Description

Business Description

Hopefluent Group Holdings Limited (“Hopefluent”, or the Company) is a real estate agency service business listed on the Hong Kong Stock Exchange since 2004 (ticker: 733), with a market cap of c.US$ 260m / c.HKD 2bn. We believe the business is undervalued with asymmetric upside-downside return profile (after all, 70% of the Company’s market cap is covered by net cash already, and receivables completely covers total liabilities). Historically, c.50% of the Company’s total revenue were generated from Guangzhou City and the rest 50% from other parts of China. The Company is controlled by its Founder Mr. Fu and his family with 36.4% ownership; Fang Holdings Limited (16.8%), Value Partners (5%), PYN Fund Management (5%) are the other notable shareholders.

Hopefluent currently has four segments: Primary Property Real Estate Agency (“Primary”), Secondary Property Real Estate Agency (“Secondary”), Financial Services (“Financing”) and Property Management.

• Primary (65% of 2016A segmental profit): assist property developers in selling new residential homes and receive on average 0.7-0.8% commission for each unit sold (in some cases commission could range from 0.5-10%). Hopefluent sells new homes through a combination of “onsite” and “offsite” model (explained later). In 2016, Hopefluent worked on 1,000 projects in more than 150 cities in over 20 provinces in China and is the third largest player in China with a c.3% market share nationwide. Hopefluent has a near dominate position in Guangzhou City with over 60-70% market share; Guangzhou accounts for c.30% of Hopefluent’s Primary revenue (our estimates)

• Secondary (12%): the typical residential property brokerage business for second-hand homes, commission rate varies a lot across China and is around 1-2% in Guangzhou. Hopefluent’s Secondary business is almost all in Guangzhou with c.400 branches and >10% market share there (no.1/no.2 position)

• Financing (12%): mortgage referral and loan financing services (i.e. bridge loan) to individuals and companies for secondary properties. Historically Financing revenue were derived from Secondary transactions and thus were grouped under Secondary before 2016 reporting. For consistency purposes, we will combine this segment with Secondary in our analysis

• Property Management / Asia Asset (11%): subsidiary Asia Asset Property Services (“Asia Asset”) provides property management services to about 300 residential, office and commercial properties in Guangzhou, Shanghai, Tianjin and Wuhan with total GFA of c.30m sqm. Asia Asset was ranked no.20 in China’s top 100 property management companies list in 2017. Hopefluent announced on June 30, 2017 that it plans to list Asia Asset on China A-share market soon. Asia Asset is (relatively) the crown jewel of Hopefluent and the potential IPO could serve as a near term catalyst

Hopefluent’s historical segmental profitability:

Market and Competition

1. Primary:

• China nationwide primary market share: an increasingly concentrated market with No. 1 Shenzhen World Union (China A-share listed) having c.5% market share, No. 2 E-House (once NYSE listed) having c.4% market share, and No.3 Hopefluent having c.3% market share. Centaline and Syswin are the other two sizable players, and Home Link (Lianjia) is also active in the primary market through offsite business model. In sum, top 5 players have >15% market share

• Business model:

• Onsite: Primary players to send their sales agents to official sales offices which are usually located at new residential homes. Potential sales leads are generated through walk-in and ads placed by property developers. Shenzhen World Union, E-House and Syswin are pure plays of onsite model

• Offsite: Primary players to utilize their secondary branches to generate potential leads. Since property developers bears no ad expenses, offsite model would normally yield a higher commission %. Home Link (Lianjia) is a pure play of offsite model. Hopefluent and Centaline use a combination of onsite and offsite model in cities where they have secondary branches

• Tailwind of the industry:

• Consolidation of residential property developers in China will lead to natural market share gain for top primary players as reputable developers tend to work with reputable agencies. The market share of top 10 residential property developers increased to 26% in 1H2017 vs. 17-19% in 2015-2016 vs. <10% 5-7 years ago. As a result, the top primary players nearly doubled their market share vs. 5-7 years ago

• Top players’ economics of scale (i.e. presence in large number of cities) will help manage the cyclicality and drive smaller players out of business in tier 3/4/5 cities

• Natural / secular increase in property price in China could serve as a revenue driver even when transaction volume (GFA) stop to grow

• Headwind of the industry:

