OPG Power Ventures (UK MicroCap)

Background

OPG Power Ventures (Ticker OPG, #OPG, $OPG) operates and develops power generation assets in India. It's main asset is a 414MW coal thermal power station in the state of Tamil Nadu (near Chennai), with OPG currently owning a 100% stake in the plant. OPG also has a 31% stake in 4 solar farms in the Karnataka state:

- 20MW (Mayfair renewable energy pvt ltd)
- 20MW (Aavanti Renewable energy pvt ltd)
- 20MW (Aavanti Solar EnergyPvt Ltd)
- 2MW (Brics Renewable Energy Pvt ltd)

OPG has been listed in the UK stock exchange for over a decade, with market capitalisation reaching an all time high of ~£400m in July 2015 and been on a declining trend since, it's current market cap is £25m. What has changed? 

In 2016, OPG announced its investment in the solar assets described above, which was funded by group and project level debt. At the time, OPG's Net Debt / EBITDA was at 6-7x level so OPG was not in a position to embark on new investments and market got apprehensive. The rationale behind the investment in solar was OPG's desire to re-position the business into renewables. 

OPG's financial situation wasn't helped by the fact that the 2nd coal thermal power station that OPG had at the time (a 300MW plant Gujarat) had significant challenges with disputes with the local authority which led to missing debt repayments, and OPG ultimately deciding to write off their ownership in the plant in 2018. By then, the market capitalization had fallen to £60m (with net debt at close to £100m) and Net Debt/EBITDA at over 3x. Since 2018, the business and operational performance has been stable (ignoring COVID-19 for the time being) albeit (and understandably so) the focus has been on de-leveraging. As a result, cash dividends were halted on 31 March 2018, and all cash generated pre financing (over £100m until now) has essentially been used to repay debt. Debt is pretty much fully repaid currently or at least cash is set aside for repayment when it comes due in the next 12 months. Net Debt is therefore close to 0 currently. 

Thermal Power Coal Station Operations

The Tamil Nadu power station was commissioned in stages as shown below:

Typically, coal thermal power stations have a useful life of at least 25 years hence all units have significant useful life remaining. 

The main driver of revenue from the plant is the energy sold to customers which for OPG is both corporates as well as the local electricity company (Tangedco). Across contracts, most of them will be base on specified tariffs which may be renegotiated on annual basis. 

The main cost input into generation is coal prices with OPG's plant running on a blend on Indonesian (prime product) and Indian Coal (more basic product). The average coal price that have generated power for OPG is summarised below:

As expected, with the re-opening of global economies following COVID-19 (not helped by the Ukraine/Russia war) there has been significant demand for coal worldwide and coal prices have sky-rocketed. This has made operations for OPG challenging with OPG consciously running the plant at a lower load factor ("PLF") to ensure profitability. 

The first half of the year (ending March 2023) has been challenging for OPG with the continued heightened coal prices and hence plant running at a lower PLF. Nonetheless the business has remained profitable and is well positioned to re-start operations strongly as coal prices stabilise at a lower level. The Indonesian Coal Futures show the volatility in coal prices in 2021/2022:

Thermal Coal Generation Market in India

Despite the Decarbonisation agenda worldwide, India will continue to rely on thermal coal as part of its energy mix until 2050. 

S&P - https://www.spglobal.com/en/research-insights/featured/special-editorial/energy-transition-thermal-coal-will-remain-important-in-asia-pacific

CEA - https://economictimes.indiatimes.com/industry/energy/power/coal-to-dominate-india-power-to-2030-despite-renewables-boost/articleshow/70040887.cms?from=m

This is further evidenced by the amount of coal thermal power plants that continue to be commissioned recently, for example:

1) Uppur Thermal Power Project (1200 MW) -  Expected Cost 12,655 Crore

2) North Chennai Thermal Power stage III station (800MW) - Expected Cost 6,376 Crore

3) Uduangudi (1320 MW) - Expected Cost 13,077 Crore

4) Yamunanagar (800MW) - Expected Cost 5,352 Crore

For these new plants, the implied cost of construction per MW ranges from ~£0.7m per MW to ~£1.1m per MW. (Using a Crore to GBP exchange rate). 

Whilst there is a shift in investor appetite for these assets, especially across the Western World, with a lot of investment managers agreeing to have coal generation as part of their investment exclusions in the short term, the market is still active and attracts considerable levels of interest. This is evidence by transactions of thermal power plants in India in recent months:

1) Feb 2020 - JSW Energy agreed to acquire GMR’s Odisha thermal plant for 5,321 Crore. This a 1,050 MW plant commissioned in 2013/2014. The implied purchase price of this was ~£0.56m per MW

2) Sep 2022 - NTPC agreed to acquire a 50% stake in Jabua Power Limited, which owns and operates a power plant of 600MW for 925 crore through bidding via a liquidation process. The plant was commissioned in 2016. The implied purchase price of this was ~£0.34m per MW

3) April 2021 - JSPL agreed to sell a 96.4% stake in Jindal Power to Worldone for 3,015 crore. Jindal Power is a 3,400 MW power plant, commissioned in 2007 and 2015 (various units). The implied purchase price of this was ~£0.46m per MW

4) March 2021 - JSW Energy agreed to sell an 18 MW thermal power plan to JSW Cement for 96 Crore. Whilst this was a related party transaction the price was determined by an independent valuer. The implied purchase price of this was ~£0.58m per MW

5) November 2022 - Adani Power is in the process to acquire a distressed power plant, Lanco Amarkantak Power, with the latest bid submitted totalling 2,950 Crore. The power station has installed capacity of 600MW but has the approval to expand and construct further should the buyer decide. The latest bid implies a purchase price of £0.54m per MW. 

So all in all, the evidence is that new thermal coal power plants cost ~£0.7m-£1.1m per MW to build and transactions for operational power plants are at ~£0.4m-£0.6m per MW, which makes sense. A new plant will have a longer useful life and likely be more efficient and hence command a premium in cost/valuation. 

