Description

The idea is listed as Nexen Corp and the ticket provided is for the Nexen Corp preferreds because I think those are the most attractive securities in the structure but below I will discuss 4 different securities all with their own pluses and minuses. If you're put off by the size of the entity or the implied liquidity you may want to take a look anyway as the Nexen Tire common stock is considerably larger (US$750m MCap) and more liquid.

The numbers below come from Bloomberg, Google translations of the companys’ annual and semi-annual reports, and the companys’ english language financial statements.  Numbers are in KRW except where a $ is used (generally just to give a sense of scale and provide insights into liquidity in $ terms). Values are as of 09/09/19.

The Nexen corporate family is primarily engaged in the production and sale of tires.  The largest entity, Nexen Tire, is a growing and profitable tire producer with ~2bln KRW of LTM sales (~US$1.7bln at current FX rates); the company has lost money once (2008) in the past 20 years.  The company is currently FCF negative as it funds construction of a facility in The Czech Republic that should be completed in 2023.

In addition to tire holdings, the corporate family has interests in a Korean TV/Radio business and Real Estate.

Unfortunately, I have no particular view on the tire industry and the company does not file in English (Nexen Tire does put out a quarterly presentation summarizing results in English and you can get English financial statements without any notes or discussion from either company’s website).  That said, some investors may view the valuations for all or some of the securities in this structure as cheap enough to warrant an investment without detailed English disclosures. As is often the case, the cheapest securities have limited liquidity so may not be appropriate for many strategies.

There are a number of potentially attractive ways to make an investment in the Nexen entities.  One could purchase the common stock of Nexen Tire (which trades more cheaply than competitors), the preferred stock of Nexen Tire (less liquid but with superior economic rights and a 60% discount to the common), the common stock of Nexen Corp (a cheaper way to play Nexen Tire’s common as well as some other investments but less liquid) or the preferred stock of Nexen Corp (limited liquidity, superior economic rights, 40% discount to the already discounted Nexen Corp common).

As a brief explanation, the preferred shares discussed are non-voting (but the entity is controlled anyway so votes don’t matter), are less liquid, but come with a higher dividend than the common (+1% of par - +5KRW/year in this case). 

Nexen Tire:

While I think that Nexen Corp is cheaper and aligns you better with management’s interests, Nexen Tire appears to be cheap on a stand-alone basis and has proven to be a durable and high-quality tire business.  The business is well diversified, has limited China exposure (~33% North America, 20-25% Korea, 20-25% Europe, 5% China, 15% RoW), and has a mid to high 40’s mix of ultra high performance (higher margin/less commoditized) tires.  Unfortunately, the financials are all in Korean; Google can translate them into English but this is generally just good for looking at the numbers as the text doesn’t translate very well. In any event, the business has proven very stable with EBITDA margins routinely in the 15-20% range and Net Income margins typically in the 6-9% range.

The common trades $500,000-$1,000,000 a day while the preferred trades ~$10,000 on a decent day.  This has led to the preferreds trading at a large discount to the common (~60%) - you can create the business for ~930bln KRW through the common or ~390bln KRW through the preferred (which receive a 5% higher dividend at present):

This leads to some very cheap metrics for the preferred (while the common itself appears attractive on a comps basis):

The only peer that trades in-line with Nexen’s common is Goodyear but a high-level overview indicates to me that Nexen’s a better business (or has benefited from macro trends over the past 9 years and with the KRW continuing to weaken it doesn't seem like that should abate anytime soon) as well it is less levered:

Nexen Corp:

Nexen Corp is the parent holding company which owns:

• 43.26% of Nexen Tire Common

• 100% of Nexen Sangyo (a Chinese tire company)

• 100% of Nexen D&S (Real Estate)

• 39.44% of Korea New Network (publicly traded TV/Radio Company)

• 13.46% of Gaya Development (Golf Course)

• As well as some Rubber/Tire businesses at the corporate level

The 6/30/2019 non-consolidated parent company balance sheet is reproduced in the left-most column below.  Moving right are a series of adjustments to the balance sheet which:

