Asian Idea Generator Weekly: Mark Mobius' China Movie Play, Walter Schloss' Rule No. 10 And An Obscure Bitcoin Proxy

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Includes: IMXCF, IXCNY, KMNCF, PCPPF
by: The Value Pendulum
Summary

Mobius Emerging Markets Fund’s top 10 positions include a Chinese subsidiary of a well-known U.S. theater screening technology company.

Walter Schloss' Rule No. 10 leads to a Singapore-listed exhibition services provider and interior fit-out specialist trading close to its three-year share price low.

A relatively obscure Hong Kong-listed company with no sell-side coverage is a cheap way to capitalize on bitcoin’s price surge year-to-date.

Introduction

The Asian investment universe is significant at over 30,000 stocks, including approximately 3,800 companies listed in Japan, 3,500 companies listed in South-East Asian countries, 2,300 companies listed in Hong Kong and 2,300 companies listed in South Korea. For investors who are able to ditch their home bias, Asia can offer interesting investment opportunities and diversification benefits.

Idea generation is the starting point of every investment, but it is understandable that investors might find it challenging to generate ideas outside their home markets. This is the inaugural issue of the Asian Idea Generator Weekly, which I hope would be of value to those seeking to add Asian companies to their investment portfolios.

I argue that the principles of idea generation are universal. The three main methods of idea generation that I employ are namely: 1) piggybacking on the trades of institutional investors and insiders; 2) quantitative screens; and 3) seeking proxies for secular investment themes.

Piggybacking: Father of Emerging Markets' Favored Hong Kong Stock

Mark Mobius, former executive chairman of Templeton Emerging Markets Group, left Templeton to start Mobius Capital Partners last year. Given that Mark Mobius is widely referred to as the "Father of Emerging Markets," it is fitting that he is the first guru whose trades we piggyback on in the inaugural issue of the Asian Idea Generator Weekly.

Mobius Emerging Markets Fund, managed by Mobius Capital Partners, lists Hong Kong-listed IMAX China (OTC:IMXCF) (OTC:IXCNY) [HKG:1970] as one of its top ten positions in a concentrated portfolio of around 20 names as of April 2019. IMAX China is a 68%-owned subsidiary of IMAX Corporation (IMAX) in the U.S., which Templeton Emerging Markets Group incidentally used to own when Mark Mobius was still executive chairman.

It is useful to view the IMAX China investment opportunity through the lens of Mobius Emerging Markets Fund's investment strategy. According to its website, the investment firm focuses on "dynamic mid-sized companies in many of the fastest growing economies in the world" and "identifies resilient business models which are undervalued and mispriced."

IMAX China's market capitalization is below $1 billion and fits the criteria of a mid-sized company. Also, few would argue that China is one of the fastest growing economies globally. Specifically relating to movies and IMAX China, China is the second largest cinema market globally boasting a 2018 box office of $9 billion, trailing only North America which did $11.9 billion of ticket sales last year. If one does a comparison of both China and U.S. cinema markets, it is easy to understand why China's cinema market still has a long growth runway. The number of screens per 100,000 people is 3.7 in China versus 12.3 in the U.S.; while movie admission per capita is 1.2 times in China compared with 3.5 times in the U.S. in 2017.

IMAX China's business model is definitely far more resilient than perceived, especially for those who compare IMAX China with other listed movie studios whose revenues are heavily dependent on box office hits. IMAX China earns money from both variable revenue tied to box office results generated from both theater operators and movie studios, as well as fixed revenues (not directly tied to box office ticket sales) relating to the initial sale of an IMAX theater system and a recurring annual maintenance fee earned from exhibitor partners. IMAX China has a backlog of 272 IMAX systems to be installed as at the end of 2018 and an existing network of 639 theaters fitted with IMAX systems, which supports the fixed revenue component of the business.

Also, IMAX China is relatively more asset-light and less capital intensive compared to its theater operator peers. Firstly, the installation cost of IMAX systems are approximately a quarter of that of building movie theaters. Secondly, the capital needed to install IMAX systems is pre-funded by upfront installation fees paid by theater operators. In contrast, it is impossible for theater operators to ask movie-goers to foot the bill for building theaters before they even buy movie tickets!

