Description

17% stake in recently listed Cloopen (RAAS) worth more than the market cap. SOTP = 3x current market cap

Hi Sun is a listed (in Hong Kong, ticker 818, market cap around US$1.1bn at CMP of HKD 3.13, share count 2,780m) incubator of highly successful businesses spanning across the tech/fintech space (payment processing, POS manufacturing, chipmaking, cloud communication). It has an impressive track record of value creation, resulting from incubating, developing, and eventually monetizing (partially or fully via placements to major PEs or IPOs). Since its listing in 2001 in Hong Kong, Hi Sun’s book value per share has increased some 115x. Cloopen, in which Hi Sun holds a 17% stake (27 million shares) post IPO, and which is effectively a spin-off of Hi Sun (Cloopen’s founder and CEO worked for over a decade for Hi Sun’s communication division prior to founding Cloopen, and Hi Sun first seeded Cloopen in 2014 with US$5m), just listed on the NASDAQ. First day of trading was Tuesday 9 Feb, when the stock popped 200% compared to the IPO price of US$16 per share, giving it a market cap of over $6bn. Citi and Goldman were the arrangers, and pre-IPO investors included Tencent and Sequoia (Sequoia is Cloopen’s second largest shareholder after Hi Sun). Cloopen is the largest cloud communication company in China, often referred to in the Chinese press as ‘the Twilio of China’. This event is at last bringing attention to Hi Sun, a stock that has been neglected for too long in our view, and which despite already more than tripling ytd still trades at an exceptionally wide discount to its net-asset-value / sum-of-the-parts in our view, which we believe is totally underserved given the company’s exceptional track record of value creation.

Hi Sun presently has four major assets (plus net cash), two listed (PAX Global, listed in Hong Kong, ticker 0327; and Cloopen, listed in NY, ticker RAAS), and two yet unlisted (VBill and Megahunt), but, we believe, also soon to be listed either in Hong Kong or mainland China over the next 12 months. The conjunction of all these crystallisation events leads us to believe that over the next 12 months or so Hi Sun (which up until two months ago was a totally neglected stock effectively not covered by any broker and not held by any major fund) should at last close its discount to NAV, which we estimate to be over 3x its current market value (and growing, as witnessed by the 30%+ CAGR in Hi Sun’s book value per share over the past 18 years since listing). 

The table above illustrates our sum of the parts valuation for Hi Sun. In the first column, we value the assets at current market price for the listed ones (HKD 8.7 per share for PAX and US$48 per share for Cloopen), or at the last raising rounds (always from major PEs) for the two unlisted assets, and come up with a SOTP of roughly HKD 7 per Hi Sun’s share (vs. current market price of HKD 3.1). In the second column, we present our view of what the NAV may look like one year down the road, when likely in our view the two unlisted assets (VBill and Megahunt) will have been IPOed, and when PAX, which we believe is presently also very undervalued, may have reached a more realistic valuation; here we come up with a SOTP 1-year down the road of over HKD 9, i.e. over 3x current market price. More specifically:

(A)    VBill: VBill is a major (top 10) offline payment processor/acquirer in China. It processes over US$200bn worth of transactions a year, and caters to millions of merchants (mainly small shops). Hi Sun holds a 63% stake in VBill (on a fully diluted basis). The PE fund EQT is the second largest shareholder, having bought a 10% stake in 2019 at a valuation of Rmb 5,880m (a little over US$900m). In the first SOTP calculation (first column) we value VBill at the EQT transaction, i.e. HKD 1.60 per Hi Sun’s share. VBill had been performing strongly up to 2019, but the pandemic last year hit it badly. Whilst China managed to largely contain the virus, offline retail sales actually shrank over 10% in 2020, even more if one strips out large-ticket purchases like cars (which entail little human interaction, and in fact did very well in China last year) to which VBill is not exposed. We estimate (fully year numbers not out yet) that last year VBill’s transaction volumes shrank anywhere between 10% and 15%, largely in line with its reference market. However, as small merchants got badly hit, in order to help its customers VBill last year deliberately slashed its processing fee, one of the highest in the industry by virtue of all the value-added services VBill provides to merchants (various SAAS that help merchants with settlement, accounting reconciliation, tax filing, e-commerce etc). As a result of all this, we estimate that VBill’s net profit broadly halved last year, from a 2019 base of roughly US$100m. However, as offline retail sales in China are now recovering, including for small-ticket purchases, and VBill’s processing fee has been restored to nearly its pre-pandemic level, VBill’s net profit this year may well double in our view, to broadly recover its 2019 level. Going forward, as the relationship between processors and merchant customers intensifies, and more and more SAAS/value-added-services are provided, we expect VBill’s turnover and profits to increase at a rate of 10% to 20% per annum, even assuming stability in transaction volumes. From a valuation point of view, we believe VBill’s closest listed peer (due to size and business mix) to be Huifu (also listed in Hong Kong, ticker 1806). Huifu actually recently announced delisting (by its chairman in partnership with several P/Es, who clearly thought the market was undervaluing the company) at a valuation of some 30x H1 2020 annualised earnings. Putting VBill on the same multiple, equating in our view to roughly 15x 2021e P/E, we come up with an equity valuation for VBill of some HKD 11.7bn, i.e. HKD 2.6 per Hi Sun’s share (for its 63% stake). We believe this is a valuation that very realistically VBill may achieve in any IPO, which we believe will be coming either later this year or (at the latest) early next year, as the EQT transaction in 2019 clearly signals to us an IPO over the subsequent 2-3 years. We deliberately ignore Yeahka, the only other pure-play Chinese payment processor listed in Hong Kong (ticker 9923), as we believe Yeahka’s stock is being overhyped (currently trading at over 60x 2021e consensus P/E), largely on the ground of Yeahka having Tencent as one of its minority investors.