A reminder that OPG's plant has installed capacity of 414MW. Even taking the lower end of the transaction multiple range (which was applicable to a plant which was going through liquidation), £0.34m x 414MW = £141m. A reminder that OPG's market cap is £25m hence this represents material upside of over 5x to the current share price. Whilst book value is a very flawed metric, the coal power plant's current book value is ~£185m so essentially its cost minus depreciation to date is actually not too dissimilar to the market valuation for the plant. Since 2018, the average Price to Book for OPG has been 0.8x. Currently it sits at 0.1x. 

Solar Projects

The 4 solar farms were commissioned in 2018 and funded with equity as well as debt at the project level. The other shareholder in the solar plants is IBC Solar Venture India BV, a large renewables developer (https://www.ibc-solar-energy.com/). The plants have operated as expected and have solid credit ratings (of which reports on operations can be access online). However, given high levels of debt used to finance them, OPG extracts limited cash-flows from them (also due to their 30% Share). As a result, as part of the deleveraging strategy, it was decided that OPG would look to divest of its stake in these projects. The process has been impacted by COVID and despite receiving offers early on in the process it has never completed. 

The projects remain classified as Assets Held for Sale in OPG's Balance Sheet with an attributed value of £13.5m (which I think they'll do extraordinary well if they can get that on a sale process). Looking at transactions for solar assets I would estimate the value of OPG's stake in the projects is more like £6-8m. I think this explains why they haven't yet found a buyer for the asset, they are holding out for a higher valuation. A reminder that OPG's market cap is £25m hence even if these assets are only worth £6m, this would still account for ~25% of the current market cap. 

Financials

A few snapshots are shown below (no massive red flags). Cash-flow generation is good, and revenue/EBITDA solid if we account for COVID and some of the market dynamics explained above. 

Shareholding and Governance

The Gupta family owns over 50% of OPG and has family members both in CEO and Chairman roles so overall governance is not great. Equally, there is also limited interactions with the market (investor calls etc recently). This is obviously not a positive... M&G Investment has historically held over 10% of the shares in OPG but has been in divestment mode for many months due to their corporate commitment on Coal Power generation. In mid-January 2023, M&G announced its disposal of its stake in OPG. Given the sizeable stake that M&G wanted to divest, OPG being a microcap and operating in a sector which is probably not very desirable by institutional investors, finding a new home for M&G's stake must have not been an easy task. Once the buyer is announced, the expectation is that more scrutiny on governance or focus by Management on investors will take place. 

Valuation

The upside on value is evident from what I've written above. The question then becomes can Management unlock this value for shareholders. I see two possible ways of doing it:

1) Reposition the company completely. Divest of the Thermal Power Plant and invest in renewable projects in India. The divestment will yield multiples of the market cap in cash so as long as Management allocate the cash effectively, buying assets at sensible valuations, this would create immediate value. Becoming a renewable player would open the pool of institutional investors once again for OPG. 

2) Share buybacks + Dividends. Now that debt is fully paid off (albeit there might be a convertible loan note being issued in the short term, unclear what the purpose of this is for), the business generates ample cash on an annual basis (refer graphs above). Doing share buybacks and paying dividends has the potential to signal to the market the belief in the company as well as attract yield focused investors. 

Hollysys - Busy 12 months in the Board room

Hollysys ($HOLI) provides automation solutions across various sectors such as transport and energy in the People’s Republic of China, Southeast Asia, India, and the Middle East. It is listed on the Nasdaq and has a market cap of $1bn. 

It has achieved solid revenue growth over the last 10 years with the automation trend throughout the sectors it operates, albeit it had a couple of years of revenue decline during this time, including 2020 where it was impacted by the COVID-19 pandemic. Nonetheless, it has a good client base supported by its ability to achieve healthy gross and net margins of ~40% and ~20% respectively. 

Hollysys is a relatively unfamiliar name in the Nasdaq and has historically attracted limited attention. It does however have a strong institutional holding of over 80%. The last 12 months have been more eventful than expected though, as summarised below:

07/12/20 - Non-binding offer received to take it private at $15.47 (24% Premium to prior day share Price), led by an ex-CEO, Baiqing Shao (who is deemed to hold 7% of the Company)

08/01/21 - Offer rejected, BoD argues it undervalues Hollysys. Management announces it plans to acquire $50m of stock (>6% of Mkt Cap) over next 6 months.

01/02/21 - Baiqing Shao consortium increases offer to $17.10 (30% Premium to prior day share price)

15/03/21 - Announcement that the ~7% shares held by Baiqing Shao are held on behalf of ex-Chairman, Changli Wang. 

March to Aug 2021 - Legal procedures start on the 7% ownership, and various statements issued by Baiqing Shao over time criticizing current management, and by Hollysys criticising Baiqing (and its past performance as CEO of Hollysis). Hollysys re-affirms that it has institutional support to reject the $17.10 offer as it undervalues the company.

02/08/21 - Announcement of a non-binding offer to take it private at $23.00 (48% premium to prior day share price). Consortium led by Changli Wang and Ascendent Capital Partners (Private Equity company in China)

24/08/21 - Announcement that certain members of existing Management of Hollysys have joined the Changli Wang consortium (Share price close to $20 around this time)

31/10/21 - Change in Auditor from EY to a small accounting firm (Union Power HK CPA Limited). EY had been auditors of Hollysys for 8 years. Share price crashes 30% to $13.70

02/11/21 - Nasdaq issues warning that Hollysys is not in compliance with listing regulations regarding filling of annual report ending 30/06/21 which had a deadline of 31/10/2021

15/11/21 - Company says delay in filing is due to share based awards in connection with 2009/2010, will seek an extension from Nasdaq

15/11/21 - Company announcement of a non-binding offer to take it private at $24.00, led by a listed chemicals group Zhejiang Longsheng Group Co. (Client of Hollysys) and Loyal Valley Innovation Capital (Private Equity Fund) 

Hollysys is now trading at ~$15.00, a discount of ~50% to both offers on the table at the moment so market doesn’t believe there's any chance of these deals completing

As I said, Hollysys is held 85% by Institutional Investors. Davis Funds (11% - sold 3% of position in last quarter), Fidelity (7%, upped position by 10% in last quarter), M&G (6%, sold 8% of position in last quarter), Wellington (6%, upped position by 50% in last quarter). 

