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In a similar vein as GVInvesting’s recent and excellent Keck Seng write-up, I recommend looking at a set of three Hong Kong hotel/property companies that are simply too cheap and where insiders are buying repeatedly. They are Asia Orient (214 HK), Asia Standard International (129 HK), and Asia Standard Hotels (292 HK).

Asia Standard trades at 0.18x tangible book, Asia Orient trades at 0.16x tangible book, and Asia Standard Hotels at 0.43x tangible book, and in all cases book value is meaningfully understated b/c the assets are largely held at cost and the value of Hong Kong hotels has been appreciating considerably in recent years. Asia Standard, where I recommend investing in the corporate structure, is nearly a Graham net net trading for ~ 2x EV/EBIT when Asia Standard’s EBIT is actually understated for reasons I will get into and when EBIT from hotel assets and leased up commercial real estate in Hong Kong currently goes for 20-30x+ EBIT. Unlike most net-nets which are cigar butt type companies, Asia Standard has a large and growing earnings stream and is chock full of valuable assets in a highly supply-constrained property market. All three companies have very conservative balance sheet with Asia Standard and Asia Orient having significant net cash (Asia Standard Hotels has no net debt but doesn’t have excess cash) vs. most hotel and property companies which are highly levered. When I first came across this family of companies I assumed that the Poon Jings (the controlling family of all three companies) must have a poor reputation, but as I’ll discuss after some digging in Hong Kong property circles we couldn’t find anything to justify such steep valuation discounts. The family has a reputation for integrity and skill and has been buying shares repeatedly over the last few months. Dalton Investments owns large stakes in Asia Orient and Asia Standard for many years and has also been accumulating.

The simple structure is the family (Richard Poon Jing is the patriarch) owns 51% of Asia Orient, which then owns 51% of Asia Standard, which then owns 73% of Asia Standard Hotels. Working from the bottom, Asia Standard Hotels are where the hotels in the structure are, Asia Standard has its controlling stake in the hotel company as well as other commercial and residential real estate assets primarily in Hong Kong, and Asia Orient has its stake in Asia Standard as well as cash and is just a hold co. We have our position largely in Asia Standard because it is the near net net in the structure as well as in Asia Orient but Asia Standard Hotels is also cheap. Dalton has been buying at the Asia Standard level and the Poon Jings have been buying at the Asia Orient level.

Below we start from the bottom and work our way up the corporate chain. At the end I touch on management integrity/ability and catalysts.  

Asia Standard Hotels (292 HK):

• Owns 4 hotels under the Empire brand name, 3 in the core business district (CBD) of Hong Kong.  Also runs a small travel agency business but this is break-even from a profitability standpoint and I don’t give any value to it.

• The three HK hotels are the vast majority of the value and are at 95-97% occupancy rates currently. In general the HK hotel sector is an attractive sector as space is at a premium and the government is projecting visitation to double over the next 10 years (7% CAGR) vs. supply growth which per the Hong Kong Tourist Board is expected to be a CAGR of 3-5% over the next 4 years. As hotels have a multi-year lag time given permitting and construction, supply growth over the intermediate term is well-known. Visitation of late has been growing much faster than the long-term 7% projected CAGR, in 2H13 visitation grew 18% y-y.  

• Two new Empire hotels in the works both in Hong Kong, one to open 2016 and one to open 2017. Each hotel is adjacent to one of their existing HK hotels and the land is already owned by the company and demolition work has been done, so we get the future value of these hotels only for the construction cost vs. the normal land + construction cost. In the HK market, land is obviously a large % of overall build cost. 

• Tangible book value as of 9/30/13 is 3.1B HKD vs. market cap of 1.3B HKD or ~ 43 cents on dollar. Tangible book is obviously at cost and HK land and hotel prices have appreciated meaningfully, the book value adjusted for current appraised market values (disclosed in the footnotes to the company’s financial statements) is 9.6B HKD or ~ 14 cents on the dollar.

• The appraisal isn’t public, so it’s unclear if the appraisal is giving some value for the excess land for the two additional sites which are yet to be producing EBITDA. If we just take the EBITDA of the current 4 hotels, the appraised value would imply a 2.5% cap rate which is low. Good US assets are trading hands closer to a 5% cap rate. Good HK properties can trade for lower cap rates but 2.5% is still very low, so it’s likely some excess real estate value is being incorporated.

