882 HK - Tianjin Development Holdings

[dbm]

TIANJIN DEVELOPMENT HOLDINGS (0882)

 

Price: HKD 1.45 per share

Mkt cap: HKD 1,556mm

Net debt, adjusted*: -HKD 2,059mm

EV: -HKD 504mm

 

I have been following this forum for a few years but this is my first post.

I guess I am tired of suffering alone with this small cap. It is now trading close to its all time low.

 

This is one of the most undervalued situations I have seen in my career. It can be a three-bagger and remain cheap.

 

Tianjin Dev is essentially a holding of businesses / stakes in businesses of the municipality of Tianjin, a city close to Beijing with 15mm people.

I has a market cap of less than HKD 1,600mm. I believe it is worth multiples of it.

It consists of a pile of cash, a pharma co, a port, utilities (water / heat / electricity), a hotel in HK, a loss-making machinery co and, most importantly, a 16.5% stake in Otis China.

 

The bulk of my analysis is based on "you don't have to know a man's exact weight to know that he is fat". Therefore, I don't lose much time with smaller subsidiaries or stakes in listed companies, which I just consider at market value. But its obesity is crystal clear. The stake in Otis China alone is worth at least double its market cap, and that is where I prefer to focus.

 

Consolidated IFRS results are quite complicated, because of a mix of subsidiaries being consolidated, equity-accounted or fair value measured. In any case, the segment disclosure is very satisfactory to understand it as SOTP.

 

Let's start with the most important part: its 16.5% stake in Otis China.

I am sure most of you are familiar with the qualities of the elevator business: razor / razor blade design, when a sale of a new equipment (at a profit!) assures you a decade of recurrent maintenance revenues at a high margin, a high ROIC business, strong moat, high visibility, and so on. Listed companies in this sector (Kone, Schindler, Zardoya Otis) usually trades at 25-30x earnings. Thyssenkrupp just sold its elevator subsidiary, which delivered EBIT of less than EUR 1bn, for EUR 17.2bn.

The recent spin-off of Otis from UTX adds a lot of visibility to the case. For anyone interested, Otis investor day presentation is really educational.

 

However, the elevator business in China is not as good a business as in US / Europe. Service market is very fragmented and the conversion ratio is much lower - ~30% instead of 90%+ in developed markets -, harming the razor / razor-blade construct. According to management, this is a key point they intend to focus on, and there are significant opportunities for improvement (focus on top developers where the conversion ratio is closer to developed markets).

As expected, the market in China is huge: more than 6mm units in operation (out of 16mm globally), of which Otis serves only 210k units. More than 500k units are added each year. Worse business from one point of view, opportunities from another.

 

Tianjin Dev has been Otis partner in China for 36 years. It was the first JV established by Otis in China, and the chosen one to consolidate all others during the last decade or so. One of Otis' major R&D centers is in China. This is a strong indicative that it is not another Chinese swindle.

 

Look-through earnings (and dividends received) from Otis China were more than HKD 200mm in every single year over the last decade.

While it might not deserve a 25-30x multiple, it is worth what... 15-20x? I assume 18x, which at HKD 220mm of profits, values it at HKD 3,960mm.

 

Listed stakes:

Tianjin Lisheng Pharma, listed in Shenzen (ticker: 002393). I don't have a view on whatever the difference might be between its intrinsic value and its market cap, but its stake (34.4%) at market value is worth HKD 1,671mm. That alone is more than Tianjin Dev market cap.

 

Tianjin Port, listed in HK (ticker: 3382). Its stake (21%) at market value is worth HKD 640mm.

 

Pile of cash: after excluding cash & equivalents of Tianjin Lisheng Pharma (although its effective interest is only 34.4%, it is controlled by a double layer of holding companies, and therefore consolidated), it has HKD 1,395 in net cash.

 

Other businesses:

All other businesses combined are probably worth something close to Tianjin Dev market cap - they do deliver more than HKD 100mm in combined profits after you exclude impairments at the mechanical division, which is up for sale. Marriott HK was already impacted by protests in HK, and now, of course, will be severely impacted by covid-19. The utilities business serving TEDA, the Technological Development Area, seems more interesting. Most of the Tianjin Dev's cash is kept at these subsidiaries, so for the sake of simplicity, at these prices we can even disregard them.