At $15 per share, the business is trading at 2.7x NTM EBITDA. The offer prices imply a multiple of ~6x EBITDA which is still towards the low end of the range at which the business traded at pre-covid. This is one of the recent updates from Davis Fund on Hollysys:

"Hollysys Automation (HOLI) has been a long-term holding in Davis Global Fund, but is still unfamiliar to most investors. Hollysys is a Chinese manufacturer of automation equipment for power plants, petrochemical facilities and factories, as well as safety and control systems for high-speed rail and subway cars. The company has attractive growth prospects in a handful of industrial automation niches, where it has built a loyal customer base over the years, as well as in the rapidly-growing high-speed rail market in China. While Hollysys has seen some order delays during the pandemic, it is a provider of essential equipment to keep the Chinese economy running and should resume growing once order cycles return to their normal cadence. HOLI is one of the cheapest stocks in the Fund, currently trading for 8–9x owner earnings, and if one takes into account the roughly $0.6 billion of net cash the company has on its balance sheet (equal to well over half of the company’s market cap), HOLI is trading under 5x owner earnings.

So why is it so cheap? Part of Hollysys’ challenge is that while it is one of the top industrial automation firms in China, it is still relatively unknown to the investing public in the U.S., where HOLI is listed. The recent push to de-list U.S.-traded Chinese companies has led to worries that it could have an adverse impact on HOLI’s trading liquidity and even force a de-listing in three years, if regulators do not find a compromise. This could make for a bumpy ride in the capital markets and force the company to seek out a more receptive trading venue (i.e., one closer to its end market of China), but we believe there is underlying value in Hollysys that will eventually be more fully recognized, regardless of where the stock trades. The value is being driven by the earnings of the business, rather than the exchange it is being traded on."

With this institutional shareholder base and with two offers from credible parties on the table implying a 50% uplift to the share price, the risk seems asymmetric at the moment. The change in auditor, imo looks like a tactic played by Management (which are backing the Changli Wang consortium) to force the competition out of the transaction process as well as force institutional shareholders to agree a sale. This is supported by the fact that the competing offer was only announced by Hollysys on 15/11/2021 to the market but they outlined it was received on 10 September 2021 and the interested party confirmed the interest even after the change in auditor.

Engie EPS (a play on Energy Transition)

Background and Business Update

Originally founded in the late 2000s from within the Politecnico de Torino university, Engie EPS (EPA:EPS / EPS / $EPS) (formerly known as Electro Power Systems) has grown from strength to strength and is currently a global leader in energy storage and eMobility. The early years of operations were focused on R&D and commercial development concentrating on emerging markets. The focus on the Asian markets did not deliver the expected results and hence in 2013 on the borderline of bankruptcy, the company underwent a corporate restructuring , led by one of its main shareholders (360 Capital Partners, an early VC Fund) to streamline operations and focus on activities in Europe and USA. At the time, the VC sent its own employee (Carlalberto Guglielminotti) to manage the process and extract any possible value from the existing assets. Upon arrival at EPS, Carlalberto started designing what he thought was a possible way forward and committed to becoming the CEO of Engie EPS should 360 Capital Partners believe in the plan. And believe it they did.

Two years after, in 2015, the business started getting commercial traction and upon discussions with investment banks decided to pursue an IPO to raise €15m. The IPO at ~€7 per share implied an Enterprise value of ~€50m. At the time, the business had some contracts in the pipeline (backlog of ~€2m for 2016) but the revenue in FY15 was only €0.4m. Nonetheless, the ambition and scale up of the business was evident, 29 employees in 2014 became 57 in 2015 and 86 in 2016. By the end of FY16 the company had generated €7.3m in revenue (and had a backlog of €6.4m), mainly through 1) microgrid installations and 2) hybrid energy storage systems. It was working with Enel, Terna, Toshiba, GE Energy, all across the globe, completing in total 36 large scale projects in FY16.

FY17 was another solid year for the company, with revenues up to €10m (and backlog of €25m). The strong growth of the company in a growing industry prompted Engie S.A. to acquire a 50.1% stake in the business in January 2018 at €9,5 per share, with Electro Power Systems rebranded to Engie EPS and continuing to be traded in the stock exchange.   

The growth continued under the Engie umbrella with FY18 revenue of €15.7m (and backlog of €36m), with the business benefitting from the focus on cleantech and renewables worldwide. The bulk of the projects making up the revenue continued to be 1) installation of microgrids, with the business now recognised as a global leader in this by consultants such as Navigant Research, and 2) energy storage (Solar + Storage installations). By the end of 2018 the business had grown to 100 employees.

2019 saw the introduction of a third segment to the business, eMobility, with focus on both charging stations and charging systems and benefit from the boom in EV sales. Revenues in FY19 continued to grow, with total sales of €20.2m (and backlog of €30m). The growth trend was halted with COVID-19 especially on projects in the USA, and the business ended FY20 with disappointing total sales of €11.1m (backlog of €33m). Despite this, Management re-affirmed its medium term strategy with FY22 revenue guidance of €100m and FY25 revenue guidance of €400m (excluding the eMobility JV which I will discuss below).

The positive news for FY20 was the development of the eMobility segment, with distribution of the easyWallbox charger (“plug and play” charger) starting in 19 European countries through an unofficial partnership with Fiat Chrysler at first (focusing on providing the charger for one Jeep and one Fiat model), and production ramping up to a target of 50,000 units per year (at June 2020). In November 2020, a memorandum of understanding was signed to set up a JV with Fiat Chrysler with the aim to become a European leader in eMobility. The FCA merger with the Peugeot Group was completed in January 2021, creating Stellantis. At the same time, Engie EPS announced that the JV agreement for eMobility would go ahead with the Stellantis group. On 31 March 2021, Free2Move eSolutions was announced and the JV transaction was concluded on 3 May 2021. Stellantis is investing heavily on the EV market and expects to sell more than 400,000 electric vehicles in Europe during 2021 (equivalent to 14% of sales), to up to 70% by 2030. In a recent investor presentation, Engie EPS Management confirmed that the JV is ramping up production to 100,000 units per year and based on the Stellantis ambition this will continue to increase. Engie EPS also stated that the JV will be consolidated at Engie EPS’s level so the revenue associated with this segment will start to be reflected in the back end of FY21 but more materially beyond FY21. Whilst there’s no guidance on revenue associated with the eMobility segment, Management sees this becoming as large as the existing business of microgrids and storage systems. A recent broker note from Societe General had forecast revenue for the eMobility segment of ~€90m in FY22. Management also highlighted that the capex for the eMobility segment would be fully funded by Stellantis so Engie’s EPS capex deployment would be limited.

