Description

Hong Kong Economic Times Holdings Limited:  HKET may be the cheapest newspaper asset in the world. At HK$1.64, the stock offers the opportunity to purchase the "Wall Street Journal of Hong Kong" at an extremely compelling valuation on an absolute basis and at a deep discount to global comps facing profound secular pressure. HKET has a highly cash generative business leveraged to a cyclical rebound in Hong Kong's advertising spend and capital markets activity, and in contrast to North American peers with significant declines in readership, has maintained stable circulation. We believe the company is conservatively worth ~3x its current share price, with limited downside owing to HK$0.78 of net cash per share, HK$0.27 FCFPS and a 10% dividend yield on adjusted equity value.

Overview

HKET publishes a Chinese-language financial newspaper, operates a Bloomberg-like market data service, and has a classified recruitment business.  HKET has an enterprise value of HK$370mm and for the fiscal year ending March 2010, we estimate the company will generate revenue and EBIT of HK$780mm and HK$92mm, respectively. Management has increased the company's dividend payout ratio in each of the last four years, most recently to 60% of earnings.

(HKD in mm)

Wall Street Journal of Hong Kong:  With ~65% market share, the Hong Kong Economic Times is Hong Kong's Chinese-language equivalent of the Wall Street Journal.  Between FY2003 and FY2008, circulation revenue and ad revenue grew at 19% and 11% annual rates, respectively. Circulation has shown remarkable resilience over time, and is now less than 2% off its 2007 peak after increasing 8% sequentially in 1H09.

Increasing stock market activity has historically driven higher circulation and ad rates.  In 2H08, average daily trading volumes on the Hong Kong Stock Exchange Main Board fell 50% and this trend continued through April 2009. Recently, however, volumes have picked up: 

Similarly, IPO listings, which generate announcement revenue for the company, were down nearly 30% year-to-date through August but increased dramatically in September and the number of IPO applications approved in principle and under review has jumped, suggesting listing activity is likely to accelerate in the near term.

As the Hong Kong economy and stock market activity recover, HKET is well positioned to benefit from growth in its readership within the financial community and increasing advertising and IPO listing announcement revenue.

Lagging Share Price Performance and Valuation:  Due to their shared dependence on the health of Hong Kong's capital markets, Hong Kong Exchanges and Clearing (which operates the Hong Kong Stock Exchange) and HKET have historically exhibited a tight correlation in their share price performance. This relationship has recently broken down as the table of indexed share price performance below demonstrates:

While the HSI and Hong Kong Exchanges and Clearing shares have rebounded 106% and 180%, respectively, from their lows, HKET has recovered only 45%. We expect HKET shares to snap back as investors recognize this disconnect.

With an adjusted P/E of 4.5x, HKET also trades at a ~60% discount to its Hong Kong newspaper peers SCMP Group and Next Media despite superior defensive characteristics and growth. Shares in US comp Gannett trade at 8.5x earnings and 7x EBITDA, and trading levels for the bank debt and bonds of distressed US newspapers imply valuations of 4.5x EBITDA and higher, despite the severe secular pressures they face.

Hidden Value in "Chinese Bloomberg": The company's ET Net segment (reported as the Financial News Agency segment) provides investors with market data and news.  Because of its dedicated staff of reporters that cover Hong Kong listed companies, ET Net is the dominant service-provider for Chinese language terminals, with over 70% market share (ahead of Reuters).  Like Bloomberg, ET Net has an "economic moat" that protects it from competition: proprietary content, "mission critical" information, a reputation for reliability, and a network effect.  In FY2008, ET Net grew operating profit 134% and in FY09 at 38% even as Hong Kong's financial sector contracted.  The current monthly rate per terminal is US$130 versus US$1,500 per month for Bloomberg, suggesting significant room for price increases.  While this business is currently small, it has tremendous growth prospects and deserves a high valuation.

New Publications and Lifestyle Portals:  HKET launched three new publications between October 2005 and October 2007.  Combined, the new publications lost HK$10 million to HK$15 million in both FY2007 and FY2008, and broke even in FY09. Management has said that these publications can achieve run-rate EBIT of HK$30 million within the next few years. In addition, in FY09, the company launched three internet-based "lifestyle portals" providing food, travel and health-related information and services. These lost HK$11mm in FY2009, but we conservatively estimate can contribute HK$5mm over time.

Cost Cuts:  Management has identified HK$60mm of cost cuts for FY2010. These include the benefits of headcount reductions and pay cuts already implemented in Q1 2010 to staff costs (47% of total opex) and collapsing newsprint prices (14% of total opex, down 40% from December 2008 peak levels):

Free Option on China:  China is a vast opportunity for HKET.  As of December 2007, China had an estimated 138 million investment accounts compared to 1.6 million investors in Hong Kong.  ET Net has already established partnerships with two leading market data providers in China and is poised to dominate the Chinese market for Hong Kong data and financial news.  If HKET is able to achieve even a small fraction of its Hong Kong ET Net and newspaper penetration in China, that business could conservatively be worth HK$10-HK$20 per share. We do not include this in our valuation but highlight it as a significant free option.

Historical Results and FY2010 Projections

The following FY2010 projections assume no near-term benefit from expansion into China, continued declines in advertising, listing and recruitment revenue and no ramp in ET Net, new publications and other new initiatives. Declines in advertising revenue are more than offset by approximately HK$60mm cost cuts described above. We believe FY2010 will represent trough revenue for the company as adspend and financial newspaper readership recover. 

 The following table bridges FY09 to FY10 EBIT:

Valuation

For HK$1.64, you are receiving HK$0.78 of current cash balance (net of minority interest), HK$0.27 of FY2010 FCF, and ET Net and core operations for 3x FY2010 EPS of HK$0.19 on trough cyclical revenue, with free options on a cyclical adspend/circulation rebound, HKET's new publications, the recruitment business's return to profitability, the lifestyle portals and potential China expansion. We arrive at a target value of HK$4.50 based on a sum-of-the-parts analysis. The company's current net cash balance and FY10 FCF are worth HK$1.05 per share. The performing portion of the business, including ET Net and core publications valued at 15x and 10x earnings, respectively, are worth HK$2.42.  This represents over 100% upside to the current share price and is arguably overly-conservative given the cyclical revenue decline reflected in our FY2010 projections. Valuing HKET's new publications and recruitment business at 10x normalized earnings and the lifestyle portals at 15x implies an incremental HK$1.03 of upside, for total value of HK$4.50, nearly triple the current share price.

Catalyst

 -Hong Kong Stock Exchange trading/listing activity recovery

-Cost cuts

-ET Net return to growth

-New publications profitability

-Dividend increases

-Expansion into China