- $31.39 Base Case.
- $36.16 Upside Case.
- $22.45 Downside Case.
- $30.00 probability weighted intrinsic value at 7/4/2017.
I. Executive Summary:
II. Investment Thesis:
Retail Holdings N.V. (OTCPK:RHDGF), hereafter referred to as REHO, is a Curacao based holdco that is trading on the pink sheets.
As of 7/4/2017, REHO’s market capitalization was ~ US $90.0 million. REHO’s main asset is its 54.1% ownership of Sewko Holdings (“Sewko), a Cayman based holding company that ultimately owns, through Singer Asia (“Singer Asia”), a 71.2% equity interest in Singer (Sri Lanka) PCL, a 72.4% equity interest in Singer India Limited and a 59.8% equity interest in Singer Bangladesh Limited, each a publicly listed entity on its respective national stock exchange (see Exhibit 1).
As of 12/31/2016, REHO’s reported NAV was US $28.57 1. Using the same methodology while adjusting for share dispositions and related distributions 2, 3, REHO’s adjusted reported NAV at 7/4/2017 is ~ US $26.90 per share.
However, based on my research to date, I believe that REHO’s reported NAV does not appropriately reflect REHO’s intrinsic value which I estimate, on a probability weighted basis, at ~US $30.00 per share as reflected in Table 1 below:
Table 1: Adjusted Reported NAV per Share vs. Indelible Capital Estimated Intrinsic Value per share at 7/4/2017:
My variant perception is based on the following key considerations:
REHO’s adjusted reported NAV does not reflect my estimate of underlying intrinsic value because it does not consider the following:
First, the present value of REHO’s sublicensed Singer trademark earnings that will continue to accrue to REHO post-liquidation. These earnings, in my opinion, represent close to US $5.50 per share in incremental value over adjusted NAV on a probability weighted basis.
Second, the present value of REHO’s potential recovery from the SVP Seller Notes which represent, in my opinion, close to US $1.00 per share in incremental value over adjusted NAV on a probability weighted basis.
Third, REHO’s adjusted reported NAV does not reflect the reduced value of REHO’s ownership of non-remittance shares in Singer Bangladesh, which, together with other adjustments to the reported value of REHO’s ownership in the remaining controlled subsidiaries, reduces, in my opinion, adjusted reported NAV by US $0.47 per share on a probability weighted basis.
Finally, REHO’s adjusted reported NAV diverges from intrinsic value because it does not reflect any transaction costs or the bonuses due to Mr. Goodman post-liquidation, which together, based on my assumptions, reduce REHO’s adjusted reported NAV by US $2.80 per share on a probability weighted basis.
While management continues to guide towards a two to four-year liquidation time frame 4, management is likely targeting the earlier part of this window. Mr. Goodman’s does have generous bonus structure that ends in December 2018 and may not be renewed in its current form, and management’s stated objective is to make additional distributions to shareholders, and possibly resume share repurchases, in the later part of FY 2017. This would require incremental share dispositions to fund. The company has also increased communication efforts with shareholders, starting with the issuance of an Updated Strategy Statement on 1/4/2017 5, coupled with significant IR efforts at the subsidiary levels.
More granularly, (see Exhibit 2) my estimate of REHO’s intrinsic value is derived from a conservative downside case estimate of US $22.40 per share, a reasonable base case estimate of US $31.41 per share and a realistic upside case estimate of US $36.20 per share. Given my current analysis of the likelihood of each case occurring, I have conservatively chosen to equal weight each case to arrive at my probability weighted intrinsic value of US $30.00 per share as of 7/4/2017. Importantly, however, this estimate of intrinsic value is not static. For example, the share price of the subsidiaries should, all else being equal, accrete by their respective discount rate over time preserving or possibly widening the discount unless price and intrinsic value converge through market forces.
In summary, an investment in REHO shares is likely to yield superior risk-adjusted returns if shares are held for the entirety of the liquidation process, albeit that it is probable that the market will eventually force the convergence of price and fair market value as distributions are made and intrinsic value recognized.
Furthermore, over the long term, permanent capital loss risk appears limited as illustrated by my downside case intrinsic value estimate of US $22.40, which implies that REHO shares are trading at a 15% discount to a conservative estimate of intrinsic value. To illustrate, my downside case estimate assumes no recovery from the SVP Seller Notes and no value for REHO’s post-liquidation Singer trademark license earnings.
Regardless, liquidity issues will make purchasing a meaningful position in REHO shares difficult and time consuming while also exposing shareholders to substantial price volatility and other risks inherent to small-cap stocks.
Given the above, an investment in REHO shares only seems suitable for patient, long-term investors that will accept returns gradually through distributions if share price appreciation does not narrow the gap between price and intrinsic value over the medium term.
Importantly, REHO is exposed to risks at the subsidiary level. These risks are detailed in the relevant sections of this report and should be understood and further researched by anyone considering an investment in REHO shares.
REHO is the successor company to The Singer N.V., which at the time of its bankruptcy in September 1999 was the world’s largest manufacturer of sewing machines with sales of more than US $1.3 billion in 1998. Singer N.V. emerged from bankruptcy in September 2000. In August 2003, Singer N.V. sold a 43.2% equity interest in Singer Asia, which held its interests in retail operations in Bangladesh, India, Indonesia, Pakistan, Philippines, Sri Lanka, Thailand, and Vietnam, to UCL Asia Limited Partners L.P. for US $30 million in cash.
In June 2004, Singer N.V. sold its worldwide sewing business and the ownership of the Singer trademark to an affiliate of funds managed by Kohlberg & Co. for ~US $135 million: US $65 million in cash, US $47 million in assumed debt and US $22.5 million in 10% unsecured promissory notes. Concurrently with the sale, Singer Asia entered into an exclusive perpetual licensing agreement with SVP Worldwide to use and sub-license the Singer trademark for all non-sewing products across Asia (excluding Korea and Japan), Australia and New Zealand in exchange for royalty rate of 1% of Singer Asia’s consolidated GAAP revenue. Immediately post-sale, Singer N.V. changed its name to Retail Holdings. Over the subsequent decade, REHO divested several of its subsidiaries including Singer Thailand in June 2005 and Singer Pakistan in January 2016.
REHO used the aggregate proceeds of these dispositions to repay all corporate debt, return, through 7/4/2017, US $17.75 to investors via distributions and the repurchase 2.2 million of its own shares. As of 7/4/2017, REHO’s estimated share count stood at 4.65 million on a fully diluted basis.
IV. Reasons Behind the Discount to Intrinsic Value:
REHO has long traded at a significant discount to intrinsic value. The reasons for this discount include:
REHO is misunderstood – With a market capitalization of ~US $90 million, REHO is far off the radar screen of sell-side analysts and a majority of investment funds. Because of the lack of fundamental research, the market is yet to fairly value REHO’s hidden assets and, indeed, account for certain value detractors such as REHO’s ownership of non-remittance shares in Singer Bangladesh.
REHO is Opaque – As a Curacao based holding company, listed on the pink sheets, with assets in the form of varying majority ownerships in publicly listed subsidiaries in South East Asia, the results of which are consolidated at the REHO level in US dollars, and the whole clouded by limited public information, REHO’s true prospects are hard to understand, and its assets and liabilities, outside of the publicly traded subsidiaries, difficult to value.
REHO is illiquid – As most professional investors are allergic to illiquidity due to the short-term mark to market nature of their mandates, it is likely that a substantial portion of REHO’s current share price discount to intrinsic value is ascribable to its thin trading volumes and its listing on the Pink Sheets.
REHO has a dominant shareholder – Stephen H. Goodman, REHO’s Chairman and CEO, owns, directly or indirectly through several family trusts, 1.33 million REHO shares, which equate to ~29% of the 4.65 million REHO shares outstanding as of 7/4/2017. Due to the size of his shareholding and his position as both Chairman and CEO of REHO, investors might be discounting the value of REHO shares on the assumption that Mr. Goodman has de facto control of the company and therefore may implement decisions that could have negative consequences for other shareholders. In contrast, I believe that Mr. Goodman’s shareholding aligns him with investors as he seeks to maximize the value of his own holdings at the age of 73.
REHO is a holding company – Holdcos typically trade at a discount to NAV because their tax structures often result in double taxation. This is not the case for REHO due to its tax domiciliation in Curacao, and therefore, a discount for double taxation at the corporate level appears unjustified.
V. Trading History:
REHO shares traded at a 52-week high of US $23.70 on 4/11/2017 in contrast to a 52-week low of US $12.07 at 6/27/16 as illustrated in Chart 1 below.
