1977:HK - Analogue Holdings

[kab60]

Summary: Analogue Holdings (HK) is a good (high ROE) and growing founder-led Company trading way below NCAV when adjusting for hidden value. Pays out 50 pct. of earnings currently and has an increased focus on recurring revenue. Famous HK value investor and corporate governance advocate recently took a large stake.  Oh, and management says they’ll “spare no effort in leading the Group to a more prosperous future and in maximising returns for our shareholders” in their recent report, so fireworks might go off.

 

Company description: Analogue Holdings is a Hong Kong-based E&M engineering company. E&M works stands for electrical and mechanical works usually undertaken by contracting or subcontracting specialists.

 

It has four different business segments with Building Services being the biggest by far.

 

Building Services cover the design, supply, installation, testing and commissioning, operation and maintenance of heating, ventilation and air-conditioning system (HVAC), fire service system, plumbing and drainage system and electrical system for general buildings, and specialised buildings such as data centres, and healthcare facilities, which typically have high technical specification and requirements.

 

Other segments include Environmental Engineering, Information, Communication and Building Technologies (ICBT) as well as Lift & Escalators.

 

They make their own lifts and escalators in China (sold under the brand name Anlev) but so far only sell them internationally. Lifts and escalators can be a fabulous business as seen by Koné, ThyssenKrupp and Otis since there’s a large and high margin recurring revenue component from maintenance typically required by law. Analogue Holdings are, according to their prospectus, working on making their lifts compliant in China, which is the biggest global market. If they gain access to the Chinese market it could be a big growth driver going forward. Call it a free option. They've also recently expanded into the US and won some meaningful contracts in HK.

 

Valuation: At 1,2 HKD/share Analogue trades at 4,6x2021 EPS estimate by analysts (18 pct. EPS growth) and at some 35 pct. discount to net current asset value when adjusted for a 25 pct. stake in Chinese listed Company Canatal Data-Centre. There’s a bit of double counting here, since Analogue includes their share of Canatals earning, but it’s pretty insignificant (around 5 pct. of profit in h1 2020).

 

The shareholding in Canatal, or Nanjing Canatal Data-Centre Environmental Tech Company Ltd. to be precise, is recorded on the balance sheet at cost (117m HKD,) whereas market value is closer to 1,1B HKD today.

 

Analogue had net current assets of some 1,5b HKD at the end of June. The stake in Canatal is recorded as an interest in associates and not as a current asset. Adding the value of Canatal to the net current assets there’s almost 2,6b HKD of liquidation value compared to a market cap of 1,7b HKD at 1,2 HKD/share.

 

They’ve sold some shares in Canatal during the summer 2020 but apparently stopped when Canatal raised some convertible debt (not sure if they were considered insiders and had to stop). But on a recent webcast Analogue management said they think Canatal is undervalued (despite trading at 30x2020 EPS estimates) due to a massive boom in 5G and datacenter installations in China, so they're reviewing whether or not to keep trimming.

 

I think the core business could command a low double digit PE (high ROIC, some growth, increased focus on recurring revenue) or 100 pct. from here, and then there's potentially a windfall from optimizing the balance sheet (selling Canatal, returning proceeds to shareholders), but I wouldn't bank on it. I'm trying to be directionally right and think it's too cheap considering the core business and optionality.

 

Capital allocation: They have a policy of paying out 25-50 pct. of earnings (currently close to 50 pct. - high single digit yield), so unlike a lot of these perpetually undervalued Companies in HK you actually share in the value.

 

They emphasize return on equity in their results, and they articulate that they want to maximize shareholder value. They're doing so by increasing their amount of maintenance work and thus recurring revenue which is more stable than contracting (and demands a higher multiple) and by investing into the elevator and lift business. They’re also playing into the datacenter trend.

 

Recent results: Despite covid19 results were pretty much in line with last year in H1 2020 and they’re optimistic about H2. Their order backlog is record high.

Shareholders and governance: Poon, whos 78 years old, own around to thirds of the Company through a trust. David Webb, famed value investor in HK and corporate governance advocate, recently took a large stake (flagged a 5 pct. Shareholding in October). Webb has exposed bad actors in the HK market before, so I think Webb being onboard vounches for management.

