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(Note: I've been sitting on this for a month, but after the company unexpectedly raised dividends from 800 to 1,100/share on Monday I'm convinced they care enough about shareholders for patient investors to do well over time; with luck, South Korea's new "value-up" program will draw more favorable attention to opportunities like this)

Cuckoo Holdings: the World’s Cheapest Appliances Firm with a Desirable Brand?

https://www.bloomberg.com/news/articles/2018-08-29/billionaire-rises-as-asians-go-cuckoo-for-his-famous-rice-cooker
Billionaire Rises as Asians Go Cuckoo for His Rice Cooker        2018-08-29         By Yoojung Lee (Bloomberg)

Rice is a staple for Koreans, but as New York restaurateur Bobby Yoon explains it, the connection is deeper, almost spiritual.

                “We need the perfect bowl of rice for each meal," said Yoon, whose recently opened barbecue joint in Manhattan is an offshoot of Haeundae Somunnan Amso Galbijip, his grandfather’s venerable Busan institution. “It doesn’t have a flavor, but there is also a certain umami to it when cooked well.”
                Perfecting rice that’s integral to such everyday dishes as bulgogi and kimchi jjigae needs the best cooker possible, one that produces perfect grains without scorching them. The countertop appliances are given as gifts when people get married or move to a new house, and can symbolize wealth and good health for the family. By far the most popular brand is the Cuckoo, which emits a distinctive sound similar to the call of the bird it’s named after as it releases steam during the cooking process.

That obsession and stranglehold on the market has made Cuckoo Holdings Co. founder Koo Ja-sin a billionaire. The company controls about 70 percent of South Korea’s market for rice cookers -- easily outselling domestic rival Cuchen Co. -- and exports to more than two dozen countries, mostly in Asia.… For many Koreans living abroad, a rice cooker is a reminder of home and a link to their country’s culture. When Yoon, the New York restaurateur, was a student in Pennsylvania, he said his mother sent him a Cuckoo for his dorm room. But he was unable to make it work because the power outlet was different than in Korea.

                “My mom cried because I couldn’t use it,” Yoon said. “That’s how much a rice cooker means for the family.”

Cuckoo Holdings, via 100% subsidiary Cuckoo Electronics, has roughly 70% market share of the South Korean electric rice cooker market. Sales of rice cookers – an appliance Asian consumers happily splurge on – are sticky thanks to replacement demand, and the “Cuckoo” brand of induction heating cookers is very desirable, even overseas. How do we know? Because Cuckoo has 1) successfully raised product selling prices over time despite shrinking the average size of its rice cookers (to cater to more single-person, carbohydrate-conscious households), 2) attracted meaningful inbound tourist demand, and 3) inspired overseas counterfeiters.

Even after popping 9% yesterday (12 March 2024) after announcing a 38% YoY dividend increase, at market close Cuckoo still sold for just 5.7x trailing P/E (2.6x ex-cash), 0.57x book value, and a 6% dividend yield. Incredibly, Cuckoo – a company whose 2014 IPO was 175x oversubscribed – now still sells just below our estimate of “net net” liquidation value (i.e., the sum of cash and securities at a 10% haircut, income-yielding property, and the pre-tax market value of listed affiliate Cuckoo Homesys).

How rare is Cuckoo’s undervaluation today? As the below Bloomberg screenshot shows, as of 3 March 2024, there were a total of 36,331 listed companies in Asia (developed plus emerging markets). Of these, just 111 or 0.3% a) averaged >10% ROE for the last five years, b) trade at >4.5% dividend yields, c) show trailing P/E ratios less than 5x, and d) carry less than zero net debt (i.e. are in a net cash position). Incredibly, Cuckoo Holdings is one of these 111 companies.

Cuckoo suffers from this seemingly ludicrous valuation despite a) averaging, without leverage, 13% ROE (17% ex-cash) from 2018-2022, b) increasing cash dividends from KRW 600 to 1,100 per share between 2018-2022, c) committing publicly to a 3% minimum dividend yield for the past three years (see English translation), and d) sustaining superior EBIT margins (2018-2022 average: 15%) versus listed peers with desirable brands like Zojirushi, De’Longhi, and SharkNinja.