Chart 1: REHO Annotated Stock Chart
In summary, through most of 2016, REHO shares traded in a range between US $13.00 and US $15.00 per share. Then, in December 2016, Chris DeMuth, a portfolio manager at Rangeley Capital and well-regarded commentator on Seeking Alpha with 20,000+ followers, published an article stating that REHO was his top pick for 2017 6. This endorsement led to an increase in demand for REHO shares and a very steep increase in the price of the shares. Subsequently, in March 2017, REHO announced strong results for FY 2016, including a 16.9% increase in revenues as well as a 39% increase in net profits from continuing operations to US $16.3 million from US $11.7 million in FY 2015 7. The company also announced a $2.00 dividend. Furthermore, management hinted at further distributions in 2017 “to be determined in large part, by the amount of proceeds from  divestments” 8. As expected, the strength of REHO’s FY 2016 results led to a further increase in share price as did the April 2017 announcement of share dispositions across all controlled subsidiaries for proceeds of US $10.4 million 9. Together, these events resulted in REHO’s share price hitting its 52-week high of $23.70 on 4/11/2017. Subsequently, on May 3rd, 2017, REHO started to trade ex the $2.00 per share dividend announced in conjunction with FY 2016 results, and as of 7/4/2017, REHO shares are trading at US $19.30 per share.
VI. Risks to my Variant Perception:
In addition to risks specific to the value of its underlying assets which are discussed further in this report, there are several key risks related to management’s and shareholders' ability to ultimately realize REHO’s intrinsic value that warrant discussion. These include:
a) REHO shares are subject to illiquidity risk and are prone to substantial price volatility
Between 1/31/2016 and 12/31/2016, REHO traded 1.41 million shares despite the company repurchasing approximately 542,000 shares over the same period. As such, the market in REHO shares should be viewed as highly illiquid and, consequently, the price of its shares extremely volatile. While REHO’s illiquidity is, in my opinion, the fruit of misunderstanding and complexity, it is highly likely that illiquidity risk is responsible for a substantial portion of the discount between REHO’s current share price and intrinsic value, and there are no reasons to believe that this discount will narrow in the short term. I therefore anticipate that returns will accrue to REHO shareholders through distributions and given the liquidation time frame, which could span up to four years according to management, believe that an investment in REHO shares is only suitable for long-term investors that can withstand share price volatility over the course of the liquidation process. In addition, should my variant perception or other assumptions prove erroneous or should other factors change, it is possible that investors may find themselves unable to exit their position and/or exposed to significant losses. Given the above, an investment in REHO shares should be regarded as extremely risky and position sized accordingly.
b) REHO Management has shown the potential for suboptimal liquidation
On 1/20/2016, REHO announced the sale of Sewko’s entire 70.28% equity stake in Singer Pakistan through the Karachi Stock Exchange. The stake was sold for net proceeds of US $2.3 million and occurred at an undisclosed discount to Singer Pakistan’s Net Asset Value.
Given that Sewko owned approximately ~32 million shares in Singer Pakistan based on Singer Pakistan’s FY 2015 annual report published on 4/15/16, I conclude that Sewko received net proceeds of ~US $0.07 per share. Using the then conversation rate of the US dollar to the Pakistani Rupee, it follows that Sewko received approximately PRK 7.5 in net consideration per share, a very significant discount to the range of then trading price as illustrated in the Chart 2 below:
Chart 2: Singer Pakistan Share Price 1/1/2016 - 1/31/2016
Interestingly, a review of the local Pakistani papers that describe the sale process elicits concern. For instance, on 1/21/2016, Dawn, Pakistan’s oldest and most widely read English newspaper, quotes management as stating that it “did not seek to run a process to find a single strategic investor/investor group for purchasing its entire shareholding stake of Singer Pakistan B.V. but made active efforts to seek to spread the shareholding to various independent investors/investor groups” 10. If this is the case, then Sewko squandered the opportunity to obtain incremental value for its shareholders by seeking a strategic acquirer who might have been willing to pay a control premium as is customary in such situations.
Furthermore, since the sale, Singer Pakistan shares have very significantly outperformed the Karachi Stock Exchange with Singer Pakistan’s share price increasing in value by over 240% (without taking into consideration the significant discount) against the broader index's ~61% increase over the same period.
However, while the Singer Pakistan sale process is concerning, it is also a fact that the subsidiary was loss making and subject to significant management issues. Given Singer Pakistan’s very limited contribution to Sewko’s intrinsic value and the likely disproportionate share of management time and effort required by the subsidiary, a quick sale may well have been justified. As such, while the risk of a suboptimal liquidation process must be taken into consideration in assessing REHO’s intrinsic value, I do not currently believe that REHO’s management team led by Mr. Goodman, who owns ~29% of REHO’s shares outstanding, will dispose of REHO’s shareholding in remaining subsidiaries without attempting to maximize shareholder value, including making every effort to extract a control premium where possible.
c) REHO Management does not always act in the best interest of its shareholders
REHO’s management team does not appear to favor communication with its shareholders as evidenced by its decision to take advantage of the company’s ability to only file summary annual and semiannual reports to shareholders with limited commentary. In addition, management does not provide quarterly updates, hold earnings calls, or take proactive IR initiatives albeit for some very recent improvements in corporate communication at the subsidiary level. As a result, REHO’s prospects are misunderstood, and its shares have long traded at a significant discount to intrinsic value to the great detriment of its shareholders. Given that the company has clearly entered the final stretch with regard to the disposition of its remaining assets, investors should prompt management to further engage with/educate the investment community to accelerate value creation through a narrowing of the gap between REHO’s share price and intrinsic value.
In addition, REHO’s management compensation structure is not particularly shareholder friendly. For instance, starting in 2016 and through 2018, Mr. Goodman stands to receive 3.5% of all dividends/distributions paid to shareholders, with these payments deferred to January 2019. I believe that such payments are excessive for several reasons: 1) Mr. Goodman owns 29% of REHO shares and, after years of REHO shares trading at a discount to their intrinsic value, is already well incentivized to maximize shareholder returns 2) the 3.5% “bonus” seemingly includes those dividends and distributions paid to Mr. Goodman in his capacity as a shareholder, 3) the “bonus” payments are no longer subject to a threshold as they had been previously and 4) the new “bonus” structure appears to no longer reward Mr. Goodman for payments for share repurchases as opposed to dividends/distributions which, in theory, could incentivize him to return capital to shareholders in a suboptimal way, particularly as share repurchases could help narrow the gap between REHO’s share price and intrinsic value.
The following sections of this report attempt to illustrate the impact of the value of REHO’s remaining assets on its intrinsic value. For the sake of brevity, because it only contributes ~US $15.4 million to REHO’s consolidated intrinsic value, and because it is essentially a distributor and manufacturer of sewing products with only a small number of retail outlets, I do not include a detailed analysis of Singer India (BOM:505729) in this report. I assume therefore that Singer India’s 7/4/2017 share price reflects fair market value.
VII. Singer (Sri Lanka) PLC:
Singer (Sri Lanka) PLC (“Singer SL”) is Sri Lanka’s largest consumer durables retailer by sales, ~US $315 million in FY 2016, and the second largest by store count. The company operates 422 stores under four different store formats (see Exhibit 12) and has developed a network of 2,835 dealers, of which ~1,800 are small phone shops, that sell the company’s products and financial services which range from mobile phone top ups to utility payments. Singer SL also operates 20 Singer Finance locations that principally provide vehicle leasing. Singer SL’s financial services transaction volumes are experiencing explosive growth with an average of 222,000 transactions per month for FY 2016.
The consumer durable goods market in Sri Lanka has essentially become a triopoly: Singer SL and Albans, Singer SL’s largest competitor, roughly share 70% of the market and Softlogic, which is more focused on consumer electronics, has an approximate 13% share (see Exhibit 3). Encouragingly, Singer SL’s market share is projected to increase over the next few years as it continues to gain share in the IT, Smartphone and Digital arena.
Singer SL sells products under two main heritage brands: Singer and SISIL, which it acquired in 2000. Both brands have long-standing reputations for quality and service and together represented 55% of revenues in FY 2016. Singer products are either manufactured locally or sourced from third parties while SISIL products, mostly refrigerators, are produced locally. To complete its product offering line up, Singer SL sells third-party branded products from companies such as Apple (AAPL), Huawei, Dell (DVMT), Sony (SNE), and Whirlpool (WHR).
Importantly, Singer SL’s business model is built around a hire-purchase scheme where customers can elect to pay for goods over periods ranging from 3 to 60 months. Over the last three years, hire purchase agreements have been attached to ~45% of retail sales with minor variation. Singer SL has offered hire purchase facilities to Sri Lankans since 1905 and has developed strict credit and recovery processes that ultimately involve repossession as the hire purchase agreements are secured by the underlying product sold. Despite increasing interest rates, the company’s interest margin has grown (see Exhibit 4) and collection experience continues to be excellent with a current “paying %” of over 98% and less than 0.5% of accounts in arrears (see Exhibit 5). That said, as experience shows (as it did for Singer Thailand and, more recently, for Singer India during the demonetization debacle), “paying %” can deteriorate rapidly in times of strife and economic difficulty. In response, Singer SL tries to mitigate short-term repayment issues by encouraging customers to prepay by at least one installment which currently results in customer advances exceeding arrears by ~US $8 million as of 12/31/2016.
