Description

The Cross Harbour Holdings, Ltd. (CHH) is a Hong Kong holding company whose primary assets consist of net cash, and concessions in two toll roads providing critical infrastructure to the city of Hong Kong. While many Holdco’s trade at sum-of-the-parts discounts, CHH’s valuation is extreme and with a margin of safety backed not just by the cash & investments on the balance sheet (70% of market cap) but by a easily salable regulated asset with separately audited financials (another 120% of market cap).

Background

Both of CHHs concessions are BOT (Build, operate, transfer) infrastructure projects funded 100% by the private sector. Under the terms of the BOT, the franchisee is responsible for the construction and operation of the Tunnel until the end of the franchise period. During the franchise period, the Company is allowed to earn a its return through the collection of tolls. On expiration, the tunnels are transferred to the Government.

The Tate’s Cairn Tunnel, the longest road tunnel in HK was awarded in 1988 and completed in 1991 at a cost of HK$2Bn - this concession will expire in mid 2018. CHH owns a 37% effective interest in this concession. The Western Harbour Tunnel was awarded in 1993 and completed in 1997 at a cost of $7Bn – this concession will not expire until 2023. CHH owns a 50% interest in this concession through Western Harbour Tunnel Company (WHTCL), the other shareholders are CITIC pacific and Kerry Properties.

CHH owns two smaller businesses as well; a 35% effective interest in Autotoll limited which provides electronic toll clearing facilities in Hong Kong covering eleven different toll roads and tunnels (think -EZ pass) and a 70% interest in Alpha Hero Group, a chain of local driving schools.

For most of the company’s history, cash flow generated at the toll road concessions was used primarily to pay down the significant debt that was held at the concessionaire level. This was fully paid down around the middle of 2013 and cash has started to build on the balance sheet ever since.

The company is effectively controlled by Cheung Ching Kiu, through his Honway Holdings 42% interest. But exec comp has been reasonable and the company has paid out 30c in dividends (4% yield) every year since 2006.

Valuation

With 10 years of cash flow distributions left to come, the Western Harbour Tunnel concession is CHH’s most valuable asset by far. Because it’s a government concession, the company is required to publish its own separate financials, which are more useful the CHH’s own given they account for this business as an equity interest. (WHTs seperate financials can be found here: http://www.westernharbourtunnel.com/en/annual_report/14/09_eng_financialinformation.pdf)

Revenue is a function of toll rates and traffic growth. Toll rates are regulated, in the sense that the concession company can only raise rates up to a rate which allows them a ‘reasonable but not excessive’ return on the construction of the road.  Under the WHC Ordinance authorizing the concession, the Company is entitled to request the Government to publish a toll increase should the actual Net Revenue generated be less than the Minimum Estimated Net Revenue. The actual revenue is currently running far below (about ½) the minimum estimated net revenue calculated at the time of construction, so effectively the company has the ability to raise prices up to whatever they believe the market will bear.  The company most recently raised prices in 2013, with an effective 10% increase.  Traffic growth is also likely to be favorable as WHT is an “overflow” tunnel, the most expensive and least effective of the three crossings into the island.  As a result, traffic growth first went to the competing tunnels until they were fully congested and only recently moved into WHT. The increasing growth rates in WHTs traffic in recent years bear this out:

Traffic CAGR
2000-2014 -> 2.5%
2005-2014 -> 4.5%
2009-2014 -> 10%

Also WHT has increased its relative market share every year since its initial ramp up in the early 2000s and even increased traffic in 2013, the year they implemented a 10% price increase.

Depreciation is the largest “expense” and bears little relation to the actual costs of running the road (staff costs, maintenance, insurance and utilities). D&A is really just the amortization of the intangibles associated the concession. Technically, the amortization is calculated based off a units of usage basis, so the exact amount will vary depending on the companys internal estimates, but the company has HK$3.54Bn in intangible operating rights to amortize over the next 10 years, providing a significant tax shield to HKs already low tax rates.
My base case assumes very conservative growth rate of 5% on revenues (traffic growth of 2.5% plus 2.5% price increases) and expense growth in line with ’13 and ’14 and still yields a per share value of $10.75. The 10% discount rate is well below what the dozen global infrastructure funds/pension funds would pay for an inflation-linked 10 year highly leverageable asset. My upside case increases the revenue growth rate to 8% (still below what we have seen over the last 5 years) and lowers the discount rate to 7% yielding a per share value of $14.25.

The cash on balance sheet is fairly straightforward, with the exception of the fact that Bloomberg excludes HK$466MM in available for sale securities held under long term assets. Most of these are level 1 liquidity listed in either HK or the US, but as there’s not much transparency my base case takes a 50% discount to it. The Tate’s tunnel cash flows are valued similarly to the Western Tunnel, but as that concession only has 3 years left, and CHH only owns 37% of it, the total amount is de minimis. The company’s other businesses are pretty stable/good and have been slowly growing, but only represent HK$80MM of earnings after covering all corporate overhead and so I peg them as worth $2-$3/share at 10x and 15x trailing earnings respectively.

Clearly some discount to the SOTP is warranted here given liquidity, transparency etc..  I personally use a 20% conglomorate discount which gets me to an intrinsic value of $14.60, but there's room here for those who want to use a higher or lower rate. 

Risks:
Fraud risk – always a possibility, but the fact that we have two separate sets of financials here gives me comfort. Also the concession regime in HK is highly regulated and developed. The value of the company existing both in its cash as well as in the concession value gives one a unique margin of safety.

Waste the money risk – always a possibility, but co has significant insider ownership so they'd be wasting their own money too.  Also company has been good at giving cash back to shareholders when they have it. Div yield of 4% + it used to be higher in the 90s/00s when people had better visions for the tunnels traffic. While the cash build up looks significant, note until recently the operating companies also had significant debt.

FX Risk - all numbers are in HK$, currently pegged to the USD.

Catalyst

Increase in dividend as cash piles up on the balance sheet
Sale/monetization of the Western Tunnel asset
Cash generation will sometime in 2015 make the company screen as a negative enterprise value co, a fact that has been hidden by the Companys’ cash flows coming in not as operating FCF but as dividends from recently de-levering operating companies.