“Penny Real Estate: The world’s most valuable land — at a huge discount”

Looking at a Dan Ferris teaser for the Friday File

By Travis Johnson, Stock Gumshoe, July 25, 2014

I mostly want to take a look at Dan Ferris’ Extreme Value teaser today, which I told you the solution to earlier in the week, but I do have a few other things to note today first.

For those still following or holding Nagacorp (NGCRF), owner of the Nagaworld casino in Cambodia, I’ve for a long time been of the mind that “it’s been a nice profit, think about protecting it” (I sold my personal shares a long time ago, far too early) — but the stock still isn’t really expensive, so I haven’t been banging the table about having to sell it or anything aggressive like that. They report again in a couple weeks and they remain reasonably valued, though perhaps more challenged for growth, and their possible Russian casino project might become a catalyst either for big growth or a reason to sell if they’re going to sink a few hundred million dollars into something that speculative. Credit Suisse is getting a bit more pessimistic about their rising costs and the impact that will have on earnings, as reported here, so you can add that to your brain pan if you’re thinking about Nagacorp.

And SodaStream (SODA) owners probably noticed the stock taking a sudden 20% jump yesterday — that was on rumors of a private equity takeover for the company. The report came with some journalistic cred, from a Bloomberg author, and it wouldn’t surprise me at all if private equity companies were sniffing around the stock for a possible leveraged buyout (since they have a nice, steady cash flow business underneath the current weak US sales performance, and they have no debt so they could lever up to help improve earnings short term — which is part of what LBO firms love). But that certainly doesn’t mean it’s going to happen, or that the rumored $40 price would stick.

I’m not counting on SODA getting a buyout bid, but I have been thinking about adding to my holdings. I’m not in a rush, however, particularly when there’s also big uncertainty about companies that are operating in or that have substantial operations in Israel (SODA has been a sometime flashpoint and target of boycotts from many folks who are angry at Israel, particularly due to the fact that they have a manufacturing plant in the occupied West Bank), so I’m waiting to see how their inventory and US sales look when they report their earnings next week.

The underlying business is compellingly valuable and I think it makes sense even if the US rollout has been challenged, but I could always be wrong and when there’s a back and forth between buyout speculation and boycotts and short sellers (SODA continues to have a very high short interest) that doesn’t necessarily mean the stock price will make sense to fundamental investors. It does probably mean that the earnings report will get a lot of attention and have a substantial impact on the shares — I don’t have any great confidence that it will be great (US gas refill sales soaring) or terrible (US inventory overhang remains a big drag on earnings), so I’m just holding my shares. SODA has been a takeover/partner candidate for most of its short life on Wall Street and the likelihood of a big deal with a strategic partner still seems slim (Coke or PepsiCo or Starbucks), so if there is a change of control someday it’s more likely to be a private equity buyer — but you never know.

So now … on to the Ferris pitch for Nam Tai Property (NTP). When he presented at the Value Investing Congress back in April he pitched three likely scenarios for the stock over the next four years (that’s roughly how long it should take them to develop the project they’re thinking of building) that ended with 2018 price targets ranging from $8.75-$14 and very low downside. That’s not nearly as dramatic as the “might rise by 50-100% this year” pitch, so keep that in mind if you’re reading his ad and tempted to shorten NTP’s time frame to profitability.

Here’s how Ferris teases this idea in his ad for Extreme Value, a stock which he likens to his “discovery,” a dozen years ago, of Alexander and Baldwin and its undervalued Hawaii land bank:

“Penny Real Estate: The world’s most valuable land — at a huge discount…

“12 years ago, I never thought I’d see this opportunity again…

“But today I have found an equally rare, extraordinary opportunity, where you can purchase an ownership stake in some of the most potentially valuable real estate in the world… at a fraction of what that land is really worth, today.”

Ferris took a trip to see the property:

“I first came across this small company several years ago…

“And recently, on a call with a private money manager, it came up in conversation.

“I decided to take a closer look…

“So I flew thousands of miles to investigate this small company, in one of the wealthiest cities in the country.”

Sounds pretty compelling, right? “Boots on the ground” to verify that it’s real, and a valuable slug of property in a wealthy city? Trading at “a fraction of what that land is really worth?” Maybe so. Let’s hear some more of the promo pitch:

“Twelve years ago, when I first discovered this idea, I called land the perfect investment.

“Unlike other investments, it’s ridiculously simple to understand. Buildings come and go… and go up and down in value… but land is forever.”

So why doesn’t everyone buy up these undervalued tracts of land?