Since the 2009 cessation of hostilities in Sri Lanka, Singer SL has seen its revenue grow at a 20%+ CAGR through 2016, albeit with substantial volatility. While revenues increased ~21% in FY 2016, revenue growth is expected to slow significantly through FY 2017 (~12% growth projected) as economic reforms undertaken by the Sri Lankan government, which include the recent November 2016 increase in VAT tax rate from 11% to 15% in addition to austerity measures and fiscal tightening, will result in slower consumer spending growth for 2017. That said, FY 2018 and FY 2019 should see consumer spending increase markedly as Sri Lankan GDP per capita growth rates resume their prior momentum resulting in projected revenue growth rates for Singer SL of ~18% and ~22%, sequentially. These revenue growth rates are likely to continue over the midterm given the comparatively low penetration rates in key consumer durables categories (see Exhibits 6 - Exhibit 10), continued growth in disposable income and strong urbanization trends. Finally, while Singer SL’s revenues have nearly doubled from FY 2012 through FY 2016, operating margins have decreased over the same period (~210 bps). This decline in margin is mostly due to management’s shift in focus to IT products with an emphasis on rapidly growing digital offerings such as smartphones and computers that are less profitable per unit than the company’s traditional product lines. While analysts project operating margins to increase over the medium term, it is likely that operating margins will never return to pre-2012 levels as the continuing shift in product mix towards IT and digital will continue to offset most of the operating leverage that will result from projected revenue growth. For FY 2017, operating margins are projected to be flat year over year despite the weaker margins generated in 1Q2017 as Singer gradually increases prices to reflect the impact of these changes on its cost structure. Fitch, who affirmed Singer SL’ A- (lka) longer term rating with a stable outlook on May 4th, 2017 is more conservative, projecting a “contraction in margin in the next 12 to 18 months because of cost pressures, which the company may not be able to pass on to customers amid intense competition” 11, but this was equally the case when Fitch rated Singer Sri Lanka’s proposed senior unsecured debentures in 2016 prior to Singer Sri Lanka’s strong 2H2016 results that saw revenues and margins handily beat Fitch’s expectations on a consolidated basis.
b) Competitive Advantage:
In operation since 1877, Singer has developed extraordinary brand equity in Sri Lanka as demonstrated by Singer being recognized as “Brand of the Year” (awarded annually by A.C. Nielsen and the Sri Lanka Institute of Marketing) every year since 2005. In addition, Singer was also named “#1 youth brand” from 2005 to 2011 and then again from 2013 through 2016, a distinction of singular importance given Singer SL’s pivot towards IT and digital products that are the providence of Sri Lanka’s younger generations. Singer’s unmatched brand equity underpins its sustainable competitive advantage on multiple levels 1) it positions Singer as the premier local partner for international third parties (branded or otherwise) that are seeking to enter or gain exposure to the growing Sri Lankan market (for example, Singer SL has been the exclusive Huawei partner in SL for the last five years helping the company reach a 30% YE 2016 market share, with a goal of 50% market share by YE 2017 12); 2) it supports the sale of higher margin products manufactured by the company under the Singer brand (30% of products sold by Singer SL are manufactured by the company) and 3) it enables Singer to expand into “other products”, including financial services where Singer’s brand equity, coupled with its database of hire-purchase consumers can be leverage to, for example, launch the first VISA credit card issued outside of the traditional banking sector in FY 2016.
Singer SL is the “leading provider of consumer credit (other than homes and autos) to middle and lower income consumers in Sri Lanka and Bangladesh” 13. Given the importance of hire-purchase agreements in enabling consumer durable sales growth in Sri Lanka, particularly considering the Sri Lankan Government’s recent effort to dampen private credit growth rates, it is evident that Singer SL possesses a key competitive advantage in terms of the localized credit management processes and procedures it has developed over the last 150 years. For example, on the hire purchase front, Singer SL has developed a proven credit approval, installment monitoring and collection/recovery process that has resulted in less than 0.5% of its installment accounts (383,000+ installment accounts) being in arrears as of 12/31/2016. Whilst these results were achieved in a period of sustained economic expansion, these results are no less commendable given the inherent difficulties of credit management in a “developing” nation.
Finally, while less sustainable over time, Singer SL currently has a competitive advantage in terms of its extensive local manufacturing capabilities (31% of revenues at 12/31/2016) which, by virtue of scale, the avoidance of certain import taxes and duties and, importantly, the inherent insulation from the negative effects of continuing foreign exchange fluctuations on a portion of its production costs (LKR depreciation of 10% vs. the US dollar since 2015), results in Singer SL’s locally manufactured goods carrying significantly higher gross margins than the imported products it sells. Specifically, Singer SL, through its recently consolidated subsidiaries, Regnis and SISIL, is the largest local manufacturer of refrigerators (55% market share), televisions (33% market share), washing machines (30% market share), and sewing machines (80% market share) 14. Conversely, however, these extensive manufacturing capabilities do add to Singer SL’s fixed cost structure, which could lead to wider losses if demand declines precipitously.
c) Key Risks:
Despite being a triopoly, the Sri Lankan consumer durables market is extremely competitive and industry margins have decreased as local competitors have jockeyed for position. In addition, online competitors will gain incremental market share over time as internet access expands and domestic delivery infrastructure improves. For Singer SL, this risk is somewhat mitigated by the twin fact that 1) online retailers carry Singer SL products and 2) it will take time before domestic online merchant achieve the sophistication level necessary to directly provide and service consumer credit and/or manage a similar hire purchase program such as the one offered by Singer SL.
Regardless, it is the nature of the beast that the Sri Lankan banking system will eventually extend its reach further towards the middle and lower classes as it expands at which point the utilization of credit will become less directed and more commoditized. As sources of credit increase, so will price competition throughout the consumer durables industry, resulting in lower margins across the board. The positive aspects of this development would be a substantial de-risking of Singer SL’s balance sheet as the expansion of its hire purchase business model requires the company to bear an increasing debt burden to fund credit sales, which, while substantially more profitable than cash sales due to the resulting interest income, has the potential to cause substantial harm if exposure is poorly underwritten. In anticipation, Singer SL is taking steps to gain a foothold in the broader consumer credit arena, and in FY 2016, it launched the first VISA credit card issued by a non-banking institution, and at 12/31/2016, 9,274 cards had been issued. A debit card is in the works for FY 2017. Finally, international competitors, such as Amazon (AMZN), are unlikely to target the Sri Lankan market in the near term given its specificity, including the importance of hire purchase in the sale of consumer goods.
Singer SL’s net debt to EBITDA multiple decreased from 4.6X in FY 2015 to 4.4X in FY 2016 before increasing to 4.8X LTM EBITDA due to a disappointing 1Q2017 and increased debt levels. Overall, Singer SL’s leverage ratio is likely to increase in FY 2017 as the company requires ever increasing working capital to finance incremental hire purchase receivables and higher levels of inventory required to support growth. While current debt levels appear sustainable in the near term especially in the absence of acquisitions, Singer SL is increasingly tributary to the local Sri Lankan short-term debt market which currently funds 57% of its debt load due within 12 months (see Exhibit 11). Given this funding profile, Singer SL is exposed to the risk of a short-term local credit lock-up, and, to a lesser extent, rising interest rates (+500 bps in 2016) if those increases cannot get passed on to customers. Obviously, should the situation require it, Singer SL could, in theory, restrict non-cash sales and let its receivable book liquidate to generate cash flow, but this ignores the real possibility that the situation causing the credit “lock up” could have a concurrent negative impact on hire purchase agreement “paying %”.
Despite these risks, in May 2017, Fitch reaffirmed Singer Sri Lanka’s A- (lka) rating despite the agency expecting the following scenario to unfold: a) sluggish demand for consumer durables over the following 12 to 18 months due to rising interest rates and increased VAT taxes on consumer durables, b) pressure on margins from the continued depreciation of the Sri Lankan Rupee, c) average Capex of LKR 800 million and d) a capital injection of LKR 300 million to Singer Finance (Lanka) PLC in 2018. Fitch also disclosed its negative rating sensitivities which included Singer SL’ s leverage ratio increasing to over 5.5X (net debt/EBITDAR), fixed charge coverage falling below 1.2X and, finally, any additional significant equity support to Singer Finance (Lanka) PLC15.
Currently, in my opinion, the largest risk for Singer SL remains the unstable domestic macro environment which is driven in large part by the Sri Lankan government’s implementation of the “IMF [austerity] program”, the acceptance of which was a condition precedent to the US $1.5 billion loan granted to the government in June 2016. In November 2016, the Sri Lankan government published its 2017 budget which included several significant reforms, including an increase in the VAT rate from 11% to 15%, a 10% capital gains tax, an increase in personal tax rates and the elimination of certain tax exemptions. Despite these changes, the government optimistically anticipates GDP growth of 6% to 7% for 2017. On the other hand, the IMF, which released a Sri Lanka report on December 9th, 2016, revised its projected 2017 growth rate for Sri Lanka down from 5.5% to 4.8%, warning ominously that the Sri Lankan Central Bank should be ready to further tighten fiscal policy to avoid additional devaluation of the LKR, especially if the US continues to tighten fiscal policy in 2017 as anticipated. As expected, these austerity measures have caused significant political backlash and have provided an excuse for opposition political factions to harden rhetoric, which given the country’s history has the potential to prove inflammatory.