(B)    The cash: there’s a lot of misconceptions about Hi Sun’s cash. For many years this stock was totally forgotten in the Hong Kong market, with the cash making up a substantial portion of its market cap, leading the distracted investor to believe that this company was sitting on an insanely excessive pile of idle financial resources, or (worse) that the cash wasn’t actually there in the first place, i.e. that the books were cooked. In reality, most of the cash serves for business purposes, and anyway represents a small fraction of NAV. More specifically: as of 30 June 2020 (last reported balance sheet) on a consolidated basis Hi Sun held HKD 3.1bn net cash. However, based on company’s filings we estimate that out of this, 1.6bn is actually in VBill, which is consolidated line-by-line. As mentioned, VBill processes over US$200bn worth of transactions a year, so it looks entirely reasonable that it holds some US$200m net cash. Whenever a merchant uses a POS provided by VBill to process a transaction, effectively he is owed money by VBill (settlement is typically t+2, although VBill may offer early t+0 settlement for an extra commission); clearly no merchant wishes to deal with a cash-strapped payment processor. Mind VBill’s net cash is real cash, in the sense that all liabilities have already been deducted, hence this HKD 1.6bn cash may be returned to shareholders under a liquidation scenario. However, as long as the company is a going concern (as of course it is), the cash largely needs to stay there for business purpose, although at least some may in the future be used for M&A. In our SOTP we only include the net cash that is either in the holding company or in its fully-owned subsidiaries, equal to roughly HKD 1.5bn according to our calculations, or some HKD 50c per Hi Sun’s share, equating to less than 10% of what we believe is Hi Sun’s fair NAV.

(C)    PAX Global: PAX, a Hi Sun’s spin-off (listed in Hong Kong in 2010), and in which Hi Sun retains a controlling 33% stake, is one of the world’s top 3 manufacturers of POS (Point Of Sales) machines along with US Verifone and French Ingenico (the latter recently acquired by Worldline). Just like Verifone and Ingenico, PAX is a global business, with now a negligible presence in China, having since years deliberately abandoned the Chinese market (unattractive due to low safety standards and a plethora of low-value-added players competing mainly on price) to successfully venture on the global markets. PAX is the leader in emerging markets (ex-China), with a dominant position particularly in Latin America, where it’s main supplier of POS to Stoneco and Pagseguro (billion-dollars Brazilian payment processors listed in NY). Unlike Verifone and Ingenico, whose POS manufacturing businesses have been stagnating for years, PAX has been consistently gaining market share, by virtue of being able to supply POS machines that are just as good, safe, and technologically advanced as Verifone/Ingenico, but at a significantly lower price. PAX’s turnover has increased some 8x over the past decade, and even last year, despite the pandemic and offline retailers struggling big time, it should have achieved some 15% top line growth (according to consensus, FY results haven’t been released yet). POS machines are not a sunset product by the way. As clearly shown by the experience of China, where mobile payments are already ubiquitous (Alipay and Wechat wallet), by far and large merchants still need a POS (a ‘smart POS’) to process mobile payments as well as cards, and will still need a POS also to collect government-issued digital currency. Credit cards may one day vanish (replaced by mobile payments, e-wallets, and digital currency), but POS will still be needed, and actually the proliferation of different payment methods make them more needed than ever, in order for the merchant to be able to reconcile all these different payments in one single system for accounting/tax purposes at the end of the business day. As the world ex-China is a good 5 years behind China on payments, and still needs to fully transition away from cash, arguably PAX operates in an industry that is still growing, and in this industry, it is the single competitor gaining most market share. At PAX’s current market price of about HKD 8 per share, Hi Sun’s 33% stake in PAX is worth some HKD 1.05 per Hi Sun’s share. However, PAX trades on only 8x 2021e consensus P/E, or some 5x ex-cash. We believe this is an exceedingly low multiple for such a company. By comparison, back in 2018 Francisco Partners (a tech PE) acquired Verifone (a struggling competitor to PAX in our view) at 11x 2021e EV/EBITDA. Valuing PAX at the same multiple (but PAX would deserve a higher one in our view) we come up for a valuation for Hi Sun’s 33% stake in PAX of HKD 2.1 per Hi Sun’s share.