• If we use a 5% cap rate instead, the adjusted book value would be 5.1B HKD or ~ 27 cents on the dollar vs. ~ 14 cents on the dollar using the appraised value. The 27 cent on the dollar purchase price is conservative given there’s no value for the two additional sites being incorporated.

• Final point on the hotel segment is it has a very conservative balance sheet – 1.7B HKD of debt as of 9/30/13, 1.6B of cash/financial investments. Cash will likely fall as the two new hotels gets built, but on the other hand you get two new hotels for much lower than replacement cost given the land underneath them is already included in the current valuation.

Asia Standard International (129 HK)

• This is the one (along with Asia Orient below) I suggest you considering investing it, Asia Standard Hotels is cheap but Asia Standard International is exceedingly cheap. Owns 73% of Asia Standard Hotels above, a 353K sq. ft portfolio of retail/commercial buildings in downtown HK, and a portfolio of 5 residential projects currently under development spanning 4 million sq. ft in Hong Kong and in China. In addition, the company has 3.7B HKD of cash outside of the cash at the hotel company as of 9/30/13, and 2.1B of debt outside of the debt at the hotel company as of 9/30/13.

• To give some measure of how cheap Asia Standard is, the market cap is ~ 2.4B HKD and there is 1.6B HKD of net cash at the Asia Standard level. So for 800m HKD net you get 73% of the hotel business that is worth somewhere between 5B HKD and 9.6B HKD (see above), a 353K sq. ft commercial portfolio in downtown Hong Kong that was appraised last at 5.5B HKD as of 9/30/13, and a large residential portfolio which at cost is in excess of 4B HKD as of 9/30/13.

• On top of this Asia Standard is a net net or at least very close to one. If we strip its balance sheet for the hotel company liabilities, there are ~ 3B of total liabilities. Current assets ex the hotel company’s current assets are ~ 6B so net of all liabilities you have 3B HKD of Asia Standard net net value and the market cap is 2.4B HKD. If we want to be exact, per Graham’s definition we have to adjust current assets such as inventories to liquidation value, for Asia Standard the current assets are basically cash/investments that require no discount and 1.7B HKD of property under development held at cost. Let’s discount that by 50%. That takes the adjusted net net value to ~ 2.1B HKD vs. a market cap of 2.4B HKD, so nearly a net-net under this definition.

• While Graham focuses on current assets, most of Asia Standard’s value is in the non-current assets as you would expect for a hotel and property company and you get these all for free as well as getting 73% of the hotel company for free. The hotel value has already been discussed. The long-term retail/commercial real estate portfolio is on pace to generate ~ 90M of NOI and cap rates are extremely low for leased up commercial and retail properties in Hong Kong currently, on the order of 2-3%. 2.5% cap rate gets you to 3.6B HKD and the appraised value is 5.5B HKD, again perhaps due to excess real estate, other factors we aren’t aware of, or an aggressive appraisal as the appraisal isn’t available. It’s on the balance sheet at the appraised value of 5.5B. On top of this, there is 2.6B HKD in the residential portfolio under development as of 9/30/13 at cost which is already beginning to show strong sales (107M HKD in segment profit contribution in the 6 months ending 9/30/13 vs. nothing in the 6 months ending 9/30/12). Finally, there is an additional 250m HKD in long-term financial investments as of 9/30/13.

• So adding it all up, adjusting for the 73% ownership of the hotel co and using our haircuts for the hotel appraisal and the commercial leasing portfolio appraisal, you would get a total value of 13.1B HKD or an 18 cent dollar at the current market cap of 2.4B HKD.  If you use the full appraised value on both the commercial real estate and the hotels, you would get a total value of ~ 18.4B or a 13 cent dollar.

• As a final point, Asia Standard is very conservatively financed for a property company, with 1.3B HKD net cash at the Asia Standard level and its hotel business subsidiary has no net debt

Asia Orient (214 HK)

• This final entity is simple: it’s basically 51% of Asia Standard, ~  600m HKD of net cash as of 9/30/13, and ~ 71M HKD of convertible debt (6.5% coupon, 1.1 HKD conversion price). I assume conversion of the debt taking S/O to 779M and the market cap to 1.5B HKD, so then its ~ 600M HKD of cash and 51% of Asia Standard.

