Description

Recommendation

I am recommending an investment in Playmates Holdings Limited (SEHK: 635) (“Holdings”).  I have sized this to about a 4% position which is a little bit smaller than my normal allocation.

Company Overview

This Hong Kong company is really divided into two businesses: (1) a core real estate business and (2) a majority stake in a public toy company named Playmates Toys Ltd. (SEHK: 869) (“Toys”).  Holdings technically has three segments: (1) Property Investments and Associated Businesses, (2) Investments and (3) Toys.  The Property Investments and Associated Businesses is further subdivided into three different streams: (a) Property Investments, (b) Property Management and (c) Food and Beverage.  Holdings property investments are predominantly Hong Kong based and heavily dependent on one property which it refers to as The Toy House.  Toys is a designer, developer and marketer of toys with a focus on action characters.  The business at this point is nearly 100% driven by its world-wide rights to Teenage Mutant Ninja Turtles (“TMNT”), though it has made recent efforts outside this brand which will play a part of the story over the next five years.

Thesis Summary

An investment in Playmates Holdings provides an opportunity to own, at a sizable discount to intrinsic value, quality real estate assets in Hong Kong, including one premier property, The Toy House, and a stake in a quality and cheaply priced, if somewhat unpredictable, toy business.  The collection of assets provide significant downside protection, even after considering more realistic HK real estate valuations than is reflected on Holdings balance sheet.  An ongoing and increasingly meaningful share buyback effort is extremely accretive to value per share and provides some optimism that the gap between price and value isn’t lost on the controlling family.  

Why Does Opportunity Exist

• Holdings is a small-cap HK company controlled by the Chan family.  The market cap is about $256 mm USD at recent prices and the family owns a bit over 50% of the shares.  Holdings is small and obscure.  To my knowledge the company has no research coverage.

• As an asset class, HK listed real estate companies don’t necessarily strike one (or the market) as a generally fertile area to find intriguing value.  (Notwithstanding the Keck Seng thesis which has been discussed on VIC)

• Marking the HK real estate assets to market, an elevated market, necessitates a discount to balance sheet marks, the magnitude of which is debatable and requires some independent thought.

• Given the under-levered balance sheet there is considerable question as to incremental capital allocation opportunities and decisions.  Recent small acquisitions outside HK in the property business are not necessarily going to excite many people.

Management and Incentives

• As mentioned, the Chan family controls 51.9% of the shares of Holdings.  At recent prices that amounts to HK$1.03 billion.  The CEO and Chairman Mr. Chan has received a salary of HK$7.1 mm and HK$5.3 mm in each of the last two years.  Bonuses have taken total compensation to HK$35.8 mm and HK$29.6 mm during those two years.  This compensation is considerably higher than prior years, likely due to the success of Toys with the TMNT brand and considerable progress with The Toy House.  Regardless, the Chan family would seem to well incentivized by the share price.

• There is admittedly a mixed picture when it comes to capital allocation.  As outlined further below, recent real estate purchases in global gateway locations at what one might guess are far from bargains and which may be questionable assets is offset by an ongoing and very productive share repurchase program.  

• Given that the Toys business is nearly exclusively driven by TMNT now after nearly 20 years with the brand, one might properly question the ability of management to grow this business.  Changes in management and philosophy over the last few years may provide some hope, but it remains to be seen if the company can develop beyond TMNT.

Asset Overview

• Holdings owns what I think about as three primary HK assets and a small collection of residential real estate around the globe.  The HK assets are: The Toy House, HIillview and Playmates Factory Buildings.  The residential collection includes residential property in NY, Tokyo and surrounding London.  NY and Tokyo are recent additions.  There is little information at this point on the residential collection but these purchases don’t appear to be predicated on cash on cash returns.

• The Toy House is the biggest driver by far, producing HK$79 mm in rental income in H1 which is 64% of the entire gross revenue of the Property Investments and Associated Business segment.  The property appears to be a premier property, located at 100 Canton Road.  Canton Road is a premier retail location globally… http://www.colliers.com/-/media/files/global/pdf/global-retail-highlights-2014.pdf?campaign=Global-Retail-Report-2014-PDF.  In 2014 it ranked third globally in retail rent per square foot behind Fifth Avenue in NY and Queen’s Road Central in HK.  As a testament to the quality of the property, a few years ago it added Apple as the primary tenant of the ground floor of the building.  This has helped to drive rental income much higher from the property.  In fact, income from The Toy House grew from HK$42 mm in 2012 to HK$151 mm in 2014.  Growth in the half year to June 2015 was 4.7%.  