 

So, summing it all up:

Otis China stake, HKD 3,960mm, or HKD 3.69 per share

Tianjin Lisheng Pharma stake, HKD 1,672mm, or HKD 1.56 per share

Tianjin Port stake, HKD 621mm, or HKD 0.60 per share

Cash ex-Tianjin Lisheng Pharma, HKD 1,395mm, or HKD 1.30 per share

Other businesses: ?

SOTP: HKD 7,667mm, or 7.15 per share. That's more than 380% above current stock price.

 

We can be as conservative as you want... the pile of cash is worth nothing to the minority shareholders (only as a margin of safety) since it never leaves the house? Fine.On top of that, let's add a fat 25% holding discount? That is still HKD 4.38 per share, or about 200% upside.

 

Otis China at 10x earnings and nothing else? That alone is 40% more than current market cap, even considering everything else is worthless.

 

Value is there, not matter how you slice it.

 

A more realistic risk here is governance.

If a shrewd capital allocator controlled a holding company trading at such a huge discount and with such liquidity, they would be buying back stock hand over fist, boosting intrinsic value per share. In contrast, management interest in company's shares is nonexistent.

Its share option scheme expired last year, with zero shares exercised - exercise price was multiples of current price. Maybe if it is reinstated we can get a better alignment, who knows.

At HKD 0.08 per share, current dividend yield is a little less than 5.5%. It sounds ok, but that represents less than 40% of what the company receives as dividend from Otis China.

As is usually the case with SOE companies in emerging markets, possibilities of harming minority shareholders abound: destruction of shareholder value by misallocation of funds, conflicts of interest with another businesses owned by the municipality, fraud in subsidiaries... I am not saying any of that will happen, but it is something to keep in mind.

In any case, it would have to be an incredible amount of harm to justify such a discount.

 

Does it make sense, or I am going nuts?

 

Catalyst:

Improved visibility of Otis China after spinoff of Otis Worldwide

Huge value discrepancy

 

Disclosure: I am long Tianjin Dev.

 

* Adjusted by the proportionate ownership of Tianjin Lisheng Pharma' cash

[mjohn707]

This does sound like a bear as far as all the complications, but if they’re paying some sort of dividend it can’t be all bad.  Do we not know anything about the management and organizers here at all?

[Foreign Tuffett]

I went back and read the last five "Chairman's Statement" from the annual reports. They give almost no hint of what the company's business plans are. I would almost go so far as to say that they are intentionally written to be as vague and uninformative as possible.

 

Dividends per year:

 

2015 - $0.1018 HKD

2016 - $0.0962

2017 - $0.0863

2018 - $0.0804

2019 - $0.0804

 

Not a great trend. Is there any indication of why the company is paying lower dividends now?

 

Tianjin municipality is the ultimate controlling shareholder. Whatever management (or whoever is really in charge here) is optimizing for, it clearly isn't shareholder value. One possibility is that the company is primarily a vehicle to bolster Tianjin's economy and create jobs. The fact that it did an IPO years ago on the Hong Kong exchange is a minor distraction from this mission, but since the city maintains majority control outside shareholders can be largely ignored.

[dbm]

mjohn707, I don't think there is much to be said about the management. The chairman has been with the company or other municipalities holdings for a couple of decades now, but at the end of the day they probably just follow municipal government guidelines.

 

Foreign Tuffett, I 100% agree with you that optimizing shareholder value is not the primary objective of this company. In fact, I believe that is true for most SOE companies: you can pick any Russian one to serve as an example. 

However, that does not mean they are worthless for minority shareholders. While value stuck in such a non-friendly structure may take a long time to cristalize, it is still there - plus or minus whatever management does with the assets. In this case, probably minus... but to say minus 100% is a stretch. 

It may not be its most important KPI, but even a municipality government prefers to have as much cash in hand as possible.

 

And while you wait, the main portion of the company is run by well-incentivized Otis management, and is probably a growing pie. 

 

As for the trend in dividends, Otis China's profit was in a downtrend from 2014 to 2018, as explained at their investor day. In 2015 for example, Tianjin Dev received HKD 500mm in dividends from Otis China, compared to HKD 260mm last year. Otis did mention that the trend is improving for the sector in China. Given the amount of debt they are stuck with because of the recent IPO, I don't see it distributing less than 100% of profits.

 

Of course it deserves a discount. I am just saying that 75% discount makes little sense to me.

[patientcapital]

Very interesting idea. There are very few ideas posted here with a differentiated view / good assets, so I tip my hat to you.