Despite the above, most experts remain confident that the Sri Lankan economy will rebound starting FY 2018 and will then resume a growth trajectory that will result in disposable income through 2020 growing by 10% a year on average. Obviously, such a scenario would prove very positive for Singer SL. In the short term, however, it is possible that the current economic turmoil will take longer to abate, particularly given the volatile political environment. Should this be the case, it is even feasible that demand for consumer durables will decline, given that most consumer durables are discretionary in nature, but such a scenario would more likely be caused by an exogenous shock such as a natural disaster or an actual resumption of hostilities between supporters of opposing political parties, ethnicities or religious groups. In fact, Singer SL’s 1Q2017 was impacted by a drought that affected many states where the company operates and it is extremely likely that the May monsoon floods, that have resulted in 600,000 Sri Lankans being temporarily displaced, will have a negative impact on financial performance for the balance of FY 2017. 16
d) Impact on REHO Intrinsic Value:
Chart 3: Colombo Stock Exchange LTM P/E vs. Singer SL LTM P/E (Bloomberg)17
Despite the volatility inherent to its geography, the domestic and regional political environment and risk of disruption due to natural disasters, Singer SL is projected to become an increasingly dominant retailer in an industry that is projected to grow at 2 to 3X the rate of GDP in the near term. Singer SL’s prospects are buttressed by a significant competitive advantage that results from its hire purchase expertise, its repair and maintenance capabilities and its superior brand equity. At 9.2X LTM EPS and 11.5X FY 2017 projected EPS, Singer SL’s listed shares18 appear significantly undervalued. This view is bolstered by a comparison to both Singer SL’s own four-year average LTM EPS multiple of 18.2X and the three-year 18.7X average LTM EPS multiple for companies listed on the Colombo Stock Exchange. Regionally, Singer SL also appears undervalued when compared to the three-year average LTM EPS multiple of ~17X for a composite “Comparable Index” (an average of the LTM P/E ratios of the Indian, Sri Lankan, Vietnamese, Pakistani, Thai, Malaysian, and Indonesian stock exchanges). That said, Singer SL does seem more fairly valued from an LTM EBITDA and LTM EBIT multiple perspective at 9.3X LTM EBITDA and 10.4X LTM EBIT vs. its own four-year average of 9.7X and 10.9X, respectively.
Table 2: Singer SL Contribution to REHO’s Intrinsic Value:
While it is tempting to model the future value for Singer SL shares at some time of disposition, which could range anywhere from imminently to four years hence according to management, and discount that value back using the appropriate cost of equity to determine intrinsic value, the nature of the assumptions needed to be made, including the assumption that market and fair market value converge prior to a sale, make this exercise somewhat foolhardy. As Singer SL shares seem undervalued on fundamentals, it seems appropriate to use Singer SL’s current share price as the basis for each of my downside, base and upside case, with additional upside possible, should the shares re-rate prior to a disposition.
REHO’s ownership in Singer SL has the following impact on REHO’s intrinsic value:
In a Downside Case: ~US $40.8 million net contribution (+US $8.78 per share). The downside case accounts for REHO’s portion of the unrecognized, combined LRK 1.7 billion in deemed VAT and extra duties claimed by Sri Lankan Government that Singer SL is disputing and claims there is no basis for. Despite Sewko’s 71.2% ownership in Singer SL, the downside case also assumes that Sewko will monetize its ownership in Singer SL entirely through the Colombo Stock Exchange (as opposed to a sale to a strategic buyer, etc.) and that REHO will not receive a control premium.
In a Base Case: ~US $45.2 million net contribution(+US $9.72 per share) based on the 7/4/2017 share price of LKR 48.00. Similar to the downside case, I do not assume the benefit of a control premium in my base case.
In an Upside case: ~ US $51.6 million net contribution (+US $11.09 per share). The upside case assumes that Sewko will monetize its ownership in Singer SL through the Colombo Stock Exchange until it holds 50% + 1 share in Singer SL and that subsequently these remaining shares will be sold at a price that reflects a premium for control. I estimate this control premium at 20% of the current share price, which is well below the average control premium paid in South East Asia over the last three years. This assumption is all the more conservative given that the value of Singer SL shares should accrete by its cost of equity further reducing my assumed control premium on a percentage basis over time.
VIII. Singer Bangladesh Limited:
Singer Bangladesh Limited (“Singer BD”), which has been in operation since 1905, is Bangladesh’s largest provider of consumer durables by sales and store count. With revenues exceeding ~US $115 million in FY 2016, Singer BD remains the major consumer durables brand in Bangladesh despite heavy competition from Walton’s and Butterfly Marketing, LG’s exclusive distributor in Bangladesh. Unlike Singer SL, which operates four-store format, Singer BD utilizes a two-store format model: Singer Mega (20 stores as of 12/31/2016) – a large store format that includes furniture in addition to a wide selection of consumer durables - and Singer Plus (354 stores as of 12/31/2016), which offers Singer branded products and a more limited selection of third-party branded products ranging from consumer electronics to home appliances (see Exhibit 13). In addition to its core distribution platform, Singer BD has developed a network of 425 dealers that operate under the “Singer Pro” umbrella.
In Bangladesh, Singer BD manufactures refrigerators (since May 2016) and furniture in addition to assembling air conditioners and televisions. Local manufacturing has become particularly important to Singer BD’s competitive positioning as the consumer durables industry in Bangladesh has become increasingly more competitive as larger local household appliance manufacturers are investing in modern, cost competitive manufacturing facilities to leverage Bangladesh’s comparatively cheap labor force (US $0.40 per hour in Bangladesh vs. $0.95 per hour in China, $1 per hour in Sri Lanka and $2 per hour in Thailand) for export purposes.
In similar fashion to Singer SL, Singer BD’s hire-purchase scheme is the driving force behind Singer BD’s success. In fact, Singer BD is the leading provider of consumer credit to middle and lower income consumers in Bangladesh as many of these consumers do not have access to traditional banking consumer credit. In addition to consumer credit, Singer BD provides several other financial services throughout its various locations. These include the payment of utility bills, the purchase of mobile phone reloads, Western Union remittances and BKash Transactions. While still less than 1% of consolidated revenues, financial service transactions averaged close to 54,000 per month for FY 2016 and channeled more than half a million customers through Singer BD stores.
From FY 2005 through FY 2016, Singer BD’s revenues increased by a 15% CAGR despite FY 2014 and FY 2015 being marred by significant political instability and widespread civil unrest, which only abated in the last quarter of 2015. Despite the violence and protests that affected stores throughout the country, Singer BD only suffered a ~5% decrease in revenues in FY 2015 while Operating and Net Margins improved due to stringent cost control measures that were put in place to anticipate a possible worsening of the political situation. As the macroeconomic environment turned more favorable in FY 2016, Singer BD’s revenues improved significantly growing over 30% to ~BDT 9 billion (~ US $115 million). In parallel, Operating Margins improved by 90 bps year over year due to a reduction in inflationary pressures on imported raw materials offset somewhat by a surge in other operating costs. Analysts expect Singer BD revenues to increase by over 19% in FY 2017 and 18% in FY 2018, approximately 3X the projected Bangladeshi GDP growth rate over the same period.
b) Competitive Advantage:
Singer BD’s competitive advantages are comparable to those of Singer SL, with some added local specificity:
First, Singer BD has developed extensive brand equity in Bangladesh having operated in the country since 1905 and invested comparatively large sums into marketing, local manufacturing capacity, and network development. The company has been actively promoting the extensive nature of its after-service capabilities (9 service centers and 250+ service agents) contrasting it with that of other local competitors that do not have as extensive a network. In Bangladesh, post-purchase servicing (service and maintenance) is particularly important since consumer durable purchases represent a larger portion of discretionary spending due to the lower income thresholds, and durability and dependability are key features due to longer replacement cycles.
In addition, Singer BD has leveraged its brand equity, following Singer SL’s playbook, to pen some transformational strategic partnerships such as its FY 2015 partnership with SYMPHONY, Bangladesh’s leading smartphone provider with over 50% market share. These partnerships have proved invaluable at extending Singer BD’s brand awareness to a valuable subset of customer - younger and technologically savvier - that will prove very profitable over the long term and for whom the purchase of a smartphone is the first significant purchase they make. While these customers mainly purchase lower margin, IT/digital and mobile items, these products have fast and accelerating replacement cycles and even faster cash conversion cycles.
Again, as did Singer SL in Sri Lanka, Singer BD pioneered the use of the hire purchase business model in Bangladesh, and it has leveraged this expertise into providing other financial services products through its stores and distribution outlets. While still a relatively small part of consolidated revenues, these financial service offerings also serve the purpose of exposing customers to more traditional Singer products thereby ensuring its presence in the consideration set of these customers in advance of future consumer durables or home furnishing purchases.