• Hillview is a residential property located at 21-23A MacDonnel Road.  The company owns a large number of the properties at this location and appears to be working toward owning the entire building.  This is a much smaller and currently stable property, having produced HK$15 mm in 2015.  During the first half of 2015 rental income was down 9%.  Over the last five years income has fluctuated a bit but is generally stable.

• Playmates Factory Building is located in Tuen Mun.  The company in intrigued long-term by the redevelopment prospects of this property.  In 2014 it produced HK$17 mm and in the first half of 2015 rental income grew 20%.

• Additionally the company has a property management business and a food and beverage business.  Collectively, these business produced HK$52 mm in revenue in 2014 which is up about 25% from 2010.  Revenue was down 17% in the first half as one of the company’s restaurants was closed, leaving two restaurants operating in The Toy House.  A replacement or redevelopment of the space is likely.

• Toys is the exclusive world-wide toy partner for TMNT.  Oddly enough, the company has been with the brand since inception of the concept and played an integral role in the early development of the brand.  Toys is fairly mum about the contract with the brand, but I’ve been led to believe that it is a fairly unique license in the industry, including as it pertains to duration.  In 2009, TMNT was purchased by Nickelodeon, part of MTV Networks (Viacom).  After a number of years of poor investment in the brand, the change in ownership provided a much needed change in direction.  New cartoon series have been developed and a first movie was released in 2014 by Paramount.  This renaissance has been a remarkable blessing for Toys as revenue grew from HK$45 mm (trough) to HK$2.16 billion in 2014.  Not bad.  This surely will not continue, especially with strong toy competition in 2015 with Star Wars and no movie launch.  There is however a new TMNT movie planned for release next year.  New management came in a few years ago (Michael Chan, son of Holdings CEO) and eliminated the focus on poor performing and small properties to focus nearly exclusively on TMNT.  The re-launch and success of TMNT toy products has created a fair bit of momentum for Playmates Toys.  This year the company has begun a process to selectively expand and diversify the business.  It has signed agreements with Cartoon Network for Ben 10 (2017 launch), Corus Entertainment / Topps Company for a new animated action girls series called Mysticons and Corus Entertainment for Mech Mice.  While it is obviously way too early to say if any of these efforts will be successful, the TMNT success and credibility has created an emerging opportunity to greatly expand the potential of the Toys business.

Additional Notes

• Holdings owns 50% of Toys.  Toys is valued in the market at HK$2.14 billion, implying a market value of the Toys stake of HK$1.07 billion.  Toys holds HK$1 billion of net cash and has a book value of HK$1.1 billion with no intangibles or goodwill.  On a trailing basis, super-charged by TMNT, it trades at 4.5x ttm NI.  The current market price is 2x tangible book.

• The investment properties of Holdings are currently marked at HK$5.71 billion.  Total debt at Holdings is HK$0.54 billion with HK$0.33 billion of cash leaving HK$.21 billion of net debt.  Holdings also owns HK$0.13 billion of public securities.  The balance sheet has significant additional capacity, as total loan to value of the properties is less than 10% and even on my adjusted marks is about 25%.

• I previously alluded to some questionable purchases.  With recent purchases in NY and Tokyo, Holdings owns a small collection of residential properties in or near global gateway cities.  The NY and Tokyo assets are high-end apartments and the assets near London are estates.  It is not hard to imagine that the cash on cash return for these assets is not an ideal use of capital.  The company would say that each required or requires capital improvements and the purchases were driven by capital appreciation potential after investment.  This is the least ideal piece of the thesis.  

• The company has been actively repurchasing shares, which would appear to be a positive driver of value per share.  At the end of 2010 shares outstanding numbered 258 mm.  Four years later this declined 11.2% to 229 mm.  This year 6.4 mm shares have been repurchased so far, reducing the share count by 2.8% with a noticeable pick-up in pace after the end of the first half in June.  In fact, 5.4 mm shares have been repurchased in just over 4 months.  While not extremely large numbers, it is a consequential quantity and in relation to the float is particularly more notable.  As a side note, Toys has also begun repurchasing shares, though in much smaller quantities and Holdings has made some small purchases of Toys.