(D)   Cloopen: we won’t spend too much time discussing Cloopen, as there’s plenty of information out there (IPO prospectus here: https://www.sec.gov/Archives/edgar/data/1804583/000104746921000268/a2242866zf-1a.htm). We will only touch on one contentious point/pushback that, from what we gather, seemed to have emerged during bookbuilding, i.e. that Cloopen’s recent top line growth (of only 30% in 2019 and 19% in 9M 2020) is disappointing compared to Twilio (TWLO), a much bigger company ($60bn market cap) growing at even higher rates. However, from what we gather this may reflect the fact that cloud communication is still in its infancy in China; what we are seeing here is really baby steps, out of a country though that has 4x the population of the United States and an economy that is by now nearly as large. Besides, Cloopen claims to have suffered from the pandemic, with only anaemic growth in H1 2020, but already a significant acceleration in Q3 (+38% y/y). Going forward, the company believes it can sustain 40% to 50% growth for the next many years. The smaller size and less than stellar recent growth was indeed reflected in the IPO price of US$16, implying some 8x 2021e EV/SALES, vs. ~25x for Twilio and over 40x for Agora (API), tentatively the two closest peers. However, the stock popped 200% on the first day of trading on February 9 (actually as much as 270% intra-day), and closed at $48. Perhaps underpinning Cloopen’s market valuation is also its scarcity premium. Cloopen is basically the only listed play on the cloud communication theme in China, and its market cap (US$6bn+) and free float (around $1bn at current market price) pale in comparison to Twilio for instance. We value Hi Sun’s stake in Cloopen (17% post-IPO, specifically 27 million shares, with 6-month lock-up) at the current market price of US$48 per share.

(E)    Megahunt (not listed, 65% stake): Hi Sun has incubated this small chipmaking business, and following its usual pattern of incubating, developing, and eventually monetizing, it has already announced (as per Hong Kong stock exchange filings) that it will be seeking listing (at a yet to be announced date) on the Science and Technology Innovation Board of the Shanghai Stock Exchange (“SSE STAR Market”). At the last raising round from PEs in March 2020, Megahunt was valued Rmb 550m, implying some HKD 16c per Hi Sun’s share (for Hi Sun’s 65% stake). However, clearly listing will be sought at a much higher valuation. We assume 2x vs last round, however chipmaking stocks are very hot in China at the moment, and would not be surprised to see an even higher valuation.

Based on the above, assuming both VBill and Megahunt IPO over the next 12 months, and PAX re-rates to a more reasonable multiple, we come up with a 1-year forward SOTP of HKD 9.2 per Hi Sun’s share. After deducting a 20% holding company discount, this equates to HKD 7.4 per Hi Sun share, vs current market price of HKD 3.1. However, we would argue that it is debatable whether or not to apply any holding company discount at all, because clearly Hi Sun is not the sleepy holding company/conglomerate, it’s rather a dynamic listed VC which incubates/develops/monetize, and has an amazing track record of value creation at it, in our view. Incidentally, the 115x increase in book value per share since 2001 (listing of Hi Sun in Hong Kong) through June 2020 (last reported balance sheet) does not take into account the ~US$1.3bn value creation out of Cloopen (value of Hi Sun’s stake in Cloopen at current market price), as Cloopen was accounted at virtually nil value on Hi Sun’s books, by virtue of its accumulated past losses. Adding the Cloopen value creation, the increase in book value per share over the 19-year period since listing would be (pro-forma) over 350x, implying some 36% CAGR. And this does not even reflect the potential listing of VBill and Megahunt, which will give a further significant boost to book value. Last caveat: Hi Sun controls other businesses (IT services to banks and telecom operators – the latter is the business from which Cloopen originates –, and electronic power meters solutions), all fully held, to which we attach zero value in our SOTP, as they are lossmaking and don’t seem to have gained much traction over the past so many years. However, given Hi Sun’s record, we wouldn’t be surprised if eventually some value may come up out of those businesses.