Since its inception in 1905, Singer BD has been known as the leading provider of consumer credit to middle and lower-class Bangladeshis. Hire purchase facilities are even more important in Bangladesh than in Sri Lanka as the gross national income per capita only surpassed US $1,000 in 2014 (vs. US $3,500 in Sri Lanka) and it is therefore a substantial competitive advantage to offer financial solutions that improve the affordability of consumer durables through access to credit. While in Sri Lanka hire purchase contracts are attached to ~45% of retail sales, the percentage of retail sales made under hire purchase agreements in Bangladesh exceeds 66%.
Given its substantial market share, current projections that disposable income will increase by an average 7% CAGR over the medium term, and the embryonic penetration levels of consumer durables in Bangladesh (See Exhibits 7, 9, and 10), it is evident that Singer BD will play a significant role in equipping Bangladeshis as improved electrification and accelerating urbanization ramp demand for Singer BD products, particularly white goods such as refrigerators, which currently generate ~50 % of Singer BD’s revenues.
As in Sri Lanka, Singer BD derives a significant pricing advantage from having invested in local manufacturing (and assembly) capacity as this local output is not subject to import duties, is less exposed to foreign currency exchange fluctuations and leverages Bangladesh’s cheap labor force (40% less than China on an hourly basis). It is thus without surprise that locally produced goods have significantly higher margin than imported goods. As of 12/31/2016, Singer BD had annual manufacturing capacity, including that of technical partners, of 250,000 televisions, 60,000 air conditioners and 5,300 sets of furniture. Importantly, in FY 2015, Singer BD made a significant investment in domestic refrigeration unit production capacity through a joint venture, International Appliance Limited, with a large home appliance manufacturer based in China. The first of these refrigerators rolled off the line in May 2016 and capacity is expected to reach 250,000 units per annum in short order. Separately, Singer BD is also adding air conditioning assembly capacity to take advantage of increasing local air conditioning demand. Together, air conditioners and refrigerators represented more than 60% of Singer BD’s FY 2016 revenues.
Finally, Bangladesh’s current economic revival has been noted by international consumer durables manufacturers that are seeking to enter the market in addition to local competitors such as Walton that are increasingly investing in local manufacturing capabilities. While incremental local competition is unavoidable, Bangladesh’s reputation as a difficult business environment (176th overall out of 190 countries in the World Bank’s FY 2017 “Doing Business” ranking 19) should act as a short-term deterrent for international competitors considering direct entry into the market. This will benefit Singer Bangladesh in two ways: 1) by reducing competition generally and 2) by making Singer BD more attractive as a local partner to international consumer goods manufacturers that wish to gain exposure to the Bangladeshi market without investing in local operations.
c) Key Risks:
After experiencing periods of significant political unrest in FY 2014 and FY 2015 which were set off by contentious 2014 parliamentary elections, Bangladesh is enjoying a period of relative political and economic calm. Growth in FY 2016 exceeded expectation, forcing several upward revisions to GDP growth estimates as a sharp increase in consumer confidence led to greater spending on discretionary items. As evidenced by the 30+% revenue growth at Singer BD in FY 2016, consumer durables, including IT and digital media products, were a strong beneficiary of this trend. Lower inflation rates have also contributed to the uptick in demand. Finally, 1.3 million government employees received a 100% pay increase in 2016, which had an immediate impact on demand. Should the peaceful political status quo remain, Bangladesh’s economy is likely to experience growth rates of between 6% and 7% CARG over the medium term. That said, Bangladesh’s economic revival is at risk from a possible rekindling of social and political unrest and/ or, less likely, armed conflict and sectarian violence. In its most recent ratings report, Fitch concludes similarly that “continued strong political polarization could again lead to widespread violence and blockades, especially nearer to parliamentary elections, which are to be held not later than January 2019” 20. Should this occur, Singer BD’s revenues and operations could be materially impacted.
Moreover, Bangladesh’s banking sector remains under-capitalized and plagued by NPLs. While this rise in NPLs might only in part be the reflection of the government’s push to loosen fiscal policy, the close ties between government and the banking sector make it likely that the Bangladeshi government would “bail out” private sector banks should they start to fail. In fact, the probability that the Bangladeshi government will need to intervene and provide “considerable additional support to the banking sector” in the near term is high according to Fitch 21. Should this scenario play out, a Bangladeshi government “bailout” could only be financed through increased tax receipts which would depress discretionary spending thereby negatively impacting Singer BD. Additionally, while Bangladeshi banks do not directly finance consumer durable purchases, they do provide certain forms of consumer credit. As such, Singer BD would be negatively affected if the supply of traditional consumer credit tightens as the company’s products are generally too expensive for outright purchased. Conversely, however, as an integrated provider of consumer loans, Singer BD’s revenues are less exposed to a banking crisis than those of local competitors. Finally, in contrast to Singer SL, which is significantly more levered, Singer BD has a very strong balance sheet as evidenced by its current AAA credit rating 22.
d) Impact on REHO Intrinsic Value:
Chart 4: Dhaka Stock Exchange Month End P/E Ratio - 2001-2017
Singer BD is Bangladesh’s leading consumer durables retailer. The company has a sustainable competitive advantage due to its scale, extensive post-purchase service network, hire purchase expertise, lower cost/higher margin local manufacturing capacity and recognized brand equity. Despite the quality of the business, Singer BD’s listed shares 23 appear expensive at 26.0X LTM EPS, particularly when compared to Singer SL which currently trades at 9.2X LTM EPS. While Singer SL is nearly 3X the size of Singer BD based on FY 2016 revenue (~US $315 million vs. ~US $115 million, respectively), Singer BD’s profitability has consistently been superior to Singer SL’s as evidenced by annual EBITDA margins that are on average 120 bps higher over the last five years due to a less competitive retail environment. Regionally, Singer BD also appears expensive vs. the three-year current average LTM EPS multiple of ~17X for a composite “Comparable Index” (an average of the LTM P/E ratios of the Indian, Sri Lankan, Vietnamese, Pakistani, Thai, Malaysian and Indonesian stock exchanges) despite it being logical for Singer BD shares to trade at a premium to the average constituent of the “Comparable Index” owing to Singer BD’s superior revenue growth projections, profitability profile and strong moat.
All told, despite appearing expensive on a relative basis, Singer BD shares are fairly valued at current levels when compared to its own historical four-year average valuation metrics as follows: current LTM EPS multiple of 26.0X LTM EPS vs. four-year historical average LTM EPS multiple of 27.7X; current TEV/ LTM EBITDA multiple of 17.5X vs. four-year historical average TEV/LTM EBITDA multiple of 16.7X and finally current TEV/LTM EBIT multiple of 18.7X vs. four-year historical average TEV/LTM EBIT multiple of 18.3X.
Importantly, however, it appears that the exact nature of REHO’s share ownership in Singer BD is misunderstood by investors and the market. Per my analysis, REHO owns, through Sewko Holdings, ~16.5 million “remittance” shares in Singer BD and ~8.3 million “non-remittance” shares in Singer BD. The difference between these two categories of shares is summarized in Singer BD’s draft September 2013 IPO prospectus which outlines that “20% of the total equity in Singer Bangladesh Limited is not eligible for remittance in foreign exchange either as a dividend or capital” [and] “therefore if a dividend is declared in respect of these shares or if [Sewko Holdings] were to dispose of any or all of these shares, the dividend payable or proceeds from the sale of the shares would not be eligible for remittance from Bangladesh”, although Sewko Holdings “may use the proceeds to make other investments within Bangladesh” 24. It is therefore logical to conclude that “non-remittance” shares are less valuable than their less restrictive counterparts. Separately, over the course of its ownership in Singer BD, Sewko and its predecessors have accumulated over BDT 1.0 billion, ~US $12.8 million, in non-remittance dividends of which REHO’s share is approximately ~US $6.9 million.
Table 3: Singer BD’s Contribution to REHO’s Intrinsic Value:
In similar fashion to Singer SL, while it is tempting to model the future value for Singer BD shares at some time of disposition and discount that value back using the appropriate cost of equity to determine intrinsic value, the nature of the assumptions needed to be made, including the assumption that market and fair market value converge prior to a sale, makes this exercise imprudent. While Singer BD shares might appear expensive when compared Singer SL shares, Singer BD shares are generally trading in line with most of its own four-year average valuation metrics. As such, it seems appropriate to use Singer BD’s current share price as the basis for each of my downside, base and upside case and compensate for any possible overvaluation by conservatively valuing “non-remittance shares”. To this end, despite similar economic (except, obviously, for the ability to remit sale proceeds or dividends outside of Bangladesh) and voting rights, I value REHO’s ~8.3 million non-remittance shares at 33%, 50% and 66% of Singer BD’s 7/4/2017 share price of BDT 189.8 25, respectively in my downside, base and upside case. As these shares are likely to be purchased by investors that can receive the ~BDT 1.0 billion in related undistributed dividends, I do not discount the value of these “unremitted” dividends.
