While many market participants are looking for the next multi-bagger stock in complex industries or growth stories where dozens of assumptions have to be made to come up with a sound thesis, Nam Tai Property (NYSE:NTP) screams value and is happily ignored. While the goal (for most investors) is to maximize return, somehow lots of investors are attracted to those places of the market where it is easiest to lose money.
Mr Market feels more comfortable at extrapolating 50% growth rates than buying a company for less than net cash with more than its market cap in land rights value.
Also, the hard work has been done. The value of Nam Tai Property is the sum of a pile of cash and the development value of several land parcels owned via long term land rights. The development value of the land parcels is researched by several well-known independent consulting firms.
One could question the correctness of the consulting reports. I believe that the valuation performed by several independent consulting firms specialized at evaluating the value of property development is the most accurate valuation one can get. This combined with the intention of the company to buy close to 50% of the shares outstanding back at current price levels makes me comfortable investing in the company. It screams value to me.
Add one of the most shareholder friendly directors that I know of (Mr. Koo) and it really starts to sound too good to be true! Time for further digging…
Shareholder friendly director + deep discount to fair value + easy to value company = long term $$
I believe that indiscriminate selling of Nam Tai Property led to a huge undervaluation
In one of my favorite books 'You can be a stock market genius' Joel Greenblatt describes the attractiveness of spin-off situations. One of the key things making investing in spin-offs attractive is the fact that a spin-off often goes hand in hand with indiscriminate selling:
- The spin-off company has little to do with the core business of the parent company
- The institutions invested in the parent company, are invested in that company because they want to be invested in the core business of that company
- Institutions decide to sell their share in the spin-off company more or less regardless of valuation, as they are not interested in being invested in the spin-off business
This indiscriminate selling can create a huge disconnect between the company's fair value and the value it trades for.
Nam Tai Property is not a spin-off situation, but a similar pattern can be found here. Did I told you that it was formerly called Nam Tai Electronics?
Nam Tai Property moved from being an electronics manufacturer to a property development & management company
Nam Tai Electronics was a contract electronics manufacturer, manufacturing components for well-known companies such as Apple, Sanyo, Sharp, Sony & Texas instruments. Early 2013 the company starts to inform investors that they experience weakness in their business and may have to halt its business if this weakness continues in order to minimize further losses and preserve cash.
The Company depends on a small number of customers. In the first quarter of 2013, as a result of the weak consumer market, LCM orders placed by the Company's major customers were significantly lower than the customers' original forecast. The Company was also compelled to lower the unit sales prices in response to its customers' cost down requirements. There was also indication that orders placed by these customers could be cancelled with short notice. In response to these adverse market conditions, the management has made efforts to minimize potential losses resulting from cancellation and fluctuation of orders by its customers and decided to halt capital investment into technology platforms that cannot produce steady income streams. Unless market conditions improve to the extent that the Company has confidence to achieve a reasonable gross profit and there is no risk of customer confirmed orders being cancelled or significantly reduced or other strategic alternatives are found, the Company may have to halt its best quality LCM production operations service in both its Shenzhen and Wuxi manufacturing facilities by the end of June 2013 in order to minimize further losses and preserve cash. The Company's LCM operations comprise the core of the Company's existing businesses.
The company also informs investors that they plan to conduct feasibility studies to redevelop land owned by the companies via land rights.
In terms of the Company's other long-lived assets, the management plans to redevelop a parcel of land of approximately 530,000 sq.ft. that encompasses its existing Shenzhen facility in light of Shenzhen government's recently announced city rezoning project to convert this area into a high-end commercial district. The redeveloped land may comprise of multi-floor high-end office buildings, hotels and shopping malls with a total floor plan of approximately 3,000,000 sq.ft for rent. The location of this parcel of land is between the Shenzhen airport, the third largest airport in China, and the Qianhai Bay Special Economic Zone. The Qianhai Bay Special Economic Zone is the result of a long-term joint collaboration and development plan between Hong Kong and Shenzhen governments and will take on significance in China's economic development through the preferential tax rates and incentives policies to be granted by the central government. Based on the development plan and other publicly available information from the PRC and Shenzhen governments, our management believes that it is likely that within the next 10 years this area will experience one of the fastest growth rates in the world. The distance between Qianhai Bay Special Economic Zone and Shenzhen airport is approximately 25 kilometers and our land is situated in the middle. The extensive incentives that the government is granting to land owner to accommodate the city rezoning plan and future tax concessions will significantly benefit the Company's interest. The management intends to engage professional experts to conduct feasibility study, evaluate commercial value and formulate plans in the best interest of the Company and will seek board approval prior to commencing the redevelopment. The Company considers its existing cash flow sufficient to finance the first phase of development that will utilize up to one quarter of the available land for a building with a total floor plan of approximately 700,000 sq.ft. However, there can be no assurance that the Company will be able to obtain the requisite permits and approvals from relevant government authorities in relation to the redevelopment of the land, or to successfully redevelop the land.