What gives? Cuckoo Holdings is legally classified a general (i.e., non-financial) “holding company,” a type of entity with a terrible reputation in South Korea. Historically, the holding company structure was promoted by South Korean regulators to “alleviate opacity in corporate governance” following the nation’s IMF bailout related to the Asian Financial Crisis.[1] While the holding company structure arguably created more transparency (i.e., less cross-shareholdings), as those of you that invest in closed-end funds know, holding companies often trade at frustrating discounts to the net asset value of its subsidiaries.[2][CH1]  Large, persistent NAV discounts have dented the reputation of South Korean holding companies among the media and many market participants.[3] While we haven’t taken surveys, our sense is that South Korean retail investors can’t stand them either.[4] This matters because retail investors in South Korea now account for ~2/3 of the nation’s trading volume.[5]

We sympathize with South Korea’s frustrated retail investors. Our experience visiting South Korean-listed companies has convinced us that investing in most of the nation’s publicly traded holding companies is not for the faint of heart. Within the holding company space, however, we feel some gems are still worth bidding for at current depressed prices.[6]

Cuckoo Holdings is one such gem, a holding company we view to be a cut above its peers – the classic “baby out with the bathwater.”[7] [DN2] This is not simply because of Cuckoo’s financial track record, but also because of its lack of governance drama. Unfortunately, there are plenty of horror stories of South Koren public companies with random capital allocation, jailbird management, outright malfeasance, or even staff that protest against “excessive dividends” to shareholders. Cuckoo Holdings (whose founder is distantly related to LG’s founder), however, has not been plagued by similar governance drama.

To be specific, we think Cuckoo Holdings stands out for five major reasons:

1. Simpler, “cleaner” holding company structure:

To us, Cuckoo Holdings, via just five direct wholly-owned subsidiaries (see below), is a “holding” company only in name. In fact, it’s an operating business purely focused on the core business of home appliances (chiefly, rice cookers).[8] The profit-center of the group, Cuckoo Electronics (which manufactures/sells rice cookers for mostly replacement demand) is 100% owned by Cuckoo Holdings. Most importantly, cashflows from Cuckoo Electronics to Cuckoo Holdings are not impeded by any layers of separately listed public companies, dividend taxes, etc.

At more complex South Korean holding companies (i.e., Orion Holdings, F&F Holdings, Nong Shim Holdings, etc.), the holding company level does not have a substantial wholly-owned operating business. For these firms, the holding company staff appear to spend their time licensing out intellectual property (i.e. brands), collecting dividends (if any) from a long list of entities, paying out those dividends to shareholders (including the founding family, which often have more personal exposure to the holding company), and executing a variety of investments for group companies that can appear random, risky or both.[9] The profit-center of these more complicated holding companies is often concentrated in a single operating company or “op-co.” These op-co’s are often a) just 30-40% owned by the holding company, b) separately listed on the Korean Exchange, and c) may generate abundant free cash flow but, because it is impeded by an extra layer of governance and/or dividend tax, distribute little of it to the holding company (or other shareholders). The op-co itself may come with added complexity; for example, we know firms where the cash-cow entity of the op-co is less than 100%-owned.[10]

2. Minimal equity paid in (~KRW 5b), massive dividends paid out (~KRW 206b):  

We are partial to companies whose cumulative long-term dividends (and share repurchases) dwarf the total amounts of new equity raised, and Cuckoo Holdings fits that mold. According to Bloomberg, from 2013 through 2023, Cuckoo Holdings only took in KRW 5 billion of cash from equity issuance (a sale of treasury shares) but has paid out KRW 206 billion in cash dividends (including the most recent 12/27/2023 ex-dated dividend).[11] The majority of these dividends were paid in the five years ending 2023.