 

Unlike most HK Companies, Analogue does results presentations and take questions which are streamed online, so I’m inclined to believe they actually care about public investors (one can find their recent webcast on their website).

 

Risks: Analogue listed in 2019. The chairman, Poon, started the company 50 years ago and they seem to have done fine without a listing so far. So it’s obviously a risk that he has taken the Company public because he sees dark clouds on the horizon, but I’ve found nothing that indicates so (however, Poon is married to HK's justice chief who’s not a popular person in US, and Poon was fined 20.000 HKD for constructing an illegal pool).

 

They state in the prospectus that they wanted to list to become a more credible trade partner and want to expand Geographically. They already have expanded into the lift and escalator market in the US by buying what is now a 49 pct. Stake in Transel Elevator & Electric, one of the largest lift companies in NY. (originally they bought 51 pct., but they recently took it to a minority due to tensions between China and HK. They say sanctions against HK officials won't affect the business)

 

Either way you slice it this is mainly a HVAC contracting business in Hong Kong, and the risk as with other contractors is that they estimate project costs wrong and get hit by cost overruns since most of the projects are won through tenders (they mention one project in the prospectus that cost them money). There's also a risk that they'll have a hard time winning new  projects.

 

There's also a risk that Canatal trades down. Canatal trades at 30x2020 EPS estimates, which is high on a headline number, but that's 56 pct. EPS growth y/o/y. Estimates are for 26 pct. EPS growth for Canatal in 2021. As stated earlier, management thinks it's cheap (I haven't looked much into Canatal yet, but it looks legit: https://canatal.en.alibaba.com/)

 

Disclosure: I have a small position, 2,5 pct. I haven't followed the Company for long. I would've sized it bigger if I had a longer track record on which to judge management and their execution. I also tend to change my mind quickly if I see something that I don't like.

[Spekulatius]

Interesting idea. I just did my 30 min of due diligence  ;D and so far I like what I see. one thing I can’t emphasize enough is they David Webb’s involvement  is a strong positive as it literally guarantees we are not looking at a fraud here.

They also pay a very nice dividend.

 

No position yet.

[SI2020]

This does look cheap but current price is same as IPO price. Why would they IPO below book value (especially if book understates the value of that minority stake)?

[kab60]

Not sure. Explanation in prospectus seems plausible - they want to expand (the lift biz in the US among other places) and being listed gives them more clout. Perhaps they also want liquidity. Or perhaps management are crooks and knows BV is overstated and their projects will have cost overruns. Seeing as the chairman and major shareholder is dating a public figure in HK, and despite them building an llegal pool, my guess is on the former, but I really don't know. I like the business, their strategy and very much the valuation. I also like their openness, but I am somewhat outsourcing the more complex governance questions in HK by applying my Webb filter.

[Spekulatius]

Not sure. Explanation in prospectus seems plausible - they want to expand (the lift biz in the US among other places) and being listed gives them more clout. Perhaps they also want liquidity. Or perhaps management are crooks and knows BV is overstated and their projects will have cost overruns. Seeing as the chairman and major shareholder is dating a public figure in HK, and despite them building an llegal pool, my guess is on the former, but I really don't know. I like the business, their strategy and very much the valuation. I also like their openness, but I am somewhat outsourcing the more complex governance questions in HK by applying my Webb filter.

 

They acquired a 51% stake in TEI, a NYC company (the stake was since lowered to 49% so they don't control it any more technically). Cost was 278.5HKD in 2019. I think that's where most IPO proceeds went. They may have overpaid for TEI (haven't really dug into this) which may be a strike against management.

https://finance.yahoo.com/news/tei-group-announces-equity-partnership-152512812.html

 

I think Webbs involvement pretty much negates the risk of fraud as much as possible in HK. Overall, I like it, but feel i should dig a little bit more.

 

Edit found some numbers on TEI (using CapitalIQ which I access over my Boston Library )

 

TEI : Transel Elevator and Electric

Revenue: 54M

Analogue bought 51% for $35.7M in 2019

Then sold back 2% to an individual (I assume a manager) for $1.4M in August 2020.