REHO’s ownership in Singer BD has the following impact on REHO’s intrinsic value:
Downside Case: ~US $52.2 million net contribution (+US $11.22 per share). In the downside case, I assume that “non-remittance” shares sell for 33% of the value of Singer BD’s publicly listed “remittance” shares to Bangladeshi investors who will benefit from the related undistributed dividends.
Base Case: ~US $55.5 million net contribution (+US $11.93 per share). In the base case, I assume that “non-remittance shares” sell for 50% of the value of Singer BD’s publicly listed “remittance” shares to Bangladeshi investors who will benefit from the related undistributed dividends.
Upside Case: ~US $58.8 million net contribution (+US $12.64 per share). In the upside case, I assume that “non-remittance” shares sell for 66% of the value of Singer BD’s publicly listed “remittance” shares to Bangladeshi investors who will benefit from the related undistributed dividends. However, as opposed to the upside case for Singer SL, I do not assume any control premium in the case of Singer BD as Sewko does not have “control” of Singer BD solely through its ownership of “remittance” shares.
IX. Present Value of REHO’s (Sub-License) Singer Trademark License Fee Earnings:
Table 4: Estimated 2016 Singer Asia License Fee Revenues
Singer Asia, in which REHO has a 54.1% ownership through its ownership in Sewko, has an exclusive perpetual license agreement with the Singer Company Limited S.ar.L, the owner of the Singer trademark, and wholly owned subsidiary of SVP Holdings, to use the Singer trademark in the Asia Pacific territory (excluding Japan and Korea) for all non-sewing products. This license agreement allows Singer Asia to use the trademark in its company name and that of any of its controlled subsidiaries, on its stores, on existing and new products and services that Singer Asia manufactures, assembles or provides or which it sources from third parties (except for sewing products and iron presses). Singer Asia can sub-license third-parties in the following countries: Australia, Bangladesh, Bhutan, Brunei, Cambodia, China, India, Indonesia, Laos, Malaysia, Maldives, Mongolia, Myanmar, Nepal, New Zealand, Pakistan, Papua New Guinea, The Philippines, Singapore, Sri Lanka, Taiwan, Thailand, Vietnam, and the Pacific Islands. Singer Asia is also the exclusive distributor of Singer sewing machines in all the markets where the company operates.
In consideration for these rights, Singer Asia pays SVP a royalty rate equal to 1% of its consolidated GAAP revenue. For FY 2016, the royalty paid to SVP was US $4.8 million.
In turn, Singer Asia charges its controlled subsidiaries and third-party licensors a sub-license trademark license fee (“trademark license fee”), which according to Singer Thailand’s FY 2015 Annual Report, prior to its disposition, was equal to 1.75% to 3.0% for external parties, [and] the fees charged to internal companies within the Singer network […] only 1.0% until 31 July 2015” (see Exhibit 14). While it remains unclear, it seems likely that the fees are based on net revenue based on the structure of the preceding agreement.
For FY 2016, I estimate Singer Asia’s trademark license fee revenues - conversely a royalty expense for controlled subsidiaries and third-party licensees - as follows:
a) Current Subsidiaries:
Singer Sri Lanka:
For FY 2016, Singer SL’s trademark license fee was ~US $3 million, approximately 1% of net revenue. In addition, Singer SL had a license fee payable balance of ~US $785,000 (see Exhibit 17).
For FY 2016, Singer IN’s trademark license fee was ~US $580,000, approximately 1% of net revenue. In addition, Singer IN had a license fee payable balance of ~US $17,000 (see Exhibit 18).
Singer BD’s trademark license fee was 4% of the net annual invoice price of audio video sets, ACs and furniture assembled manufactured in Bangladesh in FY 2016 (reduced from 6% in FY 2015) which equated to ~US $1.25 million or approximately 1.1% of net revenue. In addition, Singer BD has a license fee payable of ~US $1.2 million (see Exhibit 19).
b) Third-Party Licensees:
Singer Pakistan’s post-disposition trademark license fee has not disclosed. That said, a trademark license agreement was entered into after REHO disposed of its shares in January 2016 as detailed in the contemporaneous press release 26. For the purpose of my calculation, I assume that Singer Pakistan’s license agreement remained at 1% of net revenue for the balance of FY 2016.
For FY 2016, Singer Thailand’s trademark license fee was 0.5% of “consideration” revenue (see Exhibit 16), which I assume approximates net revenue based on the first iteration of the Trademark License Agreement signed post-disposition. Consequently, I estimate Singer Thailand’s trademark license fee to be ~US $370,000 for FY 2016.
Also, in its latest form, Singer Thailand’s licensing agreement extends through July 2025 when it is up for renewal unless a 12-month termination notice is received after July 31, 2020.
Blessington and Singer Malaysia:
Singer Malaysia’s license renews every five years in perpetuity but can be terminated by either party in case of a breach. As of 3/31/2013, Singer Malaysia had 147 direct selling Singer branches and 576 sales agents. Per Sewko’s draft Singapore IPO prospectus 27, Singer Malaysia’s 2013 revenue was ~US $101 million. The Company appears to have been purchased by Berjaya Corp., a Malaysian conglomerate. Revenue numbers for Singer Malaysia are no longer split out because they are immaterial to the size of the group.
Blessington is a private Australian company that focuses on the distribution of Singer Products through 79 Department Stores, independent traders and its own online store front. Per REHO’s draft Singapore IPO prospectus, Blessington’s license was set to expire on 12/31/2016. It appears however that the license has been renewed based on a recent review of the Blessington website 28. While Blessington’s revenues are largely concentrated in Australia, the firm also has a sub-license for New Zealand, Papua New Guinea, Fiji, Vanuatu, Solomon Islands, New Caledonia, Tahiti, and Tonga.
While no updated information exists to accurately estimate their combined trademark license fee, Singer Malaysia and Blessington (which in 2013 were REHO’s only two third-party sub-licensees), paid Singer Asia US $400,000 in 1Q2013, which would imply ignoring seasonality, a combined FY 2013 trademark license fee of ~US $1.6 million (see Exhibit 19). As no updated information is available, I estimate Singer Malaysia’s and Blessington’s combined FY 2016 trademark license fee at ~US $1.6 million, which conservatively assumes no growth for either since FY 2013.
Based on my estimates derived from the FY 2016 financial performance of Singer Asia’s controlled subsidiaries and third-party sub-licensees, Singer Asia would have generated close to US $7.0 million in trademark license fee revenues based on current agreements and, in the absence, my estimates as illustrated in Table 4.
Interestingly, it appears that the royalty agreement between Singer Asia and SVP Worldwide did not contemplate a scenario where REHO, through Singer Asia, would dispose of its shares in controlled subsidiaries and subsequently continue to collect trademark license fees. In practice, based on my limited understanding of the agreement between the parties, the royalty rate calculation for Singer Asia in relation to its annual payment requirements to SVP is based on Singer Asia’s GAAP revenue which post-deconsolidation of its controlled subsidiaries will only include trademark license fee revenues. In practice then, deconsolidation reduces the COGS associated with trademark license fee revenues from 1% of net sales when subsidiaries were consolidated for GAPP purposes to ~ 0.01% of net sales once a subsidiary has become deconsolidated despite Singer Asia continuing to capture 100% of the trademark license fee! Furthermore, Singer Asia’s license agreement is perpetual and can only be terminated in case of a material breach such as Singer Asia’s insolvency or its acquisition by a competitor of SVP Holdings, so the terms of the agreement are unlikely to change.
Given the importance of a continued trademark license fee agreement post-disposition and the successful negotiation of a new agreements for all disposed subsidiaries to date, trade license fee revenues and related earning streams are essentially akin to a growing perpetuity and therefore of substantial value. However, as all trademark license fee revenues related to controlled subsidiaries are eliminated in consolidation at the REHO level, as opposed to trademark license fees from third-parties, most investors are not aware of this “hidden asset”. Moreover, Singer Asia has the potential to increase its trademark license fees revenues by expanding into new geographies or by finding partners interested in licensing Singer’s (non-sewing related) trademark for other Asian countries where Singer Asia does not already have a sub-licensee such as China, which could represent a substantial opportunity in the future.
