Kwok Vs. The Good Guys, The Battle For Nam Tai Property Begins
Summary
- NTP is now the target of an activist campaign to reconstitute the board of directors, change capital allocation strategy, and focus management's effort on realization of value for shareholders.
- NTP management has responded back to their credit with some decent communication to shareholders, but it is not enough.
- I am behind the activist campaign due to a lack of concern for the common shareholder's return and a large amount of uncertainty around Kaisa and NTP management.
Background
I have written about my Nam Tai Property (NTP) thesis in a previous article. In that article, I did advocate for some management changes, and obviously, NTP was a great target for an activist given the wide disparity between intrinsic value and Mr. Market's current value. Prior to purchase, I had read about ISZO and their successful activist campaign. I believed that the group of shareholders I had spoken to was high quality and would not bend to the will of Kaisa (OTC:KAISY) if they were to try and do anything nefarious. However, my base case and my belief were that management could not mess up this business due to that wide disparity in intrinsic value, and after reading the new information and thinking about it more, I believe I may have underestimated this possibility.
From a common-sense perspective as well as talking to shareholders, I think that this campaign has a high chance of success and the discount to intrinsic value is so wide that I can take some pain and suffering along the way. I can't imagine ISZO doing all this work without having the votes to accomplish the campaign as well as the foresight to have a plan of value realization for shareholders.
As a quick reminder, I think the stock has a wide range of potential outcomes, but the true value could be anywhere from $20 to $100. Please see my prior article for more detailed thoughts. At a high level, I believe if this campaign works and the company is somewhat efficiently managed, it is hard to come up with a scenario in which we garner less than $30 a share for the assets and it could go as high as $100+ if land and building value continues to increase and China real estate prices do not collapse. Given $30 at the low end, I believe there is a 2/3 chance this goes through, my lower-end price target is $20/share with a wide range on the upside. If this takes one year or five years, it doesn't really matter as the IRR will still be incredible. This is the most attractive opportunity in the market I can find, albeit with some hair.
ISZO Capital Summary
Please see all the important information here. I have had some of this information, but it was nice to gain even more access to diligence materials. For purposes of disclosure, Brian from ISZO and I had a brief email exchange, but no other information than what is available online was discussed. I think he has a great vision with regard to realizing shareholder value and if board control is realized, I really don't think it is that hard to do.
ISZO's portfolio is extremely concentrated and in the business I work in that means he likely runs a lot of his own capital because institutional investors generally don't accept a 3-name portfolio. Maybe there are some names that do not show up and I do know he has a short book as well; however, portfolios like this are very volatile and thus create high career risk for the capital allocator. That being said, this is a huge positive for NTP as it means they have a ton of skin in the game and will fight like crazy to realize value in the stock. I looked back at historical public filings and found this concentrated style to be consistent and somewhat successful. I have also done a couple reference checks on the firm and came back with positive results.
See their current book as of March below.
Source: Novus
ISZO comes out firing accusing the management team of "oppressive conduct, poor governance, and value destruction." ISZO goes on to mention the collapse in share price since Kwok took over, management's lack of communication with shareholders, and a critique of their most recent $100M land purchase.
ISZO goes on to talk about the board which essentially is Kaisa controlled.
Source: Letter
I do agree with this point, although I thought that this was somewhat to be expected given Kaisa's stake in the company. If we had a benevolent dictator in Kaisa, this type of ownership would be okay with me and initially, this is how I rationalized it, as it created alignment. Directors have options, management have options, and therefore, they'd want the stock price to go up right? The nomination of the CEO's son was a wake up call for me and thankfully, it seems that nomination did fail or the dad was scared of this campaign and removed him. Either way, it is a positive sign that ISZO will have backing when the time comes to shake up the board.
We have to ask ourselves why does NTP exist? Why did Kaisa not just buy the whole company? Why did they remove valuation case studies from their website? Why do they not communicate with anyone? I have asked myself these questions many times and was never fully satisfied. Kaisa was able to assert full control over an attractive asset without buying the whole asset. Maybe management thought the value could be realized in a more efficient structure or maybe they had something more devious in mind - a way to build another empire using outside capital, running the company into the ground and buying it for cheap years down the line. If NTP is run solely to benefit Kaisa and the Kwok family rather than common shareholders, obviously, the board allowing that due to their affiliations is an issue. The answer is unclear, although this type of family-run empire building without regard to common shareholders is extremely common in emerging markets, which is why you need such a wide discount to intrinsic value to invest. I would be here with or without ISZO, but someone running the show focused on creating value is obviously welcome, and I feel more comfortable buying today at $6-7 than I did a few weeks ago at $4. I have added around 10-20% to my position at current levels, despite the large run and position size in my portfolio, now over 10%.