In September 2020, Engie launched a strategic review of various non-core segments including its investment in Engie EPS. This process culminated with an agreement in April 2021 to sell their 61% stake in Engie EPS to a Taiwan listed industrial group (Taiwan Cement Company, TCC) for €17,10 per share, implying an enterprise value of ~€200m. Whilst the acquisition price was at a premium to the last 12 months share price, the Engie EPS hovered over €20 per share for various weeks during 2021. TCC in their stock listing disclosures assessed the fair value of Engie EPS to be €16.24-€21.92 per share, hence the proposed acquisition price was towards the lower end of the range. All in all it pointed towards being a decent deal for both parties with Engie booking a healthy gain on its 3-year investment and TCC getting a good deal compared to recent share price and comparable company valuations. Whilst not confirmed by any party, based on my perception of Engie EPS Management and the positive relationship existing between Engie and Engie EPS, it is likely that the preferred acquirer of Engie’s 60.5% majority stake was a strategic/industrial player that would be able to open some doors for Engie EPS to grow, rather than a purely financially driven player (hedge fund etc). I suspect this is why TCC might have got a better deal than the market expected. The transaction is yet to officially complete (subject to the usual financial market regulations and approvals) however TCC has already outlined (as explained by Engie EPS Management) it won’t force a squeeze of minority shareholders and wants the company to remain listed. TCC has historically focused on production of cement (and is one of the world’s largest manufacturers) and in the last couple of years has committed to achieving carbon neutral products by 2050. As a result, it is investing heavily in renewable energy and battery storage so the acquisition of Engie EPS fits very well with this plan. The company has a market capitalization of over $10 billion so has a scale of operations and relationships especially in Asia that would open doors to Engie EPS in the region. 

Investment Thesis

There a few main pillars that I think form the basis of the investment thesis:

• Industry: The business operates in various sectors that are expected to grow significantly in the next few years, some of which they are industry leaders such as the installation of microgrids. Yes there is competition on storage systems and eMobility but the expected industry growth is so large that even if Engie EPS capture a small fraction of the markets it will generate significant revenue.

• Valuation: Due to the expected growth in these industries, comparable companies and transactions tend to be at obscene multiples of sales. Engie EPS currently trades at 6x 2021E Revenue and 2x 2022E Revenue (excluding the eMobility segment which is not yet incorporated into the guidance). Consensus based on 2022 Revenue of €120m also forecasts EBITDA of €26m. So Engie EPS is trading at 10x 2022E EBITDA. Despite it being a frothy valuation for the existing business on a current basis it becomes cheap if you believe the growth within 2 years. And then there’s the eMobility segment and the most recent transaction in the sector, with the Barcelona based Wallbox being acquired through a SPAC merger with Kensington Capital Acquisition II. Wallbox was founded in 2015 and is a global EV charging and energy solutions provider. In 2020 it generated revenue of $24m and the expected 2021 revenue is $79m. It expects to reach EBITDA positive in 2024 when it projects to achieve revenue of $780m. The pro-forma valuation of the merger is $1.5bn, or 20x 2021E Sales or “1.3x 2025E sales” as they are currently rationalising it. Being honest, I have not yet done my due diligence on the deal nor have I compared the products between Wallbox and Free2Move Solutions. But even if Wallbox’s products are superior, by virtue of Engie EPS being a JV with Stellantis, one of the largest automotive groups in the world with ~25% of market share, there is a sort of minimum guarantee of demand. The summary introductory video (https://www.youtube.com/watch?v=-Z5gTCihisQ). As a result, even applying a much lower multiple of sales to the potential revenue associate with this JV provides a nice upside to the share price of Engie EPS, which is currently being ignored by the market due to the early stage of the JV.

•  Management: Carlalberto Guglielminotti has helped turn this company round in 2013 and remains CEO of the business which shows the passion and belief he has in the future of Engie EPS. His profile alongside other senior Management is impressive and all the presentations and Q&A sessions I’ve observed prove that they are very capable team.

•  Partnership with TCC: Management have made it clear on various occasions that the Engie partnership was great and helped the growth of the EPS but had its limitations as Engie EPS wasn’t able to tender for certain contracts (presumably because of its ties to Engie). TCC will open doors to the Asian market where Engie EPS is weak.

 Overall, I think the current share price of ~€17 is a great entry point into Engie EPS. My initial position was at €11 a share but I’ve recently averaged up and bought additional shares at around ~€17. The investment thesis is more qualitative than quantitative which is typically not the way I like to analyse companies but I think the opportunity is too good to pass on.

Latest Updates

Having been quite busy at my normal day to day job in recent weeks I haven't had much time to focus on further entries or in fact my portfolio as a whole. It was pleasing to see that during this time, both Hi Sun and Sisram seemed to have gained some traction and a sign that the market is starting to recognise that they have both been quite undervalued in recent times.

Hi Sun

The blockbuster announcement by Hi Sun came on 20 January when it announced that Cloopen had filed for IPO in the US. The news was not overly surprising but the timing of the IPO was, I was expecting an IPO at a later date probably towards back end of 2021. I still need to go over the prospectus in more detail but the simple observation is that the last private fundraising of Cloopen was at ~22HKD per share in 2020 and the IPO was set at 124HKD per share (or $16). So almost a 6 fold increase in the value of Cloopen. Post IPO the share price went all the way up to $50 having fallen to ~$25 in the recent equities market sell-off. Hi Sun holds ~17% of Cloopen so based on the ~$25 per share that's approximately ~5bn HKD. As of today, Hi Sun trades at ~5bn HKD (equivalent to HKD 1.82 per share).  

The commentary around Pax and VBill, as well as the net cash position remains unchanged for the investment thesis. Just updating prior valuation for the latest Cloopen information, prices Hi Sun's share conservatively at ~5.30HKD a share and in a more bullish scenario (but still not overly aggressive) at around ~8.50HKD a share. 