When Cuckoo Holdings (then known as Cuckoo Electronics) decided to go public in 2014, the company did not issue any new shares despite significant indicated demand from foreign institutions.[12][CH3]   In other words, Cuckoo’s hot IPO with a “first day pop” was almost entirely a secondary share sale to facilitate the partial exit of one of the founder’s two sons (the elder son, Koo Bonhak, remained the company’s leader and major shareholder to this day). Another interesting feature of Cuckoo’s IPO was that 20% of the IPO allocation was taken up by employees alone.

Above: Bloomberg incorrectly labeled the 2014 Cuckoo IPO as a sale of “primary” shares.

3. Unique commitment to a “minimum” dividend yield (at a higher payout ratio than it seems):

It’s relatively easy to screen out a list of consistently profitable South Korean public companies trading at low valuations as measured by P/E, P/B, dividend yield, etc. It’s far more difficult, however, to determine which of these firms care (or care enough) about shareholder returns. Our method has been to zero-in on firms that tick at least two of the following three criteria:

a) consistently repurchase stock and/or increase dividends per share over time,

b) publicly commit or “promise” to keep returning (or return more) cash to shareholders, and

c) implement some other act of generosity to shareholders.  

Cuckoo Holdings ticks the first two boxes above. Not only have Cuckoo’s dividends increased consistently (see below), but the company uniquely promised to maintain a 3% minimum dividend yield from 2021 to 2023.[13] We remain hopeful that dividends will continue to increase and that the minimum dividend yield promise will be refreshed for the next three years.

What about the dividend payout ratio? Cuckoo Holdings’ consolidated dividend payout ratio appears to be only 21% (as of 2022) which would rank it only 546 of South Korea’s 3,000 public companies (including those with zero dividends).[14] The reason for this relatively unflattering payout ratio, however, is that Cuckoo Holdings recognizes a significant amount of equity-method income from 41%-owned affiliate Cuckoo Homesys, a (non-rice cooker) appliance “rental” company. Cuckoo Homesys has successfully expanded the “Cuckoo” brand of appliances (water filters, air filters, etc.) to millions more customers globally (especially in Malaysia), but the nature of the Homesys business model (monthly appliance rentals under multi-year contracts) means it comes with a) exaggerated (“pulled-forward”) profitability thanks to the quirks of finance lease accounting rules, and b) far worse cash flow and dividend characteristics (more on this company later).

In reality, Cuckoo Holdings’ effective dividend payout ratio is much higher. The company’s dividends are almost entirely self-funded from 100%-owned Cuckoo Electronics (the rice cooker business), and these profits are what is reflected in in pre-tax operating profit.  If we simply multiply pre-tax operating profits by South Korea’s 24% corporate tax rate, then Cuckoo Holdings’ effective dividend payout ratio for 2022 would jump to 33%, which would rank it just inside the top 300 of South Korea’s 3,000 public companies. 

4. Top-of-mind Brand Awareness: 70% Rice Cooker Market Share in Just 16 Years  

Koo Jashin, a distant relative of LG’s founder (also surnamed Koo), established Sungkwang Electronics in 1978 as an OEM export manufacturer of appliances (including rice cookers). The company remained strictly OEM until 1998 when it rebranded as “Cuckoo” and launched its “Cuckoo” brand of rice cookers.

From then it only took 16 years for the Cuckoo brand to rise to ~70% share market dominance by the time of the 2014 IPO.[15] We can’t identify any other Asian rice cooker brand with anywhere close to 70% market share, let alone one that only took less than two decades to reach market leadership.[16] What explains Cuckoo’s brand dominance?[17] We’re not sure we can pinpoint a single explanation, but we’re very sure a) the brand power exists and b) the stock market is giving away that brand power for less than $0.