One year later, early 2014, the company announces that they will cease all manufacturing activities and plan to develop multiple commercial properties.
Also announced previously, we have been forced to cease our core business of LCM production by the end of April 2014, due to a customer's repeated and continuous changes in its formal purchasing orders without suitable commitment and, as a result, a strong likelihood that no reasonable profit margin can be gained anymore from continuing production. We have decided our core business of LCM production will formally cease by the end of April 2014. After April 2014, we intend to sell all of our machinery and production lines in all our facilities. We expect the sales will be finalized around end of July 2014.
Upon the cessation of our core business of LCM production, our management will thoroughly focus our efforts on developing two parcels of property in Gushu, Shenzhen, and Guangming, Shenzhen, respectively, by converting these two parcels of land into high-end commercial complexes. Upon which, we will become the landlord and manager of the commercial complexes and, as a result of which, our core business will be transformed from the EMS industry to property development and management. We project that the development of these two properties will take approximately four years each to complete following our board's approval, which is scheduled in July 2014. During this development period, all overheads expenses, development costs and dividend will be funded from interest income and rental income, together with Company's cash on hand and bank facilities, which we believe is sufficient.
So the whole business effectively changes from a contract electronics manufacturer to a property development & management company in a period of a year. Investors which were previously invested in a profitable electronics manufacturing business returning plenty of capital to shareholders now own a pile of cash and land rights which produce no income. I believe that this move has resulted in a lot of indiscriminate selling.
Nam Tai Property is worth 500 to 700M, 150 to 250% upside from today's valuation
As the company's management recognized the undervaluation of the shares the company introduced a share buyback program in 2014. Under this program they bought back 2.7M shares at an average price of 6.6 USD per share. This program was terminated late 2014.
In May 2015 the company first commenced a tender offer to purchase 3M shares back at a price of 5.50 USD / share. This tender offer was oversubscribed.
In August 2015 the company announced a second tender offer to purchase 15M shares back at a price of 5.50 USD / share. This offer was undersubscribed. Unfortunately, but logical seen the huge undervaluation of the company.
After the buyback program and tender offers the company has 36M shares outstanding.
The value of the company is the sum of the development value of the land rights and the pile of cash. The value of commercial property to be developed by the company is researched by several well-known independent consulting companies. The value ranges between 200 and 400M USD.
The value of the Wuxi parcel is not examined by all consulting parties, so I use a value of 237M RMB if it is not available (the lower of the Shenzhen WorldUnion Properties Consultancy and Centaline Property Agency valuation).
All reports can be found on the company's website.
Adjusting the balance sheet results in the following:
- Replacing the land rights value which is stated at acquisition costs by the valuations of the consulting companies
- Adjusting the number of shares outstanding for the latest tender offer
The mid-point value of the land rights (300M) plus cash results in a value of 16.6 USD per share. Triple the current share price. So with this upside and literally no downside due to the large undervaluation the question remains why the stock is still selling at current prices.
Why the share price hasn't picked up yet?
I believe that the share price hasn't picked up yet for the following reasons (in order from most important to least important):
- The indiscriminate selling was still ongoing
- An investment in Nam Tai Property requires a 3-5 year horizon
- Chinese companies are associated with a higher risk of fraud
- Investors have no confidence in the major transformation of the business
- Not all permits required to develop the commercial property are in place (yet)
- The value of the land rights are recorded at acquisition costs on the balance sheet
The indiscriminate selling was still ongoing
The indiscriminate selling was still ongoing, but should now be over.
The company first commenced a tender offer to buy 3M shares at 5.50 USD / share May 2015. About 8M shares were tendered. So after this first tender offer there was about 5M shares of supply left at prices < 5.50 USD / share.
In August the company commenced another tender offer for 15M shares. Based on the first tender offer I was almost certain that this tender offer would be undersubscribed and I expected a maximum of 5M shares to be tendered. Unfortunately only 3.5M shares were tendered. A huge undersubscription. This makes me believe that the indiscriminate selling is over and the shareholder base that's left is in for the long run.