Based on its closing share price of HK$18.80 as of May 31, 2019, IMAX China is trading at 17.1 times consensus forward FY19 P/E and 15.9 times consensus forward FY20 P/E. In comparison, IMAX China's parent, IMAX, is valued by the market at 19.7 times consensus forward FY19 and 18.0 times consensus forward FY20 P/E respectively. IMAX China's under-valuation is validated by recent share buybacks. Year-to-date, IMAX China has bought back approximately 2.12% of its outstanding shares at prices ranging from HK$16.96 to HK$20.70.

The key risk factor for IMAX China is still worse-than-expected box office performance for films screened in the IMAX format, which reduces the variable revenue component which is calculated as a percentage of ticket sales paid by theater operators and movie studios. As mentioned earlier, this is partly mitigated the fact that IMAX China generates the other half of its sales from recurring annual maintenance revenue from its existing network of 639 theaters fitted with IMAX systems, and secured new IMAX systems installation revenue secured by its backlog of 272 IMAX systems to be installed as at the end of 2018.

Screens: Walter Schloss' Rule No. 10

The closest thing coming to an investment checklist for deep value investing guru Walter Schloss is the "16 Factors Needed To Make Money In The Stock Market" he listed as a part of a March 1994 speech delivered to students at Columbia Business School. Walter Schloss' Investing Rule No. 10 is as follows:

"When buying a stock, I find it helpful to buy near the low of the past few years. A stock may go as high as 125 and then decline to 60 and you think it attractive. 3 years before the stock sold at 20 which shows that there is some vulnerability in it."

I apply Walter Schloss' Rule No. 10 by doing a screen for Singapore-listed stocks trading within 10% of their three-year historical lows. I pick the Singapore market because Singapore (like Hong Kong) is one of the open economies that is vulnerable, as U.S.-China tensions lead to a slowdown in trade activity.

Singapore-listed Kingsmen Creatives (OTCPK:KMNCF) [KMEN:SP] is a leading exhibition service provider and interior fit-out specialist in the Asia Pacific started in 1976. To make things simple, Kingsmen has three key business segments: the "good", the "uncertain," and the "new".

The "good" business segment is the Exhibitions & Thematic division which produces exhibition displays for trade shows and promotional events, as well as interiors and displays for theme parks, museums and visitor centers. In particular, theme parks are the key growth driver for this division. Grand View Research forecasts the global themes parks industry to grow at a 5.8% CAGR between 2019 and 2025 to reach $70.8 billion. Kingsmen Creatives' portfolio of theme park projects include Shanghai Disneyland and Universal Studios in Singapore among others.

The "uncertain" business segment is the Retail & Corporate Interiors division which provides interiors fitting-out services for high-end retailers (clients include Fendi and Christian Dior), eateries/restaurants, corporate offices, banks and showrooms. On one hand, high-end retailers have scaled back their ambitious store roll-out plans to focus on a select number of flagship stores (less work for Kingsmen Creatives) in a difficult environment in recent years. On the other hand, the challenging retail environment means retailers have to work doubly hard to win over customers by creating new, differentiated in-store experiences (more work for Kingsmen Creatives).

The "new business" segment is the Intellectual Property division. In October this year, Kingsmen Creatives will open a NERF (NERF franchise owned by Hasbro (HAS)) Family Entertainment Center (the first of its kind globally) in Singapore where families and friends can play games with the NERF foam-based shooting toy. This is an example of how Kingsmen Creatives can work with intellectual property owners to monetize its IP. More importantly, recurring income from the monetization of IP is far less riskier and volatile than lumpy project-based revenue, which should lead to a positive re-rating of Kingsmen Creatives' valuations over time as its revenue mix changes.

Kingsmen Creatives' share price closed at S$0.52 as of May 31, 2019, versus its 52-week and 3-year historical low of S$0.49. Net cash accounted for approximately 35% of its market capitalization, so Kingsmen Creatives is trading at 8.3 times ex-net cash FY18 P/E and offers a 4.8% trailing dividend yield.

The bear case scenario for the stock would see retailers deferring expansion of new stores and refurbishment of existing stores adversely affecting the performance of the Retail & Corporate Interiors division. This risk would be partially offset by the growth potential of the new Intellectual Property division, which would see Kingsmen Creatives acquire or license new intellectual property to generate more recurring income.