As with all license fee businesses which derive revenue based on the financial performance of third-parties, Singer Asia’s trademark license fees revenues are subject to the underperformance risk of individual sub-licensees as well as global or regional threats such as recessions or credit market freezes that could affect all sub-licensees. In addition to the risks related to the financial performance of sub-licensees, Singer Asia also faces the risk that a bankruptcy or a restructuring of SVP Holdings could tarnish the prestige of the Singer brand and therefore reduce its go-forward value. Of greater concern, however, is the risk, highlighted in Sewko’s Draft IPO prospectus, that “if SVP were to face financial difficulties and seek bankruptcy protection” Singer Asia “could, over time, experience difficulty in continuing to use the trademark, particularly for new products and new markets”. Furthermore, “in extreme circumstances” Singer Asia “may lose [its] rights under the Singer License Agreement or be forced to pay a higher royalty” 29. To this point, given the tendency for lawyers to acknowledge highly improbably risks in IPO prospectuses (this risk is not mentioned in REHO’s annual reports for example) and the investment savvy of Kohlberg & Company, who most likely shifted Singer’s IP into a bankruptcy remote subsidiary if they had the opportunity, it seems highly improbable that Singer Asia could lose its rights under the Singer License Agreement regardless of the nature of SVP’s financial difficulties or the avenue chosen to deal with these issues. Regardless, to account for such a scenario given the financial difficulties currently experienced by SVP Holdings and in acknowledgement that these issues will likely result in SVP undergoing some form of restructuring, I have very conservatively assumed no value for REHO’s post-liquidation trademark license fee related earnings in my downside case.
b) Estimated FY 2016 “Stand Alone” Singer Asia License Fee by Case:
Table 5: Downside, Upside and Base Case FY 2016 Singer Asia “Stand Alone” Trademark License Fee Revenues:
Table 5 above represents my estimate of Singer Asia’s FY 2016 “Stand Alone” trademark license fee revenue and related earnings in my downside, base and upside case.
As mentioned previously, because of the minor risk associated with an SVP restructuring, I conservatively do not project any value for Singer Asia’s post-disposition license fee revenues in my downside case.
In my base case, I estimate Singer Asia’s FY 2016 “stand alone” trademark license fee revenue at ~US $4.5 million by assuming that, post-disposition, all controlled subsidiaries will negotiate an agreement with Singer Asia similar to that which Singer Asia finally agreed to with Singer Thailand: a trademark license fee equal to 0.5% of “consideration” revenues which I believe should approximate net revenue. With regard to Blessington and Singer Malaysia, I conservatively estimate a combined trademark license fee revenue of ~US $1.6 million which assumes no growth in revenue at either of these third-party sublicensees since FY 2013. Thereafter, I calculate earnings by deducting COGS equal to 1% of net revenues per the agreement with SVP and ~US $670,000 in annual administration expense. Based on these assumptions, REHO’s share of Singer Asia’s FY 2016 “stand alone” trademark license fee related earnings would be ~US $2.0 million.
For my upside case, I estimate Singer Asia’s FY 2016 “stand alone” trademark license fee revenue at ~US $5.5 million by assuming that, post-disposition, all controlled subsidiaries will negotiate an agreement with Singer Asia similar to that which Singer Asia originally agreed to with Singer Thailand: a trademark license fee equal to 0.7% of what I understand to be net revenues. In any case, this assumption is conservative, even for an upside case, given that controlled subsidiaries are currently paying Singer Asia a trademark license fee of ~1% of net sales as illustrated in Table 4 and it is equally likely that Singer Asia could simply maintain these agreements in place post-disposition, particularly if these dispositions are made via stock placements through the relevant exchange. With regard to Blessington and Singer Malaysia, I again conservatively estimate a combined trademark license fee revenue of ~US $1.6 million, which assumes no growth for either since FY 2013, and assume that Singer Thailand’s trademark license fee remains in place at 0.5% of net revenues. Thereafter, I calculate earnings by deducting COGS equal to 1% of net revenues per the agreement with SVP and ~US $820,000 in annual administration expense. Based on these assumptions, REHO’s share of Singer Asia’s FY 2016 “stand alone” trademark license fee related earnings would be ~US $2.5 million.
c) Weighted Average Multiple for the Base and Upside Case
Table 6: Base Case and Upside Case Weighted Earnings Multiple
Having calculated REHO’s share of Singer Asia’s FY 2016 “Stand Alone” trademark license fee related earnings in my base case and upside case, I value these earnings using a weighted LTM earnings multiple as detailed in Table 6. Based on this methodology, the appropriate earnings multiple for the base case is 16.9X and the appropriate multiple for the upside case is 16.8X.
d) Impact on REHO Intrinsic Value:
Table 7: Present Value of Trademark License Fee Earnings Contribution to REHO’s Intrinsic Value:
Based on my analysis, the net contribution to REHO’s intrinsic value of the present value of REHO’s share of future trademark license fee related earnings is as follows:
Downside Case:~US $1.1 million net contribution (+US $0.23 per share). As detailed above, my downside case does not contemplate any value for the present value for REHO’s share of future trademark license fee related earnings. The US $1.1 million in net contribution to intrinsic value simply reflects REHO’s current share of brand license fee revenues accrued and yet to be paid by controlled subsidiaries for FY 2016.
Base Case:~US $34.2 million net contribution (+US $7.35 per share). My base case contribution is derived from applying a weighted LTM earnings multiple of 16.9X as calculated in Table 6 to REHO’s estimated base case FY 2016 brand license fee related earnings as calculated in Table 5, in addition to REHO’s current share of brand license fees accrued and yet to be paid by controlled subsidiaries for FY 2016.
Upside Case:~US $41.5 million net contribution (+US $8.93 per share). My upside case contribution is derived from applying a weighted LTM earnings multiple of 16.8X as calculated in Table 6 to REHO’s estimated upside case FY 2016 brand license fee related earnings as calculated in Table 5, in addition to REHO’s current share of brand license fees accrued and yet to be paid by controlled subsidiaries for FY 2016.
X. Present Value of Possible Recoveries from SVP Seller Notes:
REHO’s second “hidden” asset is derived from its potential to recover a portion, if not all, of its US $30.9 million face value of SVP Seller Notes, the original portion of which the company received in June 2004 as part consideration from Kohlberg & Co.’s purchase of Singer’s sewing business. In FY 2015, REHO’s management wrote down the value of these Seller Notes to zero given SVP Holdings’ financial position, its inability or unwillingness to cure its default with regard to the Seller Notes, and, finally, their deeply subordinated nature in a complex capital structure. I believe that, while appropriately conservative given the circumstances, REHO’s management’s valuation of the Seller Notes does not reflect their probability weighted intrinsic value as there are multiple ways in which REHO stands to recover some portion of the value of the Seller Notes, and possibility, albeit unlikely, par and all accrued interest owed.
a) SVP Seller Note Chronology:
In June 2004, Singer N.V. (REHO’s predecessor) announced a transaction with an affiliate of Kohlberg & Co. for the purchase of Singer’s worldwide sewing business and the ownership of the Singer trademark for consideration of US $135 million: US $65 million in cash, US $47 million in the assumption of debt and US $23 million in unsecured subordinated 10% per annum promissory notes (7% cash minimum and 3% PIK or PAY). These unsecured subordinated notes had an initial maturity date of 9/30/2010 for 33% of the Seller Notes and a maturity date of 9/30/2011 for the balance. While there is no organization chart available to review, REHO reports that the Seller Notes are guaranteed by SVP Holdings Limited (“SVP”), the ultimate parent of Singer/Viking, Husqvarna, and Pfaff. These notes are held directly at the REHO level.
In February 2006 Kohlberg & Co. acquired VSM, the owner of Husqvarna and Pfaff sewing machines and subsequently merged it with Singer.
In October 2009, SVP defaulted with respect to several covenants on its principal credit agreement and, by cross default, SVP defaulted on the Seller Notes. In May 2010, SVP cured the default and in exchange for an increase in interest rate on the Seller Notes, REHO’s management agreed to extend all maturities to February 2014.
In June 2012, SVP refinanced its debt obligations, in part through a US $200 million senior secured term loan provided by SSLP (now part of Ares Capital (ARCC)), and a yet to be quantified mezzanine tranche, a portion of which is currently owned by BlackRock Capital Investment Corporation (BKCC).
As part of the refinancing, SVP’s debt maturities were extended to June 2017 and June 2018. Concurrent with the refinancing, REHO agreed to extend the maturity of the Seller Notes to September 2018, with no increase in interest rates. However, SVP did repurchase US $5.9 million face value of Seller Notes for US $5 million, a ~ 15% discount.
Shortly thereafter, in 2014, a strengthening US Dollar negatively impacted SVP’s financials, forcing the company to “renegotiate the financial covenants in its senior, mezzanine and subordinated debt obligations” 30. SVP’s financial condition continued to deteriorate and on 6/30/2015, and subsequently on 12/31/2015, SVP failed to make the minimum cash interest payment on the Seller Notes prompting REHO’s management to write down the Seller Notes to zero.
b) Current Situation:
Post SVP Holdings’ 2012 refinancing, it appears, to the best of my knowledge, that the company has a three-tiered debt structure: a senior secured tranche of US $181 million due June 30, 2017, (~US $200 million when disbursed) 31 a mezzanine tranche due in June 2018 and the SVP Seller Notes due September 2018.