I've studied Kaisa's history and I have talked with other shareholders privately as this being the main reason the stock has been held down, but I had believed that NTP needed a partner to develop and lease the properties, and I accepted that Kaisa had enough incentive to execute at an adequate level. I hope we don't need to find out if I was right or wrong. The additional information provided by ISZO and the additional red flags were more than I had anticipated. You can read more about Convoy under "Kaisa Self-Dealing" and "Board Record" on the website. It is pretty compelling especially when combined with Kaisa specific issues in 2014. Additionally, I recommend asking almost any China real estate analyst about Kaisa, they will not give a glowing review.
Under the path forward section of the letter, ISZO advocated for a dividend or stock buyback at all-time lows, which are similar suggestions that I had in my prior article. ISZO argues that the purchase of the new property was perhaps a bit premature, and I also lamented the lack of explanation for shareholders regarding the new purchase. ISZO also advocates for a strategic review, capital allocation changes, and improving operating income. I believe the path forward will consist of hiring a consultant or doing a comprehensive study comparing outright sale to company operation and then sell and picking the best option with the best risk/reward. I am very excited for this to occur and am cautiously optimistic.
Potential Concerns With the Approach
The Board
ISZO plans to replace the board, which it should be able to do under pretty clear-cut BVI law with proper shareholder support. I am not an expert, so readers please introduce me if you know an expert, but it does seem like Kaisa has limited recourse. Again, please do not take my word for this as I do not have a clear understanding here. This is not Starboard with a team of lawyers and unlimited resources. ISZO has put in a ton of work and time to realize value in the name. Luckily, this is not a Chinese listed name, and the manager has experience operating in these types of situations, although this is unlike most other activist campaigns. I'd imagine Brian will spend at least $1M on legal fees before this is over and shareholders all owe ISZO a debt of gratitude for taking on this cost.
The motion which I would guess will come within the next couple of weeks will require 30% of shareholders to call a special meeting, which I have high confidence ISZO has. I also have high confidence they have the 50% quorum to attend the eventual meeting and replace the board, as they wouldn't have undergone this costly and time-consuming process without a great chance of winning. My guess is Mr. Kellogg will play ball here, but they may or may not even need him at this point. If Kellogg is on board, this is a virtual lock. Given the small amount of uncertainty and my lack of expertise in the area, I would give this an 67% chance of happening. The board does get to set the time of the meeting, although courts can expedite this process if there are any unwarranted delays. If you think 67% is too high, and give it even 50%, there is still enough upside in the stock to be excited.
That being said, ISZO has to find board members willing to sit on the board. Can they find people that are experienced in Chinese real estate, M&A, and are willing to take on Kaisa for the good of the common shareholder? I believe they or someone close to them are interviewing various candidates to propose at the meeting, which is a good sign but are we sure that is a skill set they have? I assume we will see this shortly.
How Does the Shareholder Actually get Rewarded?
This question adds on to the prior point. I think ISZO's plan would most likely consist of selling off assets that are saleable at a good time in the market. They will likely hire a consultant or agent to complete that process. Hopefully, they can do so in a tax-efficient way for shareholders as the taxes can be quite high especially given the artificially low cost basis of NTP properties. See my last article for more information on the high taxes on profitable sales. I would love to know what approaches are on the table, as selling Inno Park will be complicated, and returning capital via special dividend may not be the most efficient mechanism of returns. I want to know what the value of the land in their mind is, what target are they seeking to achieve as their values mentioned in the letters are somewhat low in my opinion.
If this is approved, there are certainly a lot of hurdles seemingly with Kaisa out of the picture. There will be lots of operational execution necessary. I assume a large study will be done and the new board will select the highest risk/reward value to move forward with. I look forward to learning more about their eventual approach if the board is to be reconstructed.
China and the Kwok Family
China is not the US. Lots of bad things can happen there and do happen there which would not happen in the US. We have seen dozens of examples. If the Kwok family can scratch the right back, can they disrupt this process? They are worth hundreds of millions of dollars, and that is a worthy adversary not to be taken lightly. This could potentially backfire on shareholders if this plan does not succeed. However, one major important factor is that Kaisa (where all the real $ are held) is somewhat dependent on foreign and US bond markets for financing. If they were to do something sketchy in this situation, it could cut off their lifeline, which you would think would dissuade them from any such actions. Why fight this when you can just take a nice return on your investment?
While Kwok's somewhat shady past is generally a negative for management of the company, in this case, this may mean they have less influence in the PRC. This may actually help ISZO in their quest to take over. Kwok and family have other businesses to worry about and likely won't stake his reputation on NTP in the courts.
Other options include selling their shares creating large value destruction as there likely wouldn't be enough buyers, though this seems pretty undesirable as they know what the company is worth after buying it for $17 3 years ago.
What seems most likely to me and the best way for Kaisa/Kwoks to capture the company and still create value is to buy up as many shares as they can. This would be a feasible option, and I would not be surprised if this occurred in order for them to maintain control. However, we have seen how little volume it takes to move the stock. It doubled on a volume of around $1M shares, so it would substantially drive up the price of the stock.