Based on prior disclosures, I would expect Hi Sun's results to be published in late February/early March so we are likely to see some of the FV uplift of Cloopen reflected in the financials (or at least properly disclosed if still valued based on the share of profit from associates method).

Sisram

No real official company announcements took place in the last few weeks although there was a promotion announcement for Management in the North America division on 19 January. This was accompanied by a comment from Lior Dayan (CEO of Alma and Sisram) which hinted at good performance in North America in 2020

"Last year displayed unforeseen challenges but the culture that this leadership team has built allowed them to execute effectively to meet record-breaking targets. I anticipate strong continued growth in our North America business with this Executive Management team."

This might have prompted a large increase in the volume of shares traded in Sisram on 21 January, with someone likely taking a sizeable position in the company (10 million share volume that day, 20x typical daily volume in prior months). The volume of transactions has continued in the last month which hopefully is a sign that the company is starting to be more well known across investors in global markets.

I expect results to be published around mid March so we'll see how business is doing. Following the recent surge in share price, I don't see as much upside as for Hi Sun but still see the share price trading below what I think is a conservative target price.

 

Hi Sun Technology (Hi Sun Tech) (HK.0818)

The second stock I would like to cover is also listed on the Hong Kong Stock Exchange. It’s called Hi Sun Technology (China) Ltd (HK.818). I initially came across the company through a stock screener alongside one of its associates Pax Global (HK.327). Having analysed in a lot of detail (supported by a lot of good coverage across Twitter) and ultimately invested in Pax Global, I decided to have a look at Hi Sun as well. 

Summary

• Hi Sun Technology (HK.818) is a holding company in China with consolidated operations across various segments, weighted heavily towards its payment processing solutions business (VBill). 

• Hi Sun also has a 33% stake in Pax Global Technology (HK.327)  (accounted for as an associate) which is a leading player in the POS terminals market globally. The investment is valued at ~HKD2bn (based on latest Pax share price)

• Hi Sun also has a 19.5% stake in Cloopen (also accounted for as an associate), the first and largest cloud communications platform and service provider in China. Cloopen’s latest funding round (November 2020) implied a valuation of Hi Sun’s stake in Cloopen of close to HKD 1.0bn 

• Hi Sun has a market cap of HKD 2.6bn and Net Cash of HKD 4.4bn. It has grown revenue at 40% annually for the last 4 years. In 2019, it generated Revenue of HKD 5.6bn and EBITDA of HKD 1.0bn.

Background

Hi Sun Technology (HK.818) is a holding company in China with consolidated operations across various segments:

1) Payments Processing Solutions (VBill) – Revenue HKD 4.7bn and EBITDA of HKD 1.2bn in 2019

2) Security Chips (MegaHunt) – Revenue HKD 0.3bn and EBITDA of 0.03bn in 2019

3) Platform Operations – Revenue HKD 0.2bn and EBITDA of HKD (0.01bn) in 2019

4) Financial Solutions (Hi Sun FinTech Global) – Revenue HKD 0.3bn and EBITDA of HKD (0.006bn) in 2019

5) Smart Meters – Revenue HKD 0.3bn and EBITDA of HKD (0.012bn)

In addition, Hi Sun has two key associates:

1) Pax Global Technology (HK.327) – Leading player in the POS terminals globally

2) Cloopen (Ronglian) - First and largest cloud communications platform and service provider in China

Hi Sun has been listed for around 15 years with a focus on the same industries (Payment Solutions and POS terminals). It traded as high as 6 HKD (10x Revenue) back in 2010 when it announced it would spin-off and ultimately IPO, Pax Global. At the time Pax Global was its main profit generator, with Hi Sun generating consolidated revenues of ~HKD 1 billion and EBITDA of ~HKD 100m. The proceeds of the partial disposal of Pax Global were used to invest in the development of its other subsidiaries (Vbill which was founded in 2011, Smart Meters, Chips etc). Given these industries were still in the early stage of growth, the company was loss making at EBITDA level until 2015, with cash invested to grow the businesses. In addition, the great financial crisis and the knock on impact on the overall economy impacted the business with the share price falling to below 1HKD by late 2012, albeit recovering to 2-3HKD in 2015. From 2016 to the end of 2020, the share price hovered between 1 and 2 HKD. And in this period, is when things started to get interesting for the company (and VBill). 

(Note: Given the main subsidiary of Hi Sun is VBill, the focus of the analysis will be on this business, as well as the associates Pax and Cloopen)

VBill

VBill’s business model focuses on small and medium merchants in China by providing payment processing services (i.e. the payment systems required for merchants to accept payments from customers through credit card/QR code/mobile). Key services include acquiring of payments and settlement of funds with banks, support merchants seeking loans with financial institutions or supply chain financing. VBill also provides value add services such as data processing for marketing or users’ credit investigations. Larger and more well known players in the third party payment industry in China such as WeChat, Alipay or UnionPay have significant share of the overall market but typically only accept payments from their own e-wallets/network as well as focus on online merchants. Hence VBill does not compete directly with these for market share. 

Since 2015, VBill has benefit from a growth in the non-cash economy as well as growth of the middle-class in China. This has allowed the business to grow to over 200 cities in China including various remote areas and distinguish itself from competitors which typically focus on larger merchants in large cities. Whilst there are obvious customer acquisition costs (commissions to merchant acquirers), given the industry is not overly capital intensive or manufacturing related, the business is able to scale up and improve margins as the number of merchants and volumes of transactions grow. This is what has happened since 2015. 

From 2015 to 2019, revenue for Hi Sun grew at a CAGR of over 40%, this was driven by the growth of VBill and the Third Party Payment Industry in China. The active merchants using VBill increased at a CAGR of 45% in the same period as per the table below.

 

Hi Sun’s EBITDA has grown at a CAGR of over 100% with margins increasing as well.

Because of the nature of the industry and its competitiveness, Hi Sun also invests a considerable amount in R&D. From 2015 to 2019, R&D Expenses have grown at a CAGR of 20% with R&D accounting for 5% of 2019 Revenue. Again despite the increase in R&D that is required over time to maintain competitive position, EBITDA margins are also likely to continue to improve as the business grows (R&D expenses accounted for 10% of revenue in 2015). 