• So for 900M HKD net of cash, you get 51% of Asia Standard which we calculated is worth somewhere between 13.1B HKD to 18.4B HKD.

• Asia Orient technically isn’t a net-net, because its balance sheet would basically show ~ 600M of cash and then its investment in Asia Standard which wouldn’t be a current asset, but it’s obviously very cheap.  Note there is a deferred income tax liability of 750M HKD at the Asia Orient level. The controlling family rarely sells assets so the present value of this liability is likely to be much less than its accounting value. As an important side note, I’ve treated all values as pre-tax as historically the family hasn’t monetized by selling but by putting a modest amount of debt on its assets to expand into new ones which is a tax-free strategy obviously. I don’t see monetization occurring in the near or intermediate future as the patriarch’s son recently became a junior executive. The negative of this is there’s unlikely to be a hard catalyst (see catalyst section below, I still think there’s at least a partial catalyst), but one silver lining is that taxes are going to be deferred indefinitely.  

• Value range – stake in Asia Standard + cash means 7.3B HKD to 10B HKD (I’m excluding the deferred tax liability for the fair market value calculation which would reduce the values above by ~ 10%), or 15 to 20 cents on the dollar.  

Family Reputation/Ability:

This is obviously crucial as you will be partnering with the Poon Jing family for many years. We engaged Knight Frank, a well regarded Hong Kong real estate appraisal and services firm (http://www.knightfrank.com.hk) to dig around about the family and see if unethical behavior/poor reputation could be the reason for the large discount. The upshot is management has a good reputation, is known for being conservative in how they run their business (which fits with the very low leverage levels), and are considered to be in the upper tier (but not the all-stars) in terms of the most highly regarded property development management teams in Hong Kong.   

Catalysts:

As discussed above in discussing taxes, these companies are unlikely to be sold anytime soon. However, one small thing in our favor is that the stocks are trading even below their typical low historical price to book value range, and this is further compounded by the fact that in recent years the rapid appreciation of Hong Kong real estate means that accounting book values are increasingly understated so if anything the book value multiples could be higher than the long-term average. While there is significant and perhaps justified concern about the China residential property market, these companies’ properties are almost entirely in Hong Kong and are primarily nearly 100% occupied hotels and leased up commercial/retail assets.

So over the next several years we could benefit from continued book value per share growth, a book value multiple returning to the historical average if not higher, and finally optionality on the price getting to fair value which could mean up to 8x your money.  

• Asia Standard is currently at 0.18x tangible book vs. 2005-2013 average multiple of 0.29x or 61% upside to the average. With some book value per share growth, you could see achieving nearly a 2x return over a 4-5 year horizon even with steep discounts to intrinsic value remaining.
• Asia Orient is currently at 0.16x tangible book vs. 2005-2013 average multiple of 0.24x or 50% upside to the average.  
• Asia Standard Hotels is currently at 0.43x tangible book vs. 2005-2013 average multiple of 0.53x or 23% upside to the average.

Finally, up to now we’ve largely talked in terms of asset values, but hotels and performing real estate obviously produce earnings. Asia Standard is on a ~ 400M HKD EBIT run-rate this fiscal year (as a side note, it’s important to go to the segment reporting footnotes to calculate this, you will get a higher number from the income statement but interest income is considered as revenue which we want to exclude. This also allows us to exclude all re-valuation gains from the calculation and adjust for the minority interest in the hotel segment). Net of cash Asia Standard has an EV of ~ 800M HKD so this is ~ 2x EV/EBIT and EBIT should improve considerably from here as a large % of the company’s assets are currently non-income producing (the residential portfolio under development, the two new HK hotel properties, etc). As a point of reference, Asia Standard Hotels trades at a much more reasonable ~ 8x EV/EBIT but is still low vs. US and Hong Kong hotel valuations in the private markets.  

Earnings and earnings growth provide at least a moderate catalyst as they lead to book value per share growth which combined with a return to a more normal book value discount range can produce a nice return while waiting for true value to be recognized. 

Catalyst