“You could only buy the land I described above, at those prices, if you knew how to exploit one simple little secret, about how land values are stated by accountants on corporate balance sheets…

“And you also have to be willing to do the kind of digging and investigative work that few people are willing to do.”

That refers to Alexander and Baldwin (ALEX), largely because ALEX was at the time carrying their huge tracts of rural Hawaiian land on their books at their 100-years-ago acquisition cost — not at the true resale value of the land. Similarly, property is often understated on balance sheets either because of low purchase prices or because built properties depreciate in value. Some of these bookkeeping rules have been adjusted over the years, but it’s true that many corporate balance sheets understate, sometimes dramatically, the “real” value of real estate assets.

Nam Tai Property does not own “forever” land, to be clear, they’re in China so they can’t own anything — only the government and the collectives can really “own” land, others lease it for very long terms (often 50-100 years, Nam Tai’s key leases are 50 years and terminate in the 2040s) and often keep a pretty firm grip on what can be done with the land. Which is a little different from how land might be owned or valued in other countries, though there are varieties of regulatory risk and oversight (zoning, land use, environmental impact) everywhere.

What specifically does Nam Tai own? Here’s how Ferris puts it:

“I came here in person to check out two parcels of land in the city, ready for development, owned by the company I came to look into.

“You see, the local government here wants to turn this city into a big new financial hub… potentially the biggest in the world…

“So they’ve designated it as a “special economic zone,” designed to help bring a lot of new money here.

“In one small part of this new financial hub, businesses will pay just 15% corporate income tax.”

So that’s the draw — the government has designated part of this area, which is in or near Shenzhen in Southern China (across the border from Hong Kong), as a special economic zone that’s targeted for redevelopment and the buildup of a new lower-impact economic engine to replace the older, dirtier, less lucrative manufacturing (including the electronics manufacturing that Nam Tai did until a few months ago) that has been there for decades.

Here’s more from Ferris’ ad:

“The Triple-Digit Opportunity I Found…

“It’s in Shenzhen, China… right next to an area called Qianhai (pronounced “chin high”).

“Shenzhen is a super-modern, developed city in southern China, just over the border from Hong Kong… filled with sights most Americans would certainly recognize….

“The company I went to visit is a ridiculously simple business. It owns two valuable parcels of land. It has no debt…

“And when you buy this land through the stock market, you get the land for next to nothing… and I’m confident you could safely make 50%-100% in the next year or two. Perhaps much, much more if you are willing to hold for the long term….

“This opportunity is like owning raw land in Manhattan, before they built Wall Street. It’s like owning land next to the City of London – the ‘Square Mile’ – before it became one of the world’s leading financial centers. It’s like owning a huge chunk of land in downtown Zurich, before it became one of the world’s leading banking districts, with some of the most valuable real estate in the world. It’s like owning a huge piece of land next to Victoria City in Hong Kong, before it became the Central District and one of the biggest financial havens in Asia….”

So yes, that’s a bit over the top. And it could perhaps just as easily be described as being like buying a 30-year lease in Yonkers 10 years before Wall Street is built, which might work out fine on a cash flow basis too but doesn’t inspire such dreams of lucre.

And though it’s not yet really in the discussion as part of Nam Tai’s eventual development plans yet, they do have more than one property — the key one is a redevelopment project, the larger one is raw land further out of town in an industrial park area that was presumably initially acquired as a place for future factory expansion. Here’s how Ferris describes the assets:

“The company I went to visit owns two parcels of land in Shenzhen, near Qianhai, totaling just under two million square feet.

“The first parcel is approximately 557,000 square feet. The other is raw land measuring about 1.2 million square feet (see map below):”

There’s a pretty good description of what’s going on in Shenzhen and Qianhai here from the Economist a couple years ago — and it’s a decent reminder that while cities are rebuilt and reorganized more quickly in China than they are in many places (thanks to totalitarian control), it still takes many years. Nam Tai has not yet started to redevelop their property, they just got their recommendations from Jones Lang Lasalle (a global real estate consultancy) last Fall and even that (presumably optimistic) projection didn’t have them actually starting construction until 2016.

You can see the presentation that JLL made to Nam Tai (then still Nam Tai Electronics, before they changed the name and ticker this Spring) here, which seemed to be what Ferris mostly used to build his estimates for what the project might be worth when he presented at the Value Investing Congress, and though that land (the Gushu/Bao’an property, former Nam Tai Electronics factory and headquarters) is the key project the company did also recently release a detailed presentation about what kind of project they’d like to build in Guangming, their larger “raw land” asset.

Nam Tai Property is not likely to sell this land or come to some abrupt catalyst that has them “recognizing” the value of those assets overnight, they have already made the transition from manufacturing to property development and they seem determined to see