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.
