Imagine your neighbor's house going on sale. You have never seen the inside but think a $1 million price is a fair price based on its location. You have no intention of buying another house but what if the house went on the market for $50,000? You may think that there must be something very wrong with the house. Perhaps there are rats or snakes in the house! Maybe it is haunted! But even under the most pessimistic assumptions, you realize that $50,000 is a steal. There is a catch though. No one in your city, state or even in the US is allowed to buy that house; only outsiders can. The people outside the US have little idea about the real estate conditions in your city and so the house remains on the market. This bizarre fantasy is not so far from the truth with Nam Tai Property (NYSE:NTP).
Nam Tai Property is a property development company that is in the early stages of developing two plots of land in Shenzhen, China. It is currently trading around $7.50 a share in the NYSE. Due to its US listing and relatively small market cap of $266 million, it draws little attention from Chinese investors, mutual funds and hedge funds. It is also under the radar of US investors who know little about the Chinese real estate market or who are fearful of investing in companies that do business in China. Large US mutual funds or hedge funds also have little interest in this listing due to its relatively low trading volumes and float. The top two holders own about 35% of the company. In this article, I will argue how Nam Tai is a deeply undervalued company and could be worth $50 a share conservatively.
Nam Tai was founded in 1975 as an electronics manufacturing company. Since then it has acquired land leases from the Chinese government in Shenzhen and other cities in China. Nam tai has a long history of distributing cash and other shareholder friendly policies. I will not go into that history here. For those interested, I recommend this excellent article from 2013. I first wrote about Nam Tai in March of 2014. Back then it was a net-net stock that was in the process of changing its business from electronics manufacturing to property development. It is no longer a net-net company. As Nam Tai proceeds with its property development and spends its cash, it will become progressively less backed by cash. Investors should expect the company to go into debt in the next five years.
Real Estate Properties
Nam tai has 3 main properties:
1) Guangming, Shenzhen (Inno Park): Already approved by the government, this plot of land is set to become a 335,000 square meter construction area comprised of offices, apartments, and other commercial space. This project is expected to be completed by March of 2020. Estimated cost for the development is $345 million.
2) Gushu, Shenzhen (Inno City): This project is planned but not yet approved. This plot is set to become a 348,000 square meter construction area comprised of offices, apartments and other commercial space. Estimated completion time is December of 2021 with a cost of $580 million.
3) Wuxi plant is for sale. The company expects to sell this property in 2017 but they have not indicated the expected proceeds from the sale.
Nam tai has other real estate properties, but the bullish case for this company rests on the properties in Shenzhen and the company's execution with their development.
The company has about $184 million of cash and no debt at this point. The cash is sufficient for its continued operations for the next year and a half including its generous dividends.
Cities in China are classified into different tiers. Tier one cities are considered the richest cities with the most vibrant economies. Most casual US investors would not be able to name the four tier one cities in China. They may be able to name Beijing and Shanghai, but many have not even heard the names of the other two cities. They fail to distinguish among different cities in China. That would be like comparing the real estate market in New York to that of Kansas City. The four tier one cities in China are: Beijing, Shanghai, Guangzhou, and Shenzhen.
Shenzhen, located about 30 miles from Hong Kong, was a small village of 30,000 people in 1979. The metro area now has a population of 18 million. Its GDP of $270 billion is comparable to that of Portugal. On a per capita basis, its GDP is comparable to Spain. It has 162 miles of coast line with one of the world's busiest ports. It is also home to some of the world's largest high tech companies including Tencent (OTCPK:TCEHY) with a market cap of $247 billion, BYD (BYDDF,BYDDY), ZTE and Huawei.
The Shenzhen real estate market has been one of the hottest in the world. Average home prices are more expensive than San Jose due to a housing shortage in the city. Home prices increased over 40% in 2016 alone. This article warns of a bubble and potential risks in Shenzhen. Property prices may drop in the short term in Shenzhen but given that the market is valuing Nam tai's properties at zero and Nam tai's long term thinking, I do not see the deflating property values as a major risk. Much like a San Francisco home buyer who intends to live in her house for the next ten years need not worry about short term bubbles in the real estate market in the Bay area.
In its second quarter earnings report, the company stated: "Recently, a commercial plot in Shenzhen that measures 152,400 square meters in size was sold for $2.1 billion in June 2016, a price that was 1.6 times higher than the local government's minimum asking price and counted as the highest amount ever paid for a single parcel of land in China as at the end of the first half of 2016. This parcel of land is located 1.8 km away from our "Inno Park" project. However, we note that our "Inno Park" is zoned as an industrial plot, not a commercial plot, as compared to this other parcel of land."