The growth in the third party payment industry in China has attracted a lot of capital to the sector (albeit mainly Chinese capital), with various acquisitions taking place especially given the People’s Bank of China has limited the number of licenses awarded to operate in the industry in the last few years (payment acquiring licenses). As of December 31 2019, there were 238 third-party payment service providers in China, 33 of which were granted the bank card acquiring license only and 16 of which were granted both the bank card acquiring license and the mobile phone payment license (VBill being one of them).

In 2019, Hi-Sun engaged in a strategic partnership with EQT to develop VBill internationally. As part of this partnership, Hi Sun sold a 14% stake in VBill to EQT for HKD 676 million, valuing 100% of the business at ~HKD 5bn. The deal also involves a put option for EQT which can be exercised 3-5 years from November 2019 at an implied return of 8% for EQT. In addition, it is understood that EQT has appointed a Board Member to VBill to help guide the business. The deal agreement implicitly formalised the medium term plan for VBill, outlining a planned IPO within 5 years of the completion (so ~ 2024), with various conditions and adjustments if this does not take place or the IPO does not meet certain thresholds of returns. 

1) If the IPO price fails to deliver 25% IRR return to EQT, Vbill Management will be required to transfer up to 3% of shares in VBill to EQT;

2) If the IPO price delivers an equivalent of 25-35% IRR return to EQT, but EQT had previously disposed of the shares, EQT is liable to pay a bonus to Management equal to 20-30% of the actual investment return achieved by EQT (capped at 35% IRR)

Post the transaction, Hi Sun has a 68.83% stake in VBill, EQT has a 14.01% and Vbill Management has the remaining 17.16%. In addition, Management also has options (can be exercised until 2024) totalling 12% of the enlarged share capital at an implied 100% value of ~HKD 3.3bn.

The EQT transaction price implies a Price / Rev of ~1x (4.7bn revenue) and Price/EBITDA of ~4x (1.1bn EBITDA) for VBill. 

There are two main listed competitors of VBill, Huifu (HK.1806) and Yeakha (HK.9923) as well as others also involved in the payment processing solution value chain but less comparable such as Lakala (SHE:300773). 

Huifu had its IPO in 2018 and historically has traded at ~0.4x Revenue and ~3x EBITDA (prior to COVID). Yeakha IPOed over the summer and has traded at 3x Revenue (LTM in June) and 17x EBITDA. Both have lower margins than Vbill and lower revenue per transaction. All three had similar transaction volume in 2019 (Huifu 2.2bn, VBill 1.7bn, Yeahka 1.5bn) with CAGR in the last 3 years of 25%, 17% and 86% respectively. 

All three were impacted by COVID in H1 to some degree with transaction volumes falling across the board. Summary of key data comparing 2020H1 to 2019H1 below:

There is no doubt that China’s third party payment industry is very competitive so forecasting growth or future market share is a complex exercise. However, it is also clear that VBill is a very profitable business which remains “hidden” within the Hi Sun Tech group. COVID is accelerating the non-cash economy even further and this was highlighted by the momentum that Yeakha has been able to achieve following its IPO. Yeahka’s share price tripled its IPO price by end of August (from ~18HKD to almost 60HKD) having fallen to ~35HKD recently.  

Further, the transaction involving EQT, a reputable worldwide investor provides a seal of quality to the business and a benchmark of value. An independent report of China’s third party payment industry in 2019 by Analysys China (a data and analytics service provider) also included a deep dive analysis on VBill’s successful business model which again supports the business’ position in the industry. 

We estimate a conservative valuation of VBill to be equivalent to the price paid by EQT so ~HKD 3 billion for Hi Sun’s 69% share. An aggressive valuation would be equivalent to EQT’s purchase price assuming 25% IRR over a 4.5 year period in line with the transaction agreement and performance thresholds, and accounting for dilution arising from the exercise of Management’s options. This would value Hi Sun’s share in VBill at ~HKD 8 billion so an overall 100% value of ~HKD 12 billion. This represents 3x 2019 Revenue or 12x EBITDA, still a touch lower than Yeakha’s current valuation. 

Pax Global

Pax manufactures and sells POS terminals globally. The 2018 Nillson report summarises the key players in the sector across the various regions, a summary is shown below:

 

Pax is one of the top 4 companies by market share globally (behind Newland, on par with Verifone and above Ingenico) a position which it has been solidifying recently. With the transition to a cash-less economy, appetite for the sector has increased in the last couple of years with two key transactions taking place.  

In April 2018, an investor group led by Francisco Partners acquired Verifone for a consideration of $3.4bn (enterprise value). The purchase price implied an EV/Revenue multiple of 1.8x and EV/EBITDA of 14.5x. Verifone had an EBITDA margin of 12% historically.  

In February 2020, Worldline acquired Ingenico for a consideration of €7.8bn (Equity) and took on net debt of €1.3bn resulting in an enterprise value of €9.1bn. The purchase price implied an EV/Revenue of 2.7x and EV/EBITDA of 15x. Ingenico had an EBITDA margin of 18% historically.  

In 2019, Pax Global achieved EBITDA of ~HKD 800m and Revenue of ~5bn implying a margin of 17%. Since 2017, both revenue and EBITDA have grown at a CAGR of over 15% as shown below.

Based on the recent transaction prices, this would value Pax Global in a  range of HKD 9bn to 13.5bn as per below (enterprise value)

1.8x Revenue = HKD 9bn

2.7x Revenue = HKD 13.5bn

14.5x EBITDA = HKD 11.6bn

15.0x EBITDA = HKD 12.3bn

Pax currently has a net cash position of ~ HKD 3bn which would imply an equity value range of 12bn to 16.5bn. Hi Sun’s 33% stake would therefore be valued at HKD 4bn to HKD 5.5bn. Based on EBITDA margin, we would argue that Pax is more comparable to Ingenico rather than Verifone so the higher end of the range is likely to be a better benchmark. 

Pax has outperformed forecasts during the COVID-19 pandemic and has seen its share price increase from 4 HKD pre COVID-19 to 7 HKD currently. In addition, Pax has been improving its capital allocation embarking on aggressive share buybacks in recent months and declaring a special dividend last week in light of strong operational performance. Based on the current market capitalisation of HKD 7bn, Hi-Sun’s share in Pax is worth over ~ HKD 2bn. (Hi Sun’s own market capitalisation is currently lower than 3bn). 