 

So it seems like purchase price and the 2% sale roughly value this at 70M. Given what happened in NYC in 2020 that seems OK, but perhaps not too surprising, because Elevators need to be serviced whether they are running or not. $OTIS isn’t doing too badly either.

 

Anyway I don’t know if the 2% sale had a sweetener in it or not but overall it to me that what they bought is probably roughly worth what they paid for most likely.

 

 

 

[kab60]

Thanks for the addiional data points, Spek. It's also possible to get a feel for TEI's numbers by looking at Analogues' development in the lift and escalator biz. They do a good job of splitting up their segments. Even down to maintenance revenue numbers which tells me they're serious about going for increased recurring revenue, which sounds simple but implies that they're actually focused on value creation.

 

They also lay out in their Prospectus how they expect to use the money that they raised, and recently they did an update with some dates and numbers moving around, but I wouldn't put too much emphasis on it. It's a peculiar feature of the HK market I believe that Companies have to lay out the numbers like that when they go public. But they had plenty of cash and could've easily financed the acqusition of TEI without an IPO, so I don't think they listed because they needed the cash.

 

They sold down to 49 pct. of TEI due to tensions between HK and the USA. I'd expect them to take over the whole thing down the line since JV's rarely work, but it's a way to get a foothold in the US, and it could be very interesting if it works out since it can be a fabolous biz. But herein also lies a risk, obviously. Global expansion isn't easy, and I'm not sure Chinese lifts will be an easy sell in NY.

 

This is from the amended agreement between TEI and Analogue (Anlev), which grants Analogue a call option on TEI:

 

Acquisition Sellers’ Put Right and Anlev (US)’s Call Right

Put Right

At any time on or after the date that is seven years from the date of the Shareholders’

Agreement (i.e. on or after 31 March 2027 (Eastern Time)), the Acquisition Sellers shall have

the right (the “

Put Right

”) to cause Anlev (US) to purchase all, but not less than all, of the

shares in the Target Company held by all the Acquisition Sellers at a price which shall be the

fair value of such shares as of the date of the exercise of the Put Right or Call Right (as defined

below), as applicable (the “

Purchase Price

”).

Call Right

At any time on or after the date that is two years from the date of the Shareholders’

Agreement (i.e. on or after 31 March 2022 (Eastern Time)), Anlev (US) shall have the right (the

“

Call Right

”) to cause each of the Acquisition Seller to sell all, but not less than all, of the

shares in the Target Company held by the Acquisition Sellers to Anlev (US) at the Purchase

Price.

 

Also, a couple of nuggets from the interim report webcast (which didn't work for me halfway through the Q&A last time I tried):

 

They expect 50 pct. datacenter growth in HK in 4 years and to gain a significant part of that businesses

 

They're in discussion with two distressed European lift and escalator businesses, but it's early days and highly uncertain whether they result in a deal

 

They say they need to hold a lot of cash due to their record higher order backlog, so they're comfortable with a 50 pct. payout ratio, but I wouldn't expect them to increase that - should amount to a 10 pct. yield in 2021 based on analyst estimates of 25 pct. ebitda growth

 

Poon is quiet Bullish on Canatal... They disposed some shares when the price ran up, but since then 5G plans in China has increased the prospects while the stock hasn't done much, so he expects it to go higher... Who knows... Oh, and they also hold some shares in listed HK Utilities... Which they might - or might not - dispose of...

 

[_JJ_]

Analogue announced they will sell up to 6.5M shares in Canatal, equivalent to approx. 100M HKD. Shares in Canatal didn't respond well to the news: -7%. In my opinion it's good that they are showing their willingness to sell when they think the time is right. Not sure about their timing though. They could have sold a lot more in the summer at more attractive prices.

 

The directors of the Company consider that the Proposed Disposal, if materializes, represents an opportunity of the Company to realise part of its interests in the investment in the Nanjing Canatal at a reasonable price and allocate resources for the development of other business of the Company.

 

https://www1.hkexnews.hk/listedco/listconews/sehk/2021/0108/2021010800786.pdf

 

[kab60]

Agree. I'm all good with them simplifying the balance sheet and surfacing value, but the timing is strange considering how bullish Poon sounded on Canatal. Perhaps it shows they care about outside shareholders, but you also want them to stick to their convictions if you believe management to be any good. Don't think it is very important but a small negative in my book.