• Remove the capitalized value of subsidiary investments

• Add the market value of Nexen Corp’s ownership in Nexen Tire and Korea New Network

• Add the book value of other subsidiaries multiplied by Nexen Corp’s ownership of those subsidiaries

The result is a pro-forma book-value/fair-value estimate of ~750bln KRW.  Keep in mind that this pro-forma number only gives credit for Nexen Tire at its current market price but some may agree that Nexen Tire is itself cheap.  If I add the difference between market and book for Nexen Tire the Pro-Forma book-value/fair-value for Nexen Corp, as shown in the bottom right, would be ~990bln KRW.

Note: At 395bln KRW, the Nexen Tire stake is valued at .6x tangible book and 6.6x trailing earnings.

To sanity check this valuation, the earnings stream Nexen Corp is entitled to is roughly as follows on a LTM basis:

Which provides for an RoE of ~12-12.5% on the ~750bln KRW fair value (~10% on the ~990bln KRW value) which seems pretty reasonable.

If you buy the common you are creating the business for ~330bln KRW while the preferred create it for ~205bln KRW:

In terms of valuation metrics this is what you’re paying:

Conclusion:

The common stocks of both Nexen Corp and Nexen Tire seem cheap.  The preferreds represent a highly discounted way to buy economic interests in companies that are already cheap and which have shown an ability to compound value at attractive rates over long periods of time.  In terms of valuation, I don’t know what the right number is but it certainly seems a lot higher than present pricing. The Nexen Corp preferreds, in particular, are probably worth 4x what they’re trading for and are compounding value at a low to mid teens rate.  You’ll probably be stuck in these for a long time so they may only be appropriate for very long-term capital but if viewed as claims on the underlying businesses these securities seem mispriced. The other securities are less cheap (in my eyes) but appear to be attractive investment opportunities in their own right (potentially with a less demanding time horizon given improved liquidity).

While I have no timeline for realization of value I would note both companies are trading at their all-time lows on P/TBV, Nexen Tire is at its all-time low on P/E, and Nexen Corp is near its all-time low and >10% below its long-term average on a P/E basis.

Note: Nexen Corp is in the top half of the chart while Nexen Tire is in the bottom half.  P/TBV in Yellow; P/E in Blue

Nexen Corp’s Preferreds are trading at a much larger than typical discount:

While Nexen Tire’s Preferreds are trading more or less in-line with historic averages:

Other Considerations:

I don’t have any particular insight into (i) when dividends might pick up [my guess is when Nexen Tire is done with its investments in the Czech Republic FCF should pick up but the company has a fairly sizable debt burden and Korean companies are no strangers to hoarding cash] or (ii) when the company might make efforts to crystalize value.  That said, Korea is becoming more minority shareholder friendly and the government is attempting to improve the efficiency of the capital markets (adoption of the stewardship code, prosecution of formerly untouchable executives, more favorable media coverage of activists etc.). The father/patriarch, who still chairs both companies, is now 80 years old; an estate event or retirement might presage a structure collapse.

In terms of management/insider incentives, the controlling family (who also run the business) owns a lot more of Nexen Corp (~56%+) than of Nexen Tire (~25%+).  In addition, the son (Kang Ho-Chan) owns much more of Nexen Corp than of Nexen Tire while the father’s (Kang Byung-Joong) holdings are reversed. Both of these factors imply management should seek to shift value from Nexen Tire to Nexen Corp whenever possible - this may explain why Nexen Corp has its own investments in tire businesses and why they are performing so well (the Nexen Corp parent entity generates a ~14.5% RoE on book value less investments in subsidiaries and the Nexen Sangyo tire business generates a ~22% RoE).

Catalyst

Unfortunately this is one of the major drawbacks.  I am unaware of a clear catalyst here other than relative and absolute (vs. historic and peer) valuation and the fact that Nexen Corp's preferreds are trading near an all-time high discount to the common.