• Some have the view that primary agencies are less and less important / differentiated now. Commission rate has decreased to c.0.8% for top 3 players, and it could decrease further (although it seems to have stabilized at c.0.8% for a few years now)

• Worries that real estate developers would take over primary agencies’ job (i.e. sell the homes themselves), however, we think the risks are relatively low given 1) developers do not have the economics of scale to meet peak demand and geographical coverage and 2) primary agencies are already running on very thing margins

• We also learned from industry insiders that primary agencies sometimes are "essential" to the value chain (third party vs. in-house) for dealing with / delivering kickbacks to certain mid-level management at property developers. We won’t go into more details on that here, but quick conclusion is that we think primary agencies probably will be there for the long run

2. Secondary:

• Guangzhou secondary market share: top 4 players (Home Link, Hopefluent, Centaline and Yufeng) have c.50% of the market. Home Link and Hopefluent are the market leaders with >10% share (some sources also said 25%). The competitive dynamics have been stable, and performance are mainly affected by local market cyclicality

3. Property Management:

• Highly fragmented market but is becoming more and more concentrated towards top players. In 2016, top 10 property management companies accounted for 10% of the total market and top 100 accounted for 30%. In comparison in 2013, top 10 accounted for 5% and top 100 accounted for 16%

• Property management companies in China grow though:

• Dropdown from real estate developers – all major real estate developers have their own affiliated property management subsidiaries. Newly developed properties would automatically hire those affiliates for property management

• Acquisition of smaller property management companies which were owned by smaller real estate developers who are looking to exit the business

• Bidding for new/existing contracts on open market. We believe Hopefluent’s Asia Asset, which is differentiated by providing Hong Kong-style property management expertise, growths mainly through this

• Recently, there has been a wave of property management companies IPOs. 4 of them are now listed on Hong Kong Stock Exchange and 2 have filed for A-share IPO

• We like the property management business in general and believe top players will have long runway for growth. Please also refer to Chalkbaggery’s write up on Zhong Ao Home Group on October 12, 2016 for more information

Valuation

1. Notes on run-rate:

• 2016 was an exceptionally good year for China real estate. Although the positive trend has carried into 2017YTD (as evidenced by Shenzhen World Union’s 30%+ growth achieved in 1H2017), we would like to stay conservative on Hopefluent’s run-rate numbers given Guangzhou real estate market, Hopefluent’s core market (c.50% revenue), has cooled down significantly due to new local government policy (homebuying restrictions) implemented in March 2017

• Under the strictest homebuying restrictions policy in Guangzhou now, our channel check indicates the residential property market transaction volume for both primary and secondary have fall back to 2014/2015 levels

• We believe 2014/2015 would be a good proxy for Hopefluent’s Primary and Secondary sustainable profitability for the long run and have assumed the following numbers

• Run-rate EBIT: HKD 286m

• Run-rate NI: HKD 203m

2. Standalone / Current Valuation:

• EV/2016A EBIT: 1.4x; EV/run-rate EBIT: 2.3x

• P/2016A NI: 6.7x; P/run-rate NI: 10.0x

• P/Tangible Book: 0.86x

• 2016A Net Cash % Market Cap: 70%

• 2016A Dividend Yield on Current Share Price: 3.8%

3. STOP:

• Very conservative assumptions still yield 47%-107% upside on fair value

4. LBO:

• Hopefluent serves as a good potential privatization candidate, even under the most conservative terms, a PE could still offer at least 30% premium to achieve 30% IRR

• Key assumptions (conservative): flat financials on run-rate terms, 2x EBITDA leverage, cash sweep on, 5% equity reserved for management

• Illustrative Offer Premium to Current Price (HK$3.05) and Expected IRR

Why Undervalued?