Thematics: Cryptocurrency play

Hong Kong-listed PC Partner (OTCPK:PCPPF) [HK:1263] is the world's leading video graphics card (VGCs) manufacturer. VGCs are PC components used to process graphics display data and interface between PCs and their video display, whose applications include gaming, animation graphics and imaging processing etc. PC Partner manufactures VGCs for Original Equipment Manufacturer/Original Design Manufacturer customers, and it also designs and sells VGA cards and other PC products under its own brands (ZOTAC, Inno3D), thanks to its long relationships with Nvidia Corporation (NASDAQ:NVDA) (since 2006) and Advanced Micro Devices (NASDAQ:AMD) (since 1998), the world's largest and second largest graphics processing unit providers respectively.

PC Partner is a classic "buy on assets, sell on earnings" and "broken growth story". PC Partner has transformed from a cheap earnings growth story back into a liquidation play. Based on its share price of HK$1.87 as of May 31, 2019, PC Partner is now net-net trading at a discount to its net current asset value per share of HK$2.06. Given that the near-term earnings (driven by demand for VGCs) outlook for PC Partner is uncertain, net current asset value provides an indication of the cheapness of the stock in terms of its downside asset protection. Furthermore, PC Partner is an undiscovered, obscure play on bitcoin, as it has no sell-side analyst coverage.

In the short-term, PC Partner is a bitcoin play, as its share price fluctuates with the price movements of bitcoin, as demand for VGCs is positively correlated with cryptocurrency mining.

In 1H18, PC Partner's revenue grew 86.4% YoY to HK$5,538.4 million, while PATMI increased almost eight-fold to HK$340 million. PC Partner's share price reached a historical peak of above HK$7 in June 2018 during the last bitcoin boom where the price of bitcoin hit a high above $20,000 in January 2018 and was above $10,000 for most of 2018.

In late-2018 and early 2019, the price of bitcoin went under $5,000, and PC Partner's 2H18 results reflected that. PC Partner's 2H18 revenue declined 23% YoY to HK$3.58 billion, and it registered a loss of -HK$69 million compared with net earnings of HK$280 million and HK$340 million in 2H17 and 1H18 respectively.

Apart from the depressed bitcoin price dampening demand for VGCs, Nvidia's launch of its new generation of graphic cards, Turing, in 4Q2018 fell short of expectations as it was perceived to be overpriced, according to comments by PC Partner management. The market was flooded with oversupply of inventories from both the crypto-mining overhang (demand for VGCs relating to crypto-mining collapsed along with the price of bitcoin) and the poorer-than-expected demand for Nvidia's launch of its new generation of graphic cards, Turing.

In the mid-to-long term, advances in gaming will drive demand for higher-performance VGCs and the long-term growth prospects of PC Partner. Although the initial Turing launch was not the success that people expected, Turing still has the potential to drive long-term gaming demand. Turing is a breakthrough product, with the ability to do ray tracing, a technology associated with rendering of Pixar animated films that render a frame every few minutes, which takes gamers a big step closer to photorealism in games. As game developers eventually write software to capitalize on the potential of the Turing chip, PC Partner's sales of VGCs should grow over time.

The overhang (leading it to be valued as a net-net) on the stock relates to the oversupply of inventories and the price of bitcoin. For the former, Nvidia indicated at its most recent 1QFY2020 results conference call that the oversupply issue has eased as CEO Jen-Hsun Huang commented that "when we look at our overall inventory in the channel, we believe that this is relatively behind us and moving forward that it will not be an issue. Going forward, we will probably reach normalized level for gaming somewhere between Q2 and Q3." With respect to the latter, bitcoin price movements are difficult, if not even impossible to predict. Nevertheless, given the stock's current depressed valuations as a net-net now, PC Partner is a cheap way to "trade" the volatility of bitcoin in the near-term and capitalize on gaming-driven demand for higher-performance VGCs in the long-term.

Closing Thoughts

Idea generation is just the first stage of the investment process. Investment research and portfolio management are equally important. Nevertheless, drawing a parallel with cooking, a world-class chef could find it difficult to whip up a great meal with sub-par ingredients, while you and me could cook something decent if we have the right (and high-quality) ingredients. This illustrates the importance of idea generation, which provides a wide funnel of ideas for selection to be implemented in a positive returns portfolio.

Disclosure: I am/we are long PC PARTNER (1263 HK). 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.