Prior to Cloopen filing with the SEC for its IPO on the 19^th of January, Hi Sun’s stock was languishing at around HKD 1.2 per share, worth just a little over its net cash per share. Even now, after already going up over 2.5x on the back of Cloopen’s IPO, it still trades at barely 1/3 of our SOTP, which (we believe) is not at all based on outlandish assumptions, just market prices and peer multiples really, and after deliberately stripping out/ignoring the highest-rated peers (if we were to value VBill at the multiples of Yeahka, 9923, after all the only Chinese payment processor/acquirer left listed in Hong Kong after the imminent delisting of Huifu, 1806, we would have to add another HKD 8 to our SOTP reaching over HKD 17 per Hi Sun’s share). So why is the stock so cheap, and why was it even cheaper??? Talking to investors and analysts in Hong Kong for the past two years (this is how long for we have held the stock for), we frequently hear the following two key ‘explanations’ / concerns:

1.       The company holds way too much cash and never paid any dividend, which makes it suspicious – is the cash actually there? Are the books cooked? We partially de-bunked the ‘too much cash’ concern above in the sum-of-the-parts discussion. Over half of the cash is tied in VBill, and serves VBill’s business purposes, and the rest is really not very much as % of Hi Sun’s fair NAV, less than 10% according to our calculations. Hi Sun is basically a VC that runs permanent capital, cannot rely on LPs providing funds whenever an opportunity comes across, thus it’s only natural that it holds some cash. Rather, in our view investors were entirely ignoring the rest of NAV which was not the cash and the stake in PAX (the only ‘evident’ assets up until yesterday; and even PAX, as we discussed, they severely undervalue it in our view), which made it look, wrongly, as if the cash was well over half of NAV, and was sitting idle. As per the dividend, for a company, that is basically an investor, and that has been able to grow its book value per share at a clip of over 30% a year for nearly two decades, it would be foolish to pay any dividend in our view. Did anyone ever ask Berkshire Hathaway to pay dividends?

2.       The company is murky and mysterious, governance is poor, and minorities are taken for a ride. When companies, especially small caps, trade at truly ludicrous valuations, this is often the explanation being offered, and, let’s face it, most of the times it holds at least some merit. However, in the case of Hi Sun we believe it doesn’t hold any. When we hear investors raising such allegations/concerns, almost invariably they cite two things: one, that Che Fung is a major investor in Hi Sun (12% stake), and two, that back in 2016 an analyst got kicked out of a PAX’s analyst meeting. Let’s analyse these two things one by one. Che Fung, or Che Feng, is the son-in-law of former People's Bank of China (PBOC) governor Dai Xianglong. Back in 2015, according to media reports Che Fung was arrested, or at least put under investigation, allegedly for corruption. Subsequently, we suspect that he may have been quietly released, as hinted also by the fact that his father-in-law is still one of the most prominent figures in the Chinese Communist Party, and has never been removed from any of his official duties. From what we gather, Che Fung is a businessman worth billions of dollars, and his stake in Hi Sun represents a negligible fraction of his net worth. Additionally, he (nor any of his associates) have ever held any board seat either at Hi Sun or at any of Hi Sun’s subsidiaries. He has always ever been just a passive investor in Hi Sun, which is controlled by its founder/CEO Kui Man Chun (holding a 22% stake, and who basically controls the board), who graduated in international relations from Peking University, is a tech investor since nearly 30 years when he was in his ‘20s, and although keeping a low profile has never (to our knowledge) had any problem with the justice neither in China nor anywhere else. So overall, we would conclude that Hi Sun simply had the misfortune that an ultra-HNW individual with a questionable reputation likes the company, but clearly this doesn’t imply any wrongdoing on the part of Hi Sun nor any of its officers. Coming now to the episode of the analyst getting kicked out of the PAX’s meeting. Back in 2016 Chris Lee, who was the CFO of Pax Global, kicked a Macquarie analyst out of its results briefing due to its negative rating. Incidentally, the analyst’ bad rating was largely based on the view that PAX was wrong to de-emphasize the China market and venture abroad, particularly in Latin America; in hindsight, given PAX’s tremendous success in the global markets and particularly in LATAM, we can say that the Macquarie analyst was totally wrong, which may explain PAX’s CFO irritation. It doesn’t condone it though, and in fact Chris Lee resigned right after the incident. Does this imply that PAX and its parent have bad governance? We don’t think so, we just think that PAX had hired an irascible guy as CFO. As a matter of fact, setting aside the fact that Hi Sun is audited by a major auditor (PWC) which may not mean very much, digging into the near 20-year history of the company as a listed company, we simply could not identify a single episode of shady governance, or actual abuse of minority shareholders.