According to Global real estate consulting company, Knight Frank, the number one housing market in the world in terms of price appreciation was Shenzhen in 2016 where prices surged by over 60%. Nam tai has posted real estate valuation studies on its website. Seeking Alpha contributor thoughtfully analyzed those studies here. Investors can use these studies along with comparable sales in Shenzhen to value Nam tai's properties. The properties' values are listed at cost on their balance sheet which grossly undervalue them. It is hard for me to come up with a hard value of these assets, but it is very obvious to me that the company's assets are extremely undervalued. Similarly if you were to get off the plane in Fairbanks, Alaska today, you would not be able to tell the exact temperature but you could tell everyone that it is significantly colder there than Miami, Florida. Placing a $2 billion valuation on its properties in their current undeveloped state is not unreasonable which would value the company at approximately $50 per share. These are very rough values, but given the dynamic state of Shenzhen and the company's lack of desire to monetize its properties right away, investors should accept a certain degree of volatility in the company's valuation in the years to come. No matter what, the valuation is significantly higher than the company's current stock price.
Nam tai's dividends and buybacks
Many US investors are apprehensive of fraudulent accounting practices with Chinese companies. Nam tai has treated its investors fairly for decades. They have returned cash to investors in the form of dividends and buybacks for many years. The current dividend yield is 3.7%. Given the lack of significant earnings, I am not sure if the company should distribute its cash. However, the distribution does serve to reassure many investors that it is shareholder friendly. If they eliminated the dividends, the stock price would likely swoon to under $4 (2015 prices). As a long term investor, this would not bother me but I imagine it would spook investors and potential financiers which the company will inevitably need as it approaches later phases of its property development.
High insider ownership by Nam tai's top two investors serve further reassurance that management's interests are aligned with investors. In the words of Buffett, management eats its own cooking, and they certainly have a lot of skin in the game. Amazingly around September of 2015, the company's founder, Mr. Koo, exercised options to purchase 600,000 shares of the company at $6.60. At the time the stock's market price was under $6.
Nam tai has engaged in several buybacks since 2015. In April of 2015 as share prices were around $4, it offered to buy 3 million shares through a tender offer at $5.50. I wish they had left a clause to allow them to buy back more shares in case of oversubscribing. As expected given the low stock price at the time, the offer was oversubscribed. Over 8 million shares were tendered but the company was able to only buy the promised 3 million shares. In August of 2015, it announced a second tender offer for the same price of $5.50. This time they announced a buyback of up to 15 million shares which served the purpose of scaring away some sellers. It was only able to buy back about 3.5 million. Note that almost 5 million shares went unsold three months prior to this buyback and yet only 3.5 million shares were tendered.
The next buyback was announced in August of 2016 in the form of open market purchases of up to $50 million. Given the low volumes of the trading in the stock, the company was able to purchase less than one million shares under this program.
The dividends and buybacks are ways to keep the price from dropping and to keep some investors happy as the company's real work of property development progresses. Nam tai investors should hold off for the big returns that will likely come when the property development is completed.
Nam tai holds its cash in renminbi. Its development costs, future revenues and earnings will also be in renminbi therefore a discussion on the Chinese currency is warranted. If its currency continues devaluing against the dollar, we will see a rise in its expenses in terms of US dollars. Currently, the Chinese government is trying to prop up its currency contrary to President Trump's assertion. As China's ambitions grow in the world stage, the government wants to maintain the value of its currency. Trump's assertion that China manipulates its currency to unfairly increase its trade surplus with the US may have been true perhaps a decade ago but is no longer the case. President Trump's well intentioned goal of bringing manufacturing jobs to the US will face major economic headwinds simply because employing Americans is way too expensive for companies in the US. Health care costs for American workers dwarf those of other developed nations including Canada and Germany let alone lesser developed nations like Mexico or China. As Buffett says, "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."
In the fourth quarter NTP lost about $5 million due to depreciation of the renminbi relative to the dollar. Nam tai currently has modest rental revenue and costs. China is a fast growing economy. A slowdown for China means a drop in GDP growth rate to under 7%. Ultimately a country's currency value is determined by the robustness of its economy and trade balance. While short term currency fluctuations are inevitable, I do not foresee major fluctuations in the currency that would alter the basic valuation of Nam tai.
Investors with short time horizons (less than five years) should be particularly cautious. Nam tai's stock price is currently being supported by its generous dividends. One could argue that a company that has no earnings should not be distributing any cash. As management has warned, the dividend could be discontinued in the future which would result in a major drop in the stock price.
Trade volumes and float are also small. Given the big concentration of shares in the hands of two investors, this company's value could be divorced from its stock price for prolonged periods. Had Nam tai bought its intended 15 million shares in its 2015 tender offer, the top two holders would have controlled over 50% of the stock.
Many investors were initially attracted to Nam tai as a net-net value play. At current prices Nam tai is no longer a net-net and will be transformed into a growth real estate company. The big debt levels that are sure to come will likely scare away many of the existing investors. With debt comes increased risk. Headlines about trade war with China and geopolitical risks that are inevitable will send this stock on a roller coaster ride for years to come. Stability will come as earnings flow, which are not expected until about 2022. A long time horizon is essential with this investment.
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.