This is the hardest part of the writeup where we struggled to come up with prefect explanations. First and foremost, we believe the company is not a fraud. Since December 2014, the Founder Mr. Fu has spent c.US$6m buying Hopefluent shares on open market – equivalent to a c.2.8% stake. The Company has been paying dividend every year since 2005 (except for 2009 when the business generated a loss). The huge cash balance should be real – they were cumulated through the past decade, plus the private placement from Fang Holdings in 2014. The company has always hired Deloitte as auditor. The most comforting part came from Fang Holdings’ private placement in 2014; as a listed player in the industry, they should have known Hopefluent very well and have done the necessary due diligence before investing

• However, the cash balance did bring questions as 2016A bank interest income was only HKD 7.8m, implying a yield of merely 0.46% on 2016 ending cash balance and 0.72% on 2015 ending cash balance, whereas the Company's annual report states the interest rate ranges from 0.01% to 5.6%. In common sense, a c.2% cash interest yield would be normal. Potential explanation could be that the business requires a substantial cash balance to operate since developers might have a very long credit terms

We have spoken to a few stock market guys from both sellside and buyside. They all view the business as solely a new home broker, which is unattractive as a) in a bull property market, primary broker will have lower commission rates as new homes “sell themselves” and; b) in a bear property market, primary broker is important but will experience substantial volume contraction which leads to declining revenue & profitability

The quick summary (of what the market might think):

• Hopefluent’s revenue grows but probability doesn’t, so 10x run-rate PE for a flattish business / low quality business is fair in Hong Kong market

• Huge cash balance is not being utilized, so it is not meaningful, plus c.4% dividend yield is fair

• Low liquidity / small cap, so most of the institutions won’t bother with it (although Value Partners and PYN have invested moderately)

Potential Catalysts

1. Fang Holdings is severally underwater and may seek to divest its c.17% stake in Hopefluent. We believe such divestment would lead to a revaluation of the Company. Fang Holdings invested at c.HKD 3.0 per share, and it will certainly try the best to maximize the selling price

• Fang Holdings obtained c.17% stake in Hopefluent through a private placement in late 2014, with the aim to strengthen relationships for Fang Holdings’ new home advertising business and to develop a real estate finance JV with Hopefluent. To date, public source indicates the real estate finance business has not been materialized. In other words, Fang Holdings’ c.17% stake ownership has not brought any synergies for both parties and should be viewed as non-core to Fang Holdings

• Fang Holdings’ business model as well as the market environment it competes has drastically and structurally changed since 2014, and the business has turned from highly profitable into lossmaking, from net cash into net debt. Fang Holdings is running out of options (can read up on the Carlyle/IDG convertible debt deal in 2015 and terminated A-share backdoor listing with 600847 in 2016). Fang Holdings itself could be a good short but we won’t go into more details here

• In summary, to stay solvent, we believe Fang Holdings will have to divest its sizeable stakes in Shenzhen World Union and Hopefluent sooner or later, which should lead to a revaluation of Hopefluent

2. Hopefluent announced on June 30, 2017 that it is exploring the option to list its property management business in China A-share market

• The valuation of property management business could easily reach >15x PE in A-share IPO

• Asia Asset IPO might lead the market to value Hopefluent on SOTP basis

• Some of the IPO proceeds could be distributed as special dividend to Hopefluent shareholders

3. Hopefluent will benefit from the “Guangdong-Hong Kong-Macau Greater Bay Area” Initiative proposed in 2017

• Hopefluent generates c.50% of its revenue from Guangzhou City, which is located at the heart of the new bay area

• In addition, its strong presence in other parts of Guangdong province such as Dongguan, Foshan and Zhuhai will also benefit from the increased development / business activities

4. Founder Mr. Fu is 68 years old now and he may look to retire / cash out from the business

• From public information, the son/daughter of Mr. Fu doesn’t seem to be involved in the business

Risks

1. Although still undervalued, the share price has gone up a lot YTD, from c.HKD 2.0 to HKD 3.05 now

2. Post the new local government policy (homebuying restrictions) implemented in March 2017, the market has drastically slowed down in Guangzhou ever since. Although we have tried to reflect the normalized run-rate numbers in our valuation work, the actual results might come out even worse

Catalyst

1. Fang Holdings is severally underwater and may seek to divest its c.17% stake in Hopefluent. We believe such divestment would lead to a revaluation of the Company. Fang Holdings invested at c.HKD 3.0 per share, and it will certainly try the best to maximize the selling price
2. Hopefluent announced on June 30, 2017 that it is exploring the option to list its property management business in China A-share market
3. Hopefluent will benefit from the “Guangdong-Hong Kong-Macau Greater Bay Area” Initiative
4. Founder Mr. Fu is 68 years old now and he may look to retire / cash out from the business