Which all leads us to the real reasons why the stock is so cheap (and was even cheaper). Hi Sun does provide (in our view) timely and actually quite thorough disclosure, in its annual reports, and in general in the filings to the exchange. All the information has really always been out there, but clearly one has to go through the filings and read them and do some basic research, because the company is definitely NOT of the self-promoting type: it doesn’t hold analyst briefings (although, at least in our experience, the IR and CFO are generally accessible and speak English), it doesn’t have a flashy presentation on its website, and, as a result (plus all the misconceptions debunked above), it doesn’t have any proper broker coverage, nor (to our knowledge) is invested by any major fund. The fact that the CEO/founder controls the company with only a 22% stake (hence may fear being ousted) may go a long way to explain Hi Sun’s shyness (no briefings, no flashy presentation, no roadshows), but shyness doesn’t equate secretiveness in our view, nor (worse) wilfully misleading investors, because as mentioned filings are timely and complete, and no one (in our view) can say that any relevant information has been withheld.

Last but not least, incubating, developing, and eventually monetizing businesses is clearly a process that takes several years, with crystallisation events (typically via IPO) being inevitably lumpy; prior to Cloopen, the only other IPO of any of the group’s subsidiaries was that of PAX back in 2010. Let’s face it, most investors don’t have such patience. However, with the IPO of Cloopen now shedding a very big light on the company’s record of value creation, and (we believe) more crystallisation events likely coming over the next 12 months (IPOs of VBill and Megahunt), thus attracting the attention of even the most distracted and short-termist investors, we believe that the time has come for the stock to catch up with its fair NAV, and from there grow at whatever rate the company will manage to keep growing its assets; past performance doesn’t guarantee future results of course, but the track record here, in our view, is pretty exceptional, and mostly (totally, until 3 weeks back) overlooked.

The fact that Hi Sun’s stock is cheap (and was even cheaper) largely due to investors being lazy/distracted is clearly shown by the enlightening Cloopen’s example. Further to Cloopen filing for the IPO, in less than three weeks Hi Sun’s stock has gone up by some HKD 1.9 per share, or over 150%. Although HKD 1.9 per share captures only partially even just the value creation out of Cloopen (at CMP for Cloopen of $48, the 27 million shares Hi Sun holds in Cloopen are worth $1.3bn, or HKD 3.6 per Hi Sun share), 150% in 3 weeks is clearly something. Naturally, one would have to conclude that, prior to the IPO, investors were valuing Hi Sun’s stake in Cloopen at zero. However, although carrying the investment at nil book value (due to the accumulation of Cloopen’s past losses writing off Hi Sun’s modest investment), in its filings to the Hong Kong Stock Exchange Hi Sun has always disclosed any raising round done by Cloopen, and its implied valuation. At the last round in November last year, Cloopen had already been valued US$825m, already implying a value for Hi Sun’s 21% (pre-IPO) stake of some HKD 50c per Hi Sun’s share (and here is Hi Sun’s relative filing: https://www1.hkexnews.hk/listedco/listconews/sehk/2020/1105/2020110500011.pdf). Clearly, the investor public totally ignored or dismissed any such filing. We believe the same applies to any equivalent filing regarding VBill and Megahunt. Thus, we fully expect Hi Sun’s stock to go up by as much as the value of its stakes in VBill and Megahunt at any IPO, at the latest whenever those IPOs will occur (within the next twelve months we believe), or (at least partially) earlier if, after watching what happened with Cloopen, the investor public may have now become less distracted.

Catalyst

IPO of spin-off Cloopen (RAAS) drawing at last attention on Hi Sun's severe undervaluation and amazing track record of value creation