What happened to the other 1.5M (5M oversubscription in May, only 3.5M tendered in August) shares which were tendered just a couple of months back? I have no idea. Facts like this make me believe in the inefficient market theory.
An investment in Nam Tai Property requires a 3-5 year horizon
It could easily take a couple of years for the company to develop all the commercial properties. Developing the properties is a long process in which the company first has to obtain all the required permits, than has to look for partners to design the new property after which the new property has to be build. On top of that the company plans to develop the different land parcels in a phased approach.
The company estimated a total duration of 4 years about 1 year ago. This was just a rough estimate so I believe that it is better to be conservative on this point when assessing to invest in the company or not. I believe that a period of 3 to 5 years is realistic.
Once the property is developed and the rent starts to flow in I am certain the market will start to realize the value of the company. But there is no certainty at all when and if the market will start to realize the value of the company before the development of the property is finished. Lots of players on Wall Street don't have the luxury of a 3-5 year investment horizon and have to skip this investment idea.
Chinese companies are associated with a higher risk of fraud
Investors tend to stay away from Chinese companies as they assign a higher risk of fraud to Chinese companies. I am also more careful with Chinese companies, in the case of Nam Tai Property there is plenty of evidence that it is a legit company and far from a fraud:
Return of cash to shareholders:
- The company intended to return 100M USD to shareholders via the tender offers in 2015. In the end the company returned 36M USD to shareholders due to undersubscription in the latest tender offer.
- The company returned 18M USD via a share repurchase program, before the tender offers commenced (as discussed earlier)
- The company returned 250M USD in the form of dividends between 2003 & 2008. And the company is still paying a quarterly dividend of 2ct.
Owner/Operator Mr. Koo (16% ownership, calculated based on FY2014 ownership and 2 tender offer results) with a long history of shareholder friendly management:
- Managed several business transformations in order to preserve capital (more on this later)
- When you read through the press releases and annual & quarterly reports of the company you will discover that management is very informative about the business towards shareholders:
- Announcement of business transformation well in advance
- Supplements to tender offer which clearly describes the intention of the major shareholders in the tender offer
- Sharing of consulting reports
- Etc. etc.
- Management executes accordingly (no false promises)
I am certain that the company isn't a fraud, however a risk remains that the market will never value Nam Tai Property at full value just for being a Chinese company. The company has always been royal at returning capital to shareholders. I expect good dividends once the rent for the commercial properties starts to flow in. In general, steady dividends narrow the discount between the fair value and the market valuations of companies. Hence, I didn't discount the company in my valuations for this risk.
Investors have no confidence in the major transformation of the business
Investors seem to have no confidence in the major transformation of the business. How can a company without a background in the development of commercial property, do so successfully? One of the first questions I get from fellow value investors.
A valid question, but if one person recognizes the lack of knowledge in the new business it's Mr. Koo:
- The company started to recruit talent in the property development business directly after the cessation of the manufacturing activities
- The company appointed a very experienced Project Director with experience in the Shenzhen area
- The company is actively seeking for a partner to form a joint venture with. If the company is not successful in doing so, they will hire more knowledge from outside.
We are currently recruiting talents and gathering intelligence for our property development projects.
We have recently appointed an experienced Project Director, Mr. Eddie Tsui, age 40, to be in charge of our property development projects. Eddie is an award winning urban designer and architect, practicing integrated planning, urban design and architectural design, with over 15 years of experience in geographies covering Mainland China, Hong Kong, United States, South East Asia and South Korea.
Eddie was the managing director of the Hong Kong Design Planning and Economics Group of AECOM Technology Corporation (NYSE symbol: ACM) ("AECOM"), leading a team of over 140 staff and focusing on managing and cultivating business through delivery of quality projects, as well as its strategic planning and growth. Before this, he was the managing director for the Guangzhou and Shekou offices responsible for developing AECOM's Southern China business.
Eddie received a master of architecture degree from Harvard University and a bachelor of arts degree from the University of Pennsylvania, Eddie is fluent in English, Mandarin and Cantonese, verbally and in writing. He has also acted as the overseas representative of the People's Political Consultative Committee of Shaoxing City in Zhejiang province since 2003.
At this juncture, we continue to seek potential joint venture partners for the development of the land parcels in Shenzhen. External agents have been engaged to source suitable, capable and experienced joint venture partners. Before a joint venture partner is secured, we will work with other external professional firms in all material property development matters. In the event that no suitable joint venture partners can be found, we will continue with the land development projects mainly by relying on and supported by external professional firms. We have started to seek potential suitable, capable and experienced external professional agents or firms concerning our project management and permit applications for the development of the land parcels in Shenzhen. Based on the current timetable and progress, we do not foresee any immediate difficulties in the permit application process. We will continue to make timely announcements to keep shareholders informed about material developments.