Cuckoo’s brand awareness isn’t limited to South Korea either. The consistent, rapid increase of Cuckoo’s overseas “export” rice cooker revenues (in China, the United States, and Vietnam) from 12% of total revenues in 2020 to 20% in 2022 proves that the Cuckoo brand is increasingly accepted abroad, too.[18]

5. Catalyst: An Inevitable Malaysia IPO at Cuckoo Homesys?

One of the trickiest parts of the Cuckoo Holdings empire is its 41% non-consolidated shareholding in publicly traded Cuckoo Homesys. In short, it’s tricky enough that we think a conservative investor can safely ignore the quarter-to-quarter details at Cuckoo Homesys and just accept its current cheap-looking market valuation in any estimate of Cuckoo Holdings’ net asset value. Doing this will a) save a lot of headache and b) won’t ruin the core investment thesis of Cuckoo Holdings (i.e., that South Korea’s dominant rice cooker brand is selling “for free” and a 5% dividend yield).

For investors that don’t mind complexity, however, the barely noticeable reality is that Cuckoo Homesys – specifically, the long-rumored IPO of its high-growth 59.1%-owned Malaysian subsidiary “Cuckoo International Sdn Bhd” – could positively highlight the value within Cuckoo Holdings. In fact, the CEO of the Malaysian business, Mr. Hoe Kian Choon, has talked publicly about an IPO and Cuckoo International Sdn Bhd recently granted him (and his team) a significant share-based award in late 2022. According to Korean Exchange filings, that 2022 share-based award is premised on a successful IPO (see below English translation). In our view, since Cuckoo International Sdn Bhd has never paid a dividend due to the cash-consuming nature of its growth model (more on this below), the only way for Mr. Hoe to monetize his equity would be to complete an IPO on the Bursa Malaysia.

How does Cuckoo Homesys (and Cuckoo International Sdn Bhd) earn revenue? Unlike Cuckoo Holdings, which has always focused on the outright sale of rice cookers for cash, Cuckoo Homesys pursues a uniquely South Korean appliance “rental” business model. Pioneered by larger competitor Coway, the South Korean appliance rental model is one in which millions of subscribers (households) sign multi-year contracts to rent (on a monthly basis) water filters (the dominant product), air filters, massage chairs, and other home appliances.[19] The attraction of this rental model for consumers is they can a) avoid the hassle of ownership while reducing cash outlays to small monthly payments, and b) enjoy a uniquely Asian level of quality “door-to-door” service by an army of Cuckoo servicemen and women that ensure filters are properly installed, replaced, etc. The attraction of this business model for Coway and Cuckoo Homesys is a) the customer churn rates are relatively low, and b) consumers are contractually bound a device that requires the regular replacement of higher profit-margin consumables (filters).[20]

Source: https://www.cuckoo.com.my/

Cuckoo Homesys followed Coway into Malaysia in 2014 and recruited Hoe Kian Choon, an ex-Coway manager, to run the local subsidiary (“Cuckoo International Sdn Bhd”).[21] Hoe expanded aggressively and by 2022 Malaysia was contributing approximately 1/3 of consolidated revenue and, at least on an accrual (as opposed to cash) basis, eye-popping profit from COVID onwards. How eye-popping? By our rough estimates, the multiplying [CH4] Cuckoo Homesys’ attributable after-tax profit of Cuckoo International Sdn Bhd by the Malaysian benchmark index trailing P/E multiple of 15x as of 5 March 2024 would generate a possible market cap of KRW 465 billion.[22] This is greater than Cuckoo Homesys’ entire market cap as of 5 March 2024. 

This realization prompted us to purchase every annual audited financial statement for unlisted Cuckoo International Sdn Bhd.[23] As you can see from the decade-worth of income statements below, on an accounting (accrual) basis, Cuckoo International Sdn Bhd has delivered eye-popping revenue and profit growth in its first eight years through 2022.[24] If Cuckoo International Sdn Bhd is ultimately valued by Malaysian IPO investors based on its accrual revenue and profit, then the market value of this subsidiary will almost certainly highlight the value of its largest shareholder, Cuckoo Homesys. The rub, however, is that the cash profit of these rental firms tends to be much smaller than the accrual profit.

