the office and hotel properties generate 268 million HKD in EBITDA or 3.4x coverage.

    Financial Assets

    Evaluating the remaining 5 billion HKD in investment assets is the key to determining a fair value for ASI stock. Given the very wide range of possible outcomes, it seems reasonable to focus on what value gives a future investor a fair risk/reward. The ceiling for any reasonable valuation is clearly 5 billion. If management, for example, executes a massive 5 billion special dividend, an investor could rationally pay that amount.  The more likely outcome is that the assets will be used for real estate development over the next 3-5 years. Given the uncertainty in China and the global economy, a reasonable best case upside for the assets should be no more than 5 billion (at least with the company’s current asset position).

    Unknowns: 1) the timing of the investment is uncertain; 2) the market value of the financial assets upon liquidation is uncertain due the market fluctuations; 3) the quality of future investments is uncertain. In contrast to 5 billion going to build Marriot hotels where the future value is more certain, ASI has no brand or inherent competitive advantage other than a massive amount of dry powder and experienced property developers.

    So, an investor has at most (given the current information) 4.10 per share in upside (5 billion). In order to determine the price range where a future investor gets a fair risk/reward ratio, it is important analyze how low the stock could go. During the financial crisis in 2008, the stock bottomed at 0.40. Sellers at those levels were looking at a company with 1 billion HKD in net debt. A more realistic downside assessment probably puts the stock in 0.70-0.90 to account for the additional asset protection. At 2.90 per share, an investor has 40% near-term upside, 100-200% long-term upside with 70% downside. With a 2.90 price target, investors at today’s price have 120% upside. 


    Risks

    -          The Hong Kong property market is very volatile and ASI’s assets could lose value.

    -          The company’s assets are invested in public market securities that could lose value in an economic downturn.

    -          The Chinese economy could fall into a recession which would a) put pressure on the company’s hotel business b) create a difficult environment for developing real estate both in Hong Kong and in China.

    Disclosure: I am long ASI and ASH

     

    Catalyst

    Catalysts:

    -          Either a stabilization or recovery in the Hong Kong property market.

    -          A soft landing in China.

    -          Successful sale of remaining residential development (Westminster Terrace) which would bring in ~400 million HKD in revenue or ~235 million HKD in additional operating earnings (15% of market cap).

    -          Successful pipeline development.

    -          HKD revaluation.

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