Another concern and reason I would urge this motion be brought to the shareholders as soon as feasible is Kaisa can still manage the company in the meantime and dilute its advantages with its 2 Shenzhen properties by completing more acquisitions like Dongguan. If they buy more properties, the balance sheet gets more levered, and the story gets more and more complicated. The new purchase gives a stake to a government entity and things like that can complicate the eventual value realization process. I do not expect the management team to go away quietly.
Lawyers
At my job, I deal with lawyers a lot. Generally, they make a lot of money for delaying and making everything more complicated. This could turn into a prolonged legal battle which is something the Kwok family and Kaisa have expertise in. It could be a long painful journey for shareholders. There is a lot of unknowns here for me and this is the biggest hurdle for bulls.
What did ISZO Miss?
Not much. I believe ISZO did not articulate the upside scenario, instead focusing primarily on dated land-only valuation metrics. I think this was done purposefully for a variety of reasons. I believe they believe in similar price targets to what I have calculated. However, many people don't take you seriously when you say the stock could go up 5-10x. There is one article on the whole website showing what comparable transactions look like. This attachment shows that a construction area of 121,000 square meters in a similar area to NTP's Inno City selling at the maximum price at auction in less than 4 minutes at a price of 5.9B yuan. This translates into roughly $830M for less construction area than either of NTP's two prized possessions. If we adjust for the area of NTP's two land pieces ignoring their most recent purchase, we get a total of ~696,000 square meters or 5.75x the area of the purchase in the article. Doing quick math if NTP were able to capture a similar price per square meter, we get to a purchase price of 830*5.75 = $4.74B which is over $100 a share. Obviously, there is a ton of tax, and we have to adjust for areas, zoning, land rights, etc…, but the value is probably not more than a 75% all-in discount, right? Inno Park is likely worth less than this, but nonetheless taking the 75% discount, we get a $1.2B value, or >4x our current share price. Maybe they are just trying to under promise and over-deliver. If the board was recycled and ISZO did takeover, I would be disappointed in a low 20s type enterprise valuation. I believe if properly controlled and monetized, this should be far higher than low 20s.
Other discussion points that I am assuming will come out in the future are board appointees and value realization strategies.
Company Response
The company responded to the letter about its board of directors by extolling their virtues and skills and mentioning their independence. The management team simply missed the opportunity here to address these issues by claiming all are independent without a single mention their affiliation with Kaisa, showing a lack of trustworthiness. If they actually addressed the issues head-on, I would have been more likely to consider their perspective.
They spoke about operational expertise which has led to cost savings as well as future plans. The cost savings are impressive and the debt rates are also quite low which are both positives. The cost savings of >$100M on Inno Park translates to ~$3/share or the purchase price of their most recent acquisition. When Kaisa essentially took over the company, this is what I researched and became comfortable with. They had developed properties, and had the resources and contacts to get the job done. NTP, given its history, didn't have someone who knew how to develop property, and Kaisa was a top 30 development company.
I arranged a call with a China real estate analyst who works at one of the largest asset management firms in the world, and he stated that property development is a game of growth, and to do so you need to have financing. In order to get financing, you have to be growing. This is certainly the plan for NTP. However, we have to remember that NTP is probably not in top 100 property developers in China, but what it does have is land at least worth $1B trading at $250M. Let's leave the developing and growing to the much larger and better-managed peers and realize the value of our discounted assets.
Management does finally give some color on the giant purchase made in March in Dongguan which could be an attractive location with great GDP growth, though this is certainly a speculative purchase without any proof of concept in terms of generating income and returns for shareholders. It takes away from the inherent advantage of NTP which are its undervalued assets. There needs to be more detail here on expected ROI, payback periods, etc…
What the response lacks is any significant explanation of how they will create shareholder value. It is essentially looking at how low our costs are and how we are expanding and trust us. This does not work for me and I am sure it does not work for other larger shareholders. Management has continued to refuse to have a conversation with shareholders and continues to have an extreme lack of transparency regarding their goals and future management of the company. I have sent in numerous requests for a call all of which have been ignored. Their response was lacking in the issues most important to shareholders and ISZO's claims and seemed somewhat rushed and surprisingly timid. I don't believe they gained any shareholders who were on the fence prior to the letter being issued. I don't believe they are prepared to fight and may not be taking this seriously as it is extremely uncommon in China. I hope this is the case, but I would be surprised if they take this lying down.
Conclusion
As far as I am concerned, the company is at its best risk/reward ever as I believe ISZO has a high chance of winning this battle and if so, a lot of uncertainty is removed from the story. If ISZO does win and the board is reconstituted with the goal of realizing value, the minimum share price I can feasibly imagine garnering is $30. If this takes months or if this takes years, I am satisfied with that return.
ISZO has owned the stock in size since 2017 and has lived the entire time with this new management team in a top shareholder position. I think with proper execution this is an easy undertaking in terms of value creation. I will take a lower return of a sure thing over a painful wait and see game under current management. I would urge all shareholders to contact ISZO and use their voting power to create value in their shares of NTP.
Analyst’s Disclosure: I am/we are long NTP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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