 

The accounting is very hard to follow. Given the structure of their investments, much of the performance of the business flows through below the operating income line (OTIS China isn't consolidated into the income statement for example) which makes it hard to follow the underlying trends of that business.

 

Similarly, lots of interest/investment income, gain/loss on equity investments, other non-operating income, asset write-downs, minority interest payments, makes it hard to know what's actually happening.

 

I haven't delved into the corporate structure yet, but I assume it's a web of entities ultimately owned by the government, which makes it hard to evaluate and know if the entity that's publicly traded is safe from corporate raiding.

 

Definitely could be some value hidden in here, question is, can you actually prove that you're right? What research have you done to prove out that your thesis is valid vs the sniff test?

 

My differentiated view is that SOEs can actually be good for shareholders due to the close government oversight - when the government owns the asset you don't have to worry as much about fraud. They will literally throw management in jail if they try to pull one over on the party.

 

However, you do have to worry about the government fleecing shareholders for it's own interests. That certainly is a big concern here.

[patientcapital]

My differentiated view is that SOEs can actually be good for shareholders due to the close government oversight - when the government owns the asset you don't have to worry as much about fraud. They will literally throw management in jail if they try to pull one over on the party.

 

However, you do have to worry about the government fleecing shareholders for it's own interests. That certainly is a big concern here.

 

Ok, I already stand corrected on this one.

 

Just looking at the annual report for the Tianjin Port Development company (where they own ~20% of the equity), they have a section for "RESTATEMENTS DUE TO SUSPECTED EMBEZZLEMENT OF FUNDS."

 

This might have more hair on it than I anticipated / the SOE = safer view might be immature.

 

[Foreign Tuffett]

My differentiated view is that SOEs can actually be good for shareholders due to the close government oversight - when the government owns the asset you don't have to worry as much about fraud. They will literally throw management in jail if they try to pull one over on the party.

 

However, you do have to worry about the government fleecing shareholders for it's own interests. That certainly is a big concern here.

 

Ok, I already stand corrected on this one.

 

Just looking at the annual report for the Tianjin Port Development company (where they own ~20% of the equity), they have a section for "RESTATEMENTS DUE TO SUSPECTED EMBEZZLEMENT OF FUNDS."

 

This might have more hair on it than I anticipated / the SOE = safer view might be immature.

 

Are you familiar at all with the history of the Soviet Union? Government ownership of the means of production doesn't somehow eliminate fraud. Far, far from it....

 

The 1MDB scandal is another example. The Malaysian government, in theory, controlled this huge pool of capital, but in practice it was all being siphoned off for the sole benefit of the Prime Minister and his associates.

[Foreign Tuffett]

mjohn707, I don't think there is much to be said about the management. The chairman has been with the company or other municipalities holdings for a couple of decades now, but at the end of the day they probably just follow municipal government guidelines.

 

Foreign Tuffett, I 100% agree with you that optimizing shareholder value is not the primary objective of this company. In fact, I believe that is true for most SOE companies: you can pick any Russian one to serve as an example.

However, that does not mean they are worthless for minority shareholders. While value stuck in such a non-friendly structure may take a long time to cristalize, it is still there - plus or minus whatever management does with the assets. In this case, probably minus... but to say minus 100% is a stretch.

It may not be its most important KPI, but even a municipality government prefers to have as much cash in hand as possible.

 

And while you wait, the main portion of the company is run by well-incentivized Otis management, and is probably a growing pie.

 

As for the trend in dividends, Otis China's profit was in a downtrend from 2014 to 2018, as explained at their investor day. In 2015 for example, Tianjin Dev received HKD 500mm in dividends from Otis China, compared to HKD 260mm last year. Otis did mention that the trend is improving for the sector in China. Given the amount of debt they are stuck with because of the recent IPO, I don't see it distributing less than 100% of profits.

 

Of course it deserves a discount. I am just saying that 75% discount makes little sense to me.

 

Who said the company is worth zero? No one here is arguing that, so I'm not sure who you are addressing with that line of reasoning.

 

My general point is that outside shareholders have no control over the company's assets and cash flow, the shareholder letters are beyond vague, and in all reality some party bureaucrat or city official is in ultimate control, and maximizing the value of the company for foreign shareholders is never going to be on that person's to do list. Having said all that, I don't know what kind of discount the stock should trade at, but I'm inclined to think it should be a big one.

 

It's an interesting idea, but something like this probably should trade on dividend yield and not a NAV that is unlikely to ever be realized.