[kab60]

Webb updated his holding a couple of weeks ago, he owns 6 pct. of the Company now, and it's his biggest position at 110 HKD. It seems to be a somewhat rare company in HK in that it's actually pretty high quality, growing yet trades way below WC. But obviously they have a short public history which warrants some caution, and it's not clear that international expansion is smart. On the other hand, I suppose the payoff could be big, so perhaps consider it as a far OTM option and give management the benefit of doubt considering their track record.

[kab60]

Pretty significant news. Expands in the UK - and 3-5x of manufactoring capacity of lift and escalators due to surging demand: https://www.atal.com/2021/02/23/atal-sets-up-first-company-in-uk-further-expands-its-footprint-across-the-world/

 

This trades like a net net. Slap a KONE multiple on it, and we'd be golden :)

[SoonParted]

With Poon at age 78, is there key man risk here?

[kab60]

I think there is. It's not a business any idiot can run, there are execution risks as well as capital allocation risks. But I also have a large position in an American Conglomerate with two Coke-drinking dinosaurus.

 

All three key men seem rather sharp, still. So I would think hard about it if Poon was somehow out of the picture (6 feet under), but he seems to be going strong, and some of these old folks that love what they do often seem to surprise on the upside re longevity. *knock on wood*

[hasilp89]

kab60 - being lazy here but is there anything you've gotten from management to imply they are serious about value creation and if some of the takes here are indeed correct.

- maintenance/service portion of the business would warrant a much higher multiple - Know the majority of the business is MEP engineering/design but are they actually doing recurring life safety/inspections and all that good stuff - I like API here in the US that does that stuff

-how serious are they about elevator/escaltors hard market to break into with the big players but again very stick and good margins on maintenance

Maybe you've mentioned but what's your take on why it is so cheap? Per 2020 numbers they earned 22 cents / share and have ~80 cents / share of cash. Trading for 1.50. means 3x ex-cash on 2020 numbers - a year in which new projects/development /construction was limited by COVID and still sitting on 11b of backlog (~2 years). (Am i missing something?)

 

[kab60]

1 hour ago, hasilp89 said:

kab60 - being lazy here but is there anything you've gotten from management to imply they are serious about value creation and if some of the takes here are indeed correct.

- maintenance/service portion of the business would warrant a much higher multiple - Know the majority of the business is MEP engineering/design but are they actually doing recurring life safety/inspections and all that good stuff - I like API here in the US that does that stuff

-how serious are they about elevator/escaltors hard market to break into with the big players but again very stick and good margins on maintenance

Maybe you've mentioned but what's your take on why it is so cheap? Per 2020 numbers they earned 22 cents / share and have ~80 cents / share of cash. Trading for 1.50. means 3x ex-cash on 2020 numbers - a year in which new projects/development /construction was limited by COVID and still sitting on 11b of backlog (~2 years). (Am i missing something?)

 

They've got their money on the line, so incentives should be right re value creation. But I also like what they do and say. If you're interested you should listen/see some of their webcasts - there's a recent one from the annual results, where David Webb challenges them a bit. I took some quick and dirty notes, so I'll just reply as I recall, since this is more about approx right. A couple of hard points regarding value creation would be that they're committed to paying out up to 50 pct. of net income in dividends, and their moves definately doesn't suggest empire building unlike a lot of HK firms they mention ROE in their financial reports). Remember their clost to 25 pct. stake in Nanjiang Canatal Data-Centre (listed in Shanghai) is booked at cost, or 1/10th of market value, so when Analogue continuously sell that down, they have a large gain of which half gets returned. They definately look overcapitalized, and Webb is pushing them on that, but I like them trying to expand the lift and escalator biz. The chance of great succes are probably not huge, but it might completely change the Company.