As highlighted, Pax is treated as an associate in Hi Sun’s accounts hence a share of profit from associate is recoded in the P/L (impacting net income but not revenue and EBITDA figures of Hi Sun). 

Cloopen

Hi Sun was the first investor in Cloopen/Ronglian in 2014, a leading cloud communications company in China with major customers such as Tencent. Since then the business has done various funding rounds (both ordinary shares and preferred shares) with other investors taking part (Sequoia Capital, Trustbridge, Steppe Capital, Telstra Ventures and Prospect Avenue Capital). Hi Sun has not taken part in any funding round since February 2018 (Series D). There is limited information available for Cloopen in the financials of Hi Sun, given its treated as an associate like Pax. Because Hi Sun values associates based on “share of profit” and because Cloopen is loss making, the carrying value of Cloopen is nil. However, Hi Sun discloses the assessed fair value of its  investment estimated to be HKD 700m at 30 June 2020. 

On 5 November 2020, Hi Sun disclosed that Cloopen had undergone a Series F funding round albeit Hi Sun had not participated in it. Based on the disclosure and our analysis, we estimate that the funding round values Hi Sun’s 19.45% stake in Cloopen at HKD 900m. 

Overall

Assuming the three key businesses and the respective valuations we have:

VBill = HKD3bn (Conservative), HKD8bn (Aggressive)

Pax Global = HKD 2bn (Conservative), HKD5bn (Aggressive)

Cloopen = HKD 0.7bn (Conservative), HKD 0.9bn (Aggressive)

Total Hi Sun (5.7bn Conservative and 13.9bn Aggressive)

This ignores all remaining businesses of VBill including MegaHunt (Chips) which is due to IPO in the near future. 

Further, we also need to consider that Hi Sun has ~ HKD 4bn cash in its balance sheet and no financial debt. Assuming that the cash pays for all the liabilities (including Vbill’s Put Option) we still have excess cash of ~1.3bn (Conservative). 

Based on the closing share price of Hi Sun of 1.04HKD, the market capitalisation is 2.9bn HKD. Based on the above and the current market cap, the upside is evident. 

So why does Hi Sun trade at such as discount to its fair value? The company has never paid a dividend or performed share buybacks which obviously poses some obvious questions/risks on the investment. Hi Sun is audited by PwC so the potential fraud question is mitigated somewhat. Further, based on the high insider ownership we think the capital allocation and focus on share price will be addressed over time (perhaps in the near future). The partnership with EQT means business for VBill, co-shareholders at Cloopen will seek for an IPO in near future and Pax has had improvements in its capital allocation strategy in the last 12 months. 

The Management has all been in place for 20 years with insider ownership of over 35%. Chairman owns (12%) and CEO owns (23%) with smaller shareholdings for other key management personnel. The CEO has had the same number of shares since 2010 and the Chairman’s shares steadily increased from 2009 to 2014 having been unchanged since. Compensation for senior management (salary and bonus) looks within the expected range so its not a case that they are extracting their returns through that. 

In addition, being a hold-co typically results in lack of understand of the various business streams as it requires high level of analysis and diligence to extract information.

Time will tell if the market will correct the mispricing but at the current share price it seems a very attractive entry point. 

Introduction and Sisram Medical (HK. 1696)

After various years of debating whether to start part-time investing in the stock market, in early 2020 I finally decided that the time was right. The last few months have been a great introduction to the world of financial markets with various lessons already learned (some learned the hard way!). The end game was/is to create a portfolio of around 15 stocks across the global markets, with a balance of value stocks and growth stocks (at reasonable price, sorry Tesla). 

I will use this blog to summarise some of the positions I've taken and providing updates/views on how they evolve over time. Given this is part-time hobby, I'm in no way providing any kind of financial advice to anyone reading any entries of this blog. Please analyse investments thesis yourselves, its the best part of the journey anyway, nothing more rewarding than finding undiscovered gems!

The first stock I would like to cover is Sisram Medical (HK.1696), listed on the Hong Kong Stock Exchange. 

Summary

• Sisram Medical (1696.HK) operates in the medical aesthetics market, through its subsidiary Alma Lasers, with a focus on minimally invasive procedures (Market >10% CAGR globally in next years)

• 75% Owned by Fosun Pharma (Strategic Investor, Market Cap >$10bn), having acquired ~100% of Alma Lasers in 2013 and filing for IPO in 2017.

• Sisram Medical currently trades at LTM 0.3x Revenue (4x at IPO), 2.4x EBITDA (21x at IPO), 11x PE (22x at IPO) and vastly cheaper than listed competitors as well as past transactions in sector.

Background

Sisram Medical (1696.HK) operates in the medical aesthetics market, through its subsidiary Alma Lasers, with a focus on minimally invasive procedures (Market >10% CAGR globally in next years). 

Alma Lasers, founded in Israel, develops laser based treatment systems which help doctors provide treatments such as hair removal, skin rejuvenation, cellulite reduction, tattoo removal, acne treatment, body contouring and skin tightening. Currently Alma Lasers has around 25 products on the market and tends to release 2 or 3 new products every year or upgrade existing products with new features. 

Revenue

The company derives revenues globally (sales in over 90 countries) with  geography split illustrated below.

As at IPO, a 2017 Medical Insight Report, forecasted Alma Laser's market share in China to be 16% (#1), followed by Wuhan Miracle Laser (13%), Lumenis (11%), Cynosure (7%) and Syneron (6%). Equally, it forecasted that Alma Lasers market share globally to be 4% (#5), behind Cynosure (16%), Zeltiq (13%), Syneron (11%) and Lumenis (6%). 

Since IPO, Sisram Medical has achieved solid growth across all geographies albeit slower growth in APAC (which Management is addressing by increasing focus in new territories such as South Korea and Australia in recent months). Detailed figures in the chart below.  

Whilst, we have had no access or visibility of updated Market Insight Reports, we understand the market leading position in China remains, whilst Alma Lasers is still amongst the top companies in the sector globally (with growth in revenue outperforming the general industry CAGR every year since IPO). 

The revenue and sales model is based on two sources:

1) Direct - Alma Lasers sales representatives selling directly to Clinics/Doctors etc. This is the case for U.S, Canada, Germany, Austria and India. This accounted for ~54% of Revenue in 2019. 