*Senior Secured Debt:
Ares, through its legacy SSLP Loan Portfolio, holds the entire US $181 million face value of Senior Secured Singer Sewing Company debt (See Exhibit 15). Despite 50 bps of the 7.8% annual interest rate transitioning from cash interest to PIK interest, the US$ 181 million in principal has seemingly not been marked down and is most certainly unimpaired. However, given the 6/30/2017 maturity date of the Senior Debt, SVP could now be in default, albeit that no information to this effect, or its contrary, has filtered.
BlackRock Capital Investment Corporation (“BKCC”) owns ~US $56.5 million face value of SVP’s mezzanine debt (See Exhibit 16). While I have yet been able to quantify the aggregate total outstanding face value of SVP mezzanine debt, BKCC is the lead investor in the tranche 32. As of 3/31/2017, BKCC marked the fair value of its mezzanine debt investment in SVP holdings at 60% of face after a series of markdowns. Evidently, several amendments have also taken place over time as illustrated by a shift in interest rate from 12% per annum payable in cash at disbursement to 16% per annum currently of which 2.50% is payable in cash with the balance payable in additional notes.
Based on this past Friday’s maturity date for SVP’s Senior Secured debt, which as of 3/31/2017 totaled US $181 million in face value, it comes as no surprise to learn that BKCC had been “focusing time and resources on SVP Worldwide”33 and been in talks with the first lien debtholders, other mezzanine lenders and Kohlberg & Company. The objective of these communications was to “evaluate constructive options aimed at rightsizing SVP’s balance sheet in order to better position SVP to execute on its three-year business plan” 34. From the tone of BKCC’ s management’s comments over the last earnings calls, it appeared that BKCC was relatively optimistic about a possible restructuring of SVP’s balance sheet, particularly given SVP’s FY 2016 financial performance, which according to a 3/3/2017 article in the Tennessean, resulted in sales of ~US $500 million with operating income increasing 35% year over year 35.
Surprisingly, given that the Secured Debt matured on 6/30/2017, no information has filtered as to the outcome of these discussions. Clearly, it is now possible that SVP is in default on its Secured Debt (and by cross default the rest of its capital structure). However, it seems more likely at this point, that SVP was granted some form of amendment. As both Ares and BKCC report earnings on 9/2/2017, additional information should be forthcoming.
Regardless, however, there remain numerous scenarios in which REHO would recover a substantial portion of its investment in SVP Seller Notes particularly given REHO’s ability to facilitate a restructuring or potentially hold out. Conversely, there are also many scenarios that could result in REHO receiving no recovery. That said, even in bankruptcy, which would most certainly be value destroying for all parties, it is possible for REHO to make a recovery. For example, I note that the mezzanine tranche is characterized as unsecured debt by BKCC in its FY 2016 10K as illustrated in the table below:
Source: BlackRock Kelso
If this classification is correct, then it is, for example, feasible that REHO could successfully argue that both the Mezzanine Notes and Seller Notes are in the same unsecured class of debt and therefore should be grouped together as one impaired class. Should this argument be successful, the Seller Notes and SVP Notes would share in any recovery pari passu.
Generally, as an “orphaned” security of US $30.9 million in a large capital stack, REHO is not without power at the negotiation table. Still, it is nearly impossible to project possible recoveries at this stage. Regardless, I strongly believe that the Seller Notes are worth more than zero in numerous scenarios and have made conservative recovery assumptions to reflect the uncertainty.
c) Impact on REHO’s Intrinsic Value:
Table 8: SVP Seller Note Recovery Estimate by Case and Impact of REHO’s Intrinsic Value
Based on my analysis, the impact of the present value of REHO’s potential recoveries from the SVP Seller Notes has the following impact of REHO’s intrinsic value:
Downside Case:~US $0 million net contribution (+US $0 per share). My downside case assumes no recovery from the SVP Seller Notes.
Base Case:~US $3.1 million net contribution (+US $0.66 per share). I estimate a conservative 10% recovery which takes into consideration the costs associated with any recovery, value destruction during the restructuring or bankruptcy process and a discount for the time value of money.
Upside Case:~US $10.2 million net contribution (+US $2.19 per share). I estimate a 31% recovery which is 50% of the 3/31/2017 BKCC mark for the mezzanine tranche. My estimate of the recovery takes into account a wide range of outcomes including the potential for a full recovery in a number of scenarios such as a sale to another sponsor. In addition, my recovery percentage also takes into account the potential for the Seller Notes to be grouped with the Mezzanine Debt as Unsecured Debt should SVP file for bankruptcy. Despite being an upside case, my recovery estimate also takes into consideration the costs associated with any recovery, value destruction during the restructuring or bankruptcy process and a discount for the time value of money.
I currently have a long investment in Retail Holdings N V. I reserve the right to buy or sell shares of Retail Holdings N V at my discretion at any time and for any reason.
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Exhibit 1: Corporate Structure at 7/4/2017
Source: REHO 2016 10-K & Indelible Capital Estimates
Exhibit 2: Intrinsic Value by Case at 7/4/2017
Source: Indelible Capital Estimates
Exhibit 3: Singer SL FY 2016 Market Share Analysis
Source: CAL Research
Exhibit 4: Singer SL FY 2016 Net Interest Margin
Source: Company Presentation
Exhibit 5: Singer SL FY 2016 “Paying %”
Source: Company Presentation
Exhibit 6: Latest TV Penetration Rates in Southern & South-East Asia
Source: CAL Research
Exhibit 7: 2013 & 2014 Refrigerator Penetration Rates in Southern & South East Asia
Source: CAL Research
Exhibit 8: 2013 & 2014 Washing Machine & AC Penetration Rates in Southern & South East Asia
Source: CAL Research
Exhibit 9: Latest PC Penetration Rates in Southern & South East Asia
Source: CAL Research
Exhibit 10: Latest Smartphone Penetration Rates in Southern & South East Asia
Source: CAL Research
Exhibit 11: Singer SL FY 2016 Debt Maturity Profile
Source: Company Presentation
Exhibit 12: Singer SL Retail Store Formats
Source: Company Presentation
Exhibit 13: Singer BD Retail Store Formats
Source: Company Presentation
Exhibit 14: Singer Thailand Go-Forward Brand License Fees
FY 2015: Initial Post Sale Brand License Agreement
Source: Singer Thailand, 2015 Annual Report
FY 2016: Renegotiated Brand License Fee Agreement
Source: Singer Thailand, 2016, Annual Report
Exhibit 15: SVP Secured Debt Tranche Owned by Ares Capital – 3/31/2017
Source: Ares Capital Corporation, 1Q2017 10-Q
Exhibit 16: SVP Mezzanine Debt Owned by BlackRock Capital Investment Corporation – 3/31/2017
Source: BlackRock Capital Investment Corporation, 1Q2017 10-Q
Exhibit 17: Singer Sri Lanka Royalty Expense (Paid to Singer Asia)
LKR 460,715.461 = USD $3,011,411 as of 7/4/2017
Source: Singer Sri Lanka, 2016 Annual Report
Exhibit 18: Singer India Royalty Expense (Paid to Singer Asia)
INE LKR 37,400,000 = USD $580,000 as of 7/4/2017
Source: Singer India, 2016 Annual Report
Exhibit 19: Blessington and Singer Malaysia Royalty Expense (Paid to Singer Asia)
Source: Sewko Draft IPO 2013 Prospectus
- Retail Holdings 2016 10K
- Retail Holdings sells more shares in Singer
- Retail Holdings 2016 10K
- Rangeley Capital's top pick for 2017: Retail Holdings
- Singer Pakistan parent sells its entire stake
- Fitch Affirms Singer Sri Lanka PLC at 'A-(lka)'; Outlook Stable
- Singer - Huawei celebrates 5 years of success
- Retail Holdings 2016 10K
- Retail Holdings 2016 10K
- Fitch Affirms Singer Sri Lanka PLC at 'A-(lka)'; Outlook Stable
- 2017 Sri Lanka floods - Wikipedia
- Bloomberg has not yet updated Singer SL’S financial results for 1Q2017 so LTM for Singer SL refers to FY 2016 earnings.
- Singer SL float % at 6/10/2017 is estimated at ~29% (~108MM shares /~376 mm shares outstanding).
- Doing Business in Bangladesh - World Bank Group
- Fitch Affirms Bangladesh at 'BB-'; Outlook Stable
- Fitch Affirms Bangladesh at 'BB-'; Outlook Stable
- Singer BD float % at 6/10/2017 is estimated at ~39% (~30MM shares /~77 MM shares outstanding of which ~17 million are non-remittance shares).
- All currently listed Singer BD shares are remittance shares
- Retail Holdings N.V. Announces Sale Of Singer Pakistan Stake
- Blessington - everything you need to get sewing
- Retail Holdings FY 2014 10K
- 1Q2017 BKCC Earnings Call Transcript- 5/4/2017
- 3Q2016 BKCC Earnings Call Transcript- 11/3/2017
- 1Q2017 BKCC Earnings Call Transcript- 5/4/2017
- Singer sewing machine maker plans La Vergne HQ move, job growth
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Analyst’s Disclosure: I am/we are long RHDGF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Initial Write Up Posted to SumZero 6/21/2017
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