- Maintenance is still a small part of the overall business, but it has grown some 60-80 pct. (I seem to recall) since 2019 and did around 900m HKD in revenue in total in 2020

- They're very serious that lift and escalators are their main growth engine, but some of the other segments might have decent tailwinds as well. Some facts to underscore they're serious: They increasing their production capacity some 3-4 times which should be online in 2022. They recently opened their first office in the UK. They've been looking at M&A in Europe. They bought TEI, one of the largest independent lift and escalator companies in NY. They hope to expand on the East Coast. Numbers re TEI are messy, since the deal closed in March 2020 and the accountance of TEI was change twice during the year (remember they went from a majority to a 49 pct. stake with a call option due to Political tension). Also, there will be some accounting noise due to purchase accounting, but basically TEI services 3.000 units EOY 2020 (up from 2.800) and earned 65m HKD in 2020. So you'll need to adjust the numbers a bit. They're not going to launch their brand in the US, they think TEI would get pushback due to the political climate, but eventually they hope they'll expand in the US. I don't expect them to win against Kone og Otis necessarily, but the global market is 120B according to Analogue, so they should be able to carve out a nice business for themselvs if they're able to execute. They recently won a metro project in Cairo.

- It's actually cheaper that what you suggest. Their stake in Canatal Data-Centre is worth around close to half of the market cap. But it is booked at cost, 1/10th or so, so it's actually much cheaper that what a screener might find. But really, a ton of HK Companies are cheap. Look at some of RVP's post - he has posted a lot of cheap names. I lot of HK names are cheap for a reason and stay cheap, but it does seem pretty nuts to me. At the same time, opportunity cost is real, and I just switched all my exposure from Lion Rock Group to Analogue Holdings. One because I think it's a better business with tailwind at its back yet both trade around NVAC, two because it's a sexier story which might actually catch peoples attention if they execute (whereas book publishing and printing might make people fall a sleep).

 

[kab60]

Another note regarding 2021 and 2022. According to management, efficiancy was low in 2020 due to covid. They should be able to increase efficiancy this year and thus increase revenue without needing to hire a lot of new folks (margin expansion). It's unclear to me if that completely negates the benefits they might have had from covid relief packages, but it seems like it. They also said their record high order book is at normal margin levels, so I'd expect better profitability going forward - on a larger revenue base. Also, they had some provisions and impairments in 2020 (overdue credit amongst others), total around 20m HKD, which they expect they'll be able to recoup.

[hasilp89]

34 minutes ago, kab60 said:

 

- It's actually cheaper that what you suggest. 

 

cheaper than i thought that is always nice to hear haha.

I appreciate the thoughtful response. I had been following along with his posts but was kind of seeing the same thing - a lot of cheap stuff and there must be a reason. This one looked a little more interesting to me based on the business they are in - i'll do some research and listen to those calls. 

[Cicero]

Really like this and have a small position. Just wish I had seen this earlier when Kab60 posted this.  A few things: 

1. A lot of what they do seems to be escalators as opposed to elevators esp. outside HK. Escalators are a good but much weaker business in my mind than elevators. Less safety concerns, easier to maintain and easier to replace if needed. Brand also much less obvious than for elevators (did you ever notice the brand of an escalator?) and I would argue much less important. So from that perspective I am not sure comparing them to the likes of Thyssen Krupp, Otis and Kone makes a lot of sense. That said, break downs are a hassle for operators so I think this can be a decent business

2. Find it very interesting that they have not gone after the Chinese market even though the elevators/ escalators are manufactured in China. Yes they say in the prospectus that they are working on compliance for China, but one would think that this would have been the first market to go after outside HK. I am speculating, but that could mean there are other domestic manufacturers that are as or more competitive on price. 

3. Again speculating a bit, but I think that the maintenance contracts are highly concentrated in HK. Keeping a maintenance team for a few one-off escalators in say the UK is probably not profitable, so probably done through their distributor. Maybe that will change as they get bigger, but that would at least be my working assumption. 