In addition I would say that the business to develop and exploit real estate is not the most complex business on earth.
Looking at Nam Tai's history, this is not the first time the company goes through a major transformation. Mr. Koo did it before, and successfully:
- The company started as a distributor of Japan-made calculators in 1975
- In 1979 Mr. Koo decided to take advantage of the low labour costs in China. He expanded the business into China and started manufacturing his own brand of calculators.
- From 1980 to 1985 to company starts to diversify and starts producing simple electronic devices.
- In 2010 the company halted the production of box-built products (Bluetooth headsets and calculators) and refocuses on the assembly of key components for telecommunication products
- In 2014 Mr. Koo decides to cease all manufacturing activities and start to exploit the land rights which have risen in value enormously since the acquisition in the early 90s.
I am actually a big fan of the major transformation of the company, especially seen the very impressive track record of Mr. Koo. While other net-nets continue to lose money year in year out to save a broken business model (Deswell Industries, DSWL, for example), Nam Tai halted their broken business model in time and saved shareholders a lot of money doing so.
Not all permits required to develop the commercial property are in place (yet)
While the company believes that they can obtain all required permits (and the company is well underway) as their plans fit nicely into the local government plans, there is always a risk that the company cannot obtain all the required permits to develop commercial properties on the land.
Some of the permits are already in place, and the company hasn't communicated about any obstacles yet.
If some of the permits cannot be obtained the company has to assess other ways to exploit the land rights, which could be of less value than the planned development of commercial properties.
In relation to the land parcels (in Guangming and Gushu) in Shenzhen, the construction permit application processes have been proceeding smoothly, and we believe that we can obtain the necessary permits and approvals to carry out the next stages of our property development projects on schedule.
For the Guangming project (Phase 1), we have obtained the Permit for Construction Site Planning where we are now allowed to start planning for the work at the site. We have appointed an internationally-renowned, award-winning architectural and qualified professional architectural design firm for the mixed-use style development for the next stage of this project.
Based on the current plan, subject to the final approval of the relevant authorities in China, the Phase 1 of the Guangming project will consist of mixed development of office buildings, retail area, hotel and apartment complexes. The Guangming project (Phase 2) will commence upon the completion of Guangming project (Phase 1). Based on the current timetable, the construction at the Gushu area is expected to commence no earlier than 2017.
The value of the land rights are recorded at acquisition costs on the balance sheet
While the company took a lot of effort in informing investors about the real value of their land rights, the rights are still carried at acquisition costs on the balance sheet. This value doesn't turn up in any stock screens. Hence, some investors may not be aware of the true value of the company. I don't believe that this is a very important factor as the buyback program, tender offers & shared consulting reports should have drawn quite some attention from investors. A snippet from the latest tender offer documents:
We believe there is a divergence between our current share price and the value of our land holdings, which is booked at their historical acquisition costs and the value of which may not be unlocked until we have completed certain land development projects. After taking into account the necessary capital expenditures for the land development projects, the Board believes the best way to return shareholder value to our investors is through a tender offer that provides an efficient mechanism for some of our shareholders with the opportunity to tender all or a portion of their shares and, thereby, receive an immediate return for some or all of their investment, if they so elect.
With the indiscriminate sellers cleared out by the latest tender offer I believe a bottom is set in the 5-6 USD range and today is a good day to start a position in Nam Tai Property.
At the current valuation I can't come up with a realistic downside scenario. Patient investors will most likely be rewarded.
The biggest risk in investing in Nam Tai Property is the time it takes for the market to realize the value of the company. A 3 year timeline at mid-point valuation results in an annualized return of 45% while at 5 years it results in an annualized return of 25%.
It is possible that value is unlocked in a shorter timeframe, possible catalysts are the announcement of a joint venture and a tender offer at a higher price (the company has excess capital so I wouldn't be surprised to see another tender offer in a year).
With Mr. Koo at the top owning 16% of the stock, who openly communicates all plans to shareholders, keeps his word and returns plenty of capital to shareholders I feel very comfortable to allocate a good share of my portfolio to Nam Tai Property.
I hold a long position (>10% of my portfolio) in the stock and intend to add as time passes by or the share price decreases.
Disclosure: I am/we are long NTP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.