Above: on an accrual basis, Malaysia generated significant revenue and profit growth from 2016-2022.

Intuitively, we knew that the Korean appliance contract rental business model would require many months of subscription consumable payments to recoup the cost of “giving” a water filter or air filter to a subscriber on day one. In accounting parlance, these contracts can either be “operating leases” (i.e., those under five years) and “finance leases” (i.e., those over five years).

What we did not know, however, was that IFRS accounting standards treat the above two types of contracts very differently.[25] Without getting too technical, under shorter-term operating leases, the water filter device (equipment) is still owned by Cuckoo International Sdn Bhd and revenues are booked as the monthly rental payments come in. In other words, the accrual and cash profit more closely resemble each other.

Above: Coway’s 2023 income statement split between operating and finance leases.

Under longer-term “finance leases,” however, IFRS accounting treats the water filter device (equipment) as being “sold” to the rental customer, generating upfront “revenue” on day one even though no cash has been paid for anything. The uncollected revenue is then presented as a very large receivable that is then paid down over the next five-plus years as the water filter subscriber makes their monthly payments. As you can imagine, there’s still plenty of risk around the collectability of the future monthly payments, so that day-one “revenue” and the associated assumed “profit” don’t resemble cash reality.

We don’t believe there is anything nefarious behind the use of finance lease accounting at Coway or Cuckoo Homesys. The reality is both companies increasingly rely on lower-income emerging markets to add subscribers. In emerging markets, monthly rental payments (or at least, the monthly payments that attract new subscribers) tend to be much lower in absolute terms. At lower monthly payments, the only way for Coway or Cuckoo Homesys to have “workable” unit economics is to sign longer-term (i.e. five-plus year) rental contracts. These are exactly the length of contracts that a) necessitate finance lease accounting under IFRS and b) unfairly flatter the income statements with large amounts of uncollected revenue that goes into a ballooning accounts receivable pile. Not surprisingly, Cuckoo International Sdn Bhd has seen massive growth in accounts receivable over the last four years, and this is why no Malaysian dividends have been paid up to Cuckoo Homesys (see below).

Above: Malaysian revenue growth led to massive growth in accounts receivables since 2019 due to higher “finance lease” revenue.

Who’s been funding the massive growth in receivables? As Cuckoo International Sdn Bhd’s audits show, the immediate holding company (i.e., Cuckoo Homesys) has been funding most of this by significantly extending accounts payables and granting shareholder loans. While that’s been feasible to date, the numbers are getting too big to sustain: for example, at current exchange rates, the below payables (in red) would equate to about 15% of Cuckoo Homesys’ entire market cap as of today. Hence, for Cuckoo International Sdn Bhd to keep growing the longer-term contracts, significant additional funding will have to come from somewhere, and that is why we believe a long-rumored IPO is a realistic possibility worth waiting for.[26]

Will all this activity in Malaysia unlock value all the way back up to Cuckoo Holdings shareholders? We don’t know, but at Cuckoo Holdings’ current stock price we feel shareholders are getting that possibility for free and getting paid a 6% annual dividend (fully funded by the dominant rice-cooker business) to wait.

To be sure, Cuckoo Holdings has flaws – investor relations activity appears too ad hoc, the balance sheet has too much cash, and domestic sales volume growth appears too limited. Still, if Cuckoo’s ROE remains above 10%, the current 5% dividends continue rising at their historical pace, and foreigners continue to love the brand, we feel shareholders can be optimistic of eventually coming out ahead.[27]

Granted, this is the perspective of a shareholder that’s been invested for less than a year. What’s different today, however, is that the Korean government has started actively promoting a new “Value-Up” program[DN5] [CH6]  for discounted stocks. We’re curious to see if this program, which a) will supposedly be backed by significant pension money, and b) is being promoted in person at overseas roadshows, proves an effective re-rating catalyst.

Catalyst

Value-up program makes progress, further dividend increases, IPO of Malaysian indirect subsidiary, launch of a formal IR program, launch of English financial statements, etc.