4. There is a public body that regulates elevator safety in Hong Kong (EMSD). They mandate annual inspections and there are public records on these inspections. There are about 70,000 elevators in Hong Kong across about 9,000 high rise buildings. Only the 2020 inspection reports seem to be accessible and I counted a total of c9,000 inspections. Not sure why this does not match the total number of lifts. Do machine room elevators with several cabins count as one? Covid maybe? Do operators have to do inspections every year and the EMSD only double checks a subset? No idea, who knows. So take this with a pinch of salt, but based on these numbers a few conclusions can be drawn: 

# elevator market in HK is quite fragmented largest player (Otis) has 13%, top 10 has about 80% with 7% or so each. If you take out the players with no more than three dozen installed elevators, then you end up with 26 players. Anlev has 143 making them a bit bigger than the median player with about 2% share. There are about a dozen players of a similar size as Anlev with names at least I have never heard of (Chun Ming, Holake, Sun Fai, Shan On etc.)

# Interestingly the second biggest player is a company called Chevalier. They are a business that looks quite similar to Analogue and is listed in HK as well. Similar size and PE seems to be fairly in line. Suspect that is the comp people use for Analogue and may partially explain why Analogue trades the way it does 

# Chevalier has been in the elevator business since the 70s and have a partnership with Toshiba. They seem to have had some ambition to expand the business beyond HK, but still seems to be a fairly HK focused from what I can tell. I think illustrates some of the obstacles to international expansion. Does that mean that Analogue can't be successful internationally? No, but probability is not super high at least in elevators in my view, escalators may be a different story 

# In public tenders, safety record is a factor being considered in the decision. The way the safety rating is calculated in HK is by number of incidents in a review period. Crucially from what I can tell it does NOT take into account the installed base. This severely penalizes the larger players and may explain why some of the large ones (OTIS, TK, Kone) have so poor safety record scores. If I am not misreading something (which is entirely possible; the tender guidelines and the law on elevator safety are lengthy, vague, convoluted docs and I did not spend that much time on it) it would mean that growth rates in public tenders are mean reverting over time and one should be careful not to extrapolate from recent successes too far out into the future 

# elevators in HK are pretty old. More than a third is 30+ years (data is from 2016, but should not have changed very much I think, if anything it is worse now). There are some programs in place to encourage renewing the fleet, but uptake so far has been modest. 

5. There are similar records for escalators and the story seems broadly the same. There are way fewer escalators though (a bit more than 9,000) and not every elevator player does escalators. It's way more concentrated with the top 5 accounting for about 70%. Anlev has 30 or a market share of about 1.3%. I have the same issue on data as with elevators btw; I see about 2,300 inspection reports but an installed base of 9,000+. Escalators are much younger on average which makes sense given that widespread use is a more recent phenomenon 

6. I really like that management changed their mind on Canatal disposal. Would have been far easier to not to admit the mistake by selling. Changing your mind is underrated in my book.  

 

Edited April 9, 2021 by Cicero

[kab60]

I think you raise some very good points. I really won't put anything resembling high odds on their international expansion being a huge succes, but they're starting from a very small base. I'm a bit lazy in that I consider it somewhat of a free option and basically trust management wouldn't expand capacity 3-4x if they didn't expect that demand would be there - either internationally or in HK. I really didn't think through to much about the difference between escalators and elevators and their profitability profile or mix between projects and maintenance, but that's probably a very valid point. They do break out contracting and maintenance revenue, which was at 327m and 243m respectively for lifts & escalators-segment in 2020. That split is not too far off something like Kone and can't be attributed to TEI, since maintenance was an even higher percentage in 2019 and TEI seems to do a lot of installation/contracting work. Now I'm definately not expecting this to be the next Kone, and you're right that servicing has a lot to do with density. But I guess one way to improve density would be to offer multibrand service. There's an article with TEI and what they're up to here: https://teigroup.com/images/uploads/TEI-10QuestionsWithMarkGregorioandMichaelStaub.pdf

[Cicero]

Thanks for sharing the article. Helpful background. Though I did not quite get the sales number they were quoting. 

I agree that given the size and the valuation of ATAL even if the success in elevators turns out to be mediocre, the investment may still work out very well. 

 

[Cicero]

Does anyone know what is up with Analogue? It is up a lot for a day without news.

 

Feel like I am am the last person to understand a joke. 

[kab60]

Canatal is up 1/3 in the last month or so, but doesn't explain all the action. So yeah, no idea, but I'll take it.

[benchmark]

It has continued its rise today, still can't find anything significant ...