2) Distributors - Distribution agreements across all other jurisdictions. This accounted for ~46% of Revenue in 2016.  In particular for China, the company has an exclusive distribution agreement with one company. 

The key revenue sources are based on three core products:

- Soprano Titanium / Soprano ICE Platinum (Hair Removal) – Main competitors appear to be Candela GentleMax, Lumenis SplendorX, Cynosure Elite MPX. 

-Accent-Prime (Body Contouring) – Main competitors appear to be InMode (BodyTite, Contoura, Evolve), Cynosure Smartlipo.

- Harmony XL Pro (Skin Treatment and Hair Removal) – Main competitors appear to be Candela (Frax and Nordlys), Cynosure Picosure, Lumenis Stellar M22

Comparisons across products are difficult to make as performance depends on skin colour/type, maintenance of machine, provider experience etc but reviews across the web appear to be positive (i.e. check in RealSelf) for Alma Lasers’ products across the board. 

Costs and EBITDA

Gross Profit Margin (after Cost of Goods Sold) is ~50% and has been slightly improving over time (51% in 2014 to 55% in 2019). The other two main costs relate to SG&A and R&D Expenses. The former has grown at a fast pace from ~$27m in 2014 to $59m in 2019 at a CAGR of 17%, mainly driven by associated costs from expanding direct sales operations in key markets such as United States and Israel. 

R&D has increased from $7m in 2014 to $10m in 2019, a CAGR of 9%. R&D represents approximately 6% of Revenue and is a focus of the business (i.e. Alma Lasers seems themselves as the innovator in the sector, not a trend follower). 

As a result, EBITDA has grown at ~6% CAGR since 2014 with margins declining from ~22% in 2014 to ~18% in 2019. 

The business Working Capital position of the business could do with improvements with the business having a net working capital outflow every year (albeit it has plenty of liquidity to fund this). Hence the gap between EBITDA and Cash From Ops as highlighted above. Since the business has limited Capex (~$1m p.a.) Cash From Ops is essentially Free Cash Flow to the Firm Pre Tax. 

Working Capital Details

Receivables Days (2014-2019 Avg): 95 Days

Payables Days (2014-2019 Avg): 46 Days

Inventory Turnover (2014-2019 Avg): 140 Days

Capital Structure and Shareholding

The IPO raised $100m in Sep 2017 with all debt repaid around the same time. As a result, since IPO in 2017, the business operates with a Net Cash position of ~$100m. The Cash Position is used to fund the negative working capital as outlined above but is also being retained for potential M&A targets as outlined as part of IPO Prospectus as well as past announcements made by both Sisram Medical as well as its major shareholder Fosun Pharma. 

In addition, for FY 2019, Sisram Medical paid a dividend of $6m, equivalent to a 30% Payout based on Net Income. The dividend yield based on share price at the time (~4 HKD) was ~2%. Based on current share price of (~2.3 HKD) this would double dividend yield with plenty of coverage. 

The major shareholder of Alma Lasers is Fosun Pharma, owns ~75% of the company. Fosun Pharma is a large conglomerate across the Medical Space with a market cap of >$10bn and listed in Hong Kong. Fosun is one of the most respected investor groups in Asia, with operations across other sectors as well. This significantly de-risks any issue with potential overstatement of revenue/fraud which is commonly feared by investors of stocks listed in Asia. 

In addition, Fosun provides a great platform for Sisram/Alma to sell their products through, given connections in the sector. 

Valuation and Competitors

Fosun Pharma acquired Alma Lasers in 2013 for a consideration of ~$250m (100%). This implied an EV/Rev of 2.5x, EV/EBITDA of 12.5x and P/E of 47 based on our calculations and disclosures at the time. 

Sisram Medical Market Cap is currently ~1bn HKD or $130m (based on share price of 2.3 HKD). Hence, since the original acquisition of Fosun Pharma, the value of Alma Lasers has halved, whilst the business has delivered Revenue CAGR of >11% since and EBITDA CAGR of >6%. 

Sisram Medical currently trades at LTM 0.3x Revenue, 2x EBITDA, 10x PE (and vastly cheaper than listed competitors as well as past transactions in sector). Past transactions in the sector (excluding Cynosure in 2019) have been at implied EV/Rev of 3.0x (range 1.1x-6.8x), EV/EBITDA of 25.0x (range 10.3x-69x) and P/E data is not meaningful given disparity and majority of companies being loss making. Apart from InMode, which I will comment further on, Sisram actually has the best EBITDA margins in the sector.

Cynosure acquired in 2017 for $1.5bn was sold two years later at $0.2bn as the business went from being high growth with solid EBITDA margins, to negative growth and negative EBITDA. It highlights competitive nature of the business (no denying that). Recent transactions in the sector since 2013:

InMode, also founded in Israel, IPOed in August 2019 with a share price of ~$20 around that time implying a market cap of ~$700m. Since September 2019, the share price has doubled (granted driven by impressive revenue growth despite COVID). InMode's revenues are primarily focused in the United States (80%) with the business aiming to expand to other geographies in upcoming years. Worth noting, InMode is not a new player in the market (it was founded in 2008 whilst Alma Lasers was founded in 2005). 

Based on my high level research, the reason behind the strong EBITDA margins for InMode are driven by jurisdiction it operates in (North America) and the fact that sales are all direct. As the business expands into other geographies, I would expect the margin to decline. Having said that, my focus is not so much on InMode but on Sisram. The listed comparable companies data is shown below (in addition to InMode, Cutera is also listed). I've used LTM data (H1 2020 + H2 2019) for the comparison to include impact of COVID for Sisram (H1 2020 commentary below as well).

 

Looking at this in addition to everything outlined above, I would estimate that Sisram's Fair Value would be considerably higher than the share price as of today. Based on my calculations, I would conservatively estimate upside of over 200% from the current levels.

The H1 2020 results for Sisram were not amazing but far from bad with Revenue decreasing by ~15% albeit a further reduction in EBITDA margins due to higher costs associated with COVID impact and hence net income reduction of 50%. This is expected to pick up in H2 2020 so we will be focused on upcoming announcements by the company in the next few months.