• Holdings and Toys have been paying dividends.  Holdings declared a dividend of HK$0.075 at the end of the first half.  At the end of 2014 it declared a dividend of HK$0.075 which would imply a full year dividend of HK$0.15 or a 1.7% yield on a HK$9.00 share price.  It has also paid special dividends in each of the last two years… HK$0.20 per share at the close of 2014 and HK$0.40 at the close of 2013.  Toys has paid HK$0.10 over the last twelve months plus a further special dividend of HK$0.05.

Valuation, Potential Return and Downside Protection

• At HK$9.00 per share, Holdings trades at quite a discount to stated book values.  On first half 2015 numbers, the shares trade at 32.4% of book value.  Excluding the consolidated Toys entirely, the shares trade at 39% of book value.

• My preferred valuation is to look at a more conservative value of the properties, add in a value for Toys then sum and deduct remaining assets (which are predominantly current assets) and liabilities.  The two biggest inputs in this approach are value of the properties and value of Toys.  With conservative values for these two inputs, total value sums to HK$13.16 per share, implying the shares are trading at 68% of this conservative estimate.

• I have valued the properties at HK$2.14 billion which is 37.5% of the stated balance sheet value.  On a ttm basis the three primary properties have produced HK$188 mm in rental income.  This property valuation would imply a rental yield of about 8.8% and ascribe no value to the properties outside HK.  While not ideal, I prefer to look at the Property Investments and Associated Businesses segment.  Prior to revaluations of property investments, this segment produced operating profit of HK$160.4 mm.  At a 7.5% cap rate (inclusive of depreciation) this would be HK$2.14 billion.  The weakness in this approach is that it includes the non-real estate business of property management and restaurants, which I’m not able to tease out of the numbers.  

• Given the considerable uncertainty on Toys, I have valued the Toys stake, not at market, but at HK$610 mm.  This would be 57% of market value.  At this value, the entire Toys company would be valued at HK$1.22 billion which is a 10% premium to book value.  Net current assets is HK$1.01 billion.  I thinks this is a conservative approach that considers: (a) the one brand current business and (b) the considerable uncertainty to future earnings from TMNT.

• Using these assumptions, Toys would represent approximately 20% of the overall value.

• Downside protection is a significant piece of the thesis.  At such a discount to current market values and even to conservatively adjusted values, combined with such low leverage, it seems like an impairment of capital at current prices would require a number of things to go meaningfully wrong.

Potential Catalysts

• Ongoing share repurchases that are accretive to value per share and shrink the float.

• Ongoing growth in the premier property The Toy House driven by strong rental growth in non-Apple tenants.

• Future redevelopment of Hillview and Playmates Factory Building which drives gains in rental income.

• The Toys business continuing to perform well and justifying a better valuation.  This could be from ongoing success of TMNT and success at some of the recent diversity efforts.

Risks

• Poorly conceived acquisitions of future properties.  The company is clearly focused on expanding the portfolio beyond HK.  While perhaps logical, recent acquisitions, are likely not the most ideal selections.  Future acquisitions may also not be ideal.

• A significant portion of the asset value is currently ascribed to The Toy House.  The loss of Apple that isn’t replaced by a similar high quality tenant and similar rental rates would not be positive for the asset value of this property.

• HK retail and development exposure to mainland Chinese tourists and related business development efforts may prove a significant headwind or catalyst to drive values down valuations.  Pressure on rents could significantly impact the current portfolio.  The Toy House seems particularly susceptible to this risk given its location and retail focus.  Cushman & Wakefield has reported this fall that high street retail rents have fallen as much as 26-42% depending on the location since the peak in the fourth quarter of 2013.  The Apple agreement was likely signed in early 2012 or late 2011 as build-out was during H2 2012.    

• The elevated state of real estate valuations broadly in HK could impact sentiment and real values.  Headline reports by Holdings of negative revaluations, while in-line with my valuation thoughts could be a pressure on shares.

• With a large stake and ongoing buybacks, perhaps the family is moving slowly toward a take-under.

Catalyst

• Ongoing share repurchases that are accretive to value per share and shrink the float.

• Ongoing growth in the premier property The Toy House driven by strong rental growth in non-Apple tenants.

• Future redevelopment of Hillview and Playmates Factory Building which drives gains in rental income.

• The Toys business continuing to perform well and justifying a better valuation.  This could be from ongoing success of TMNT and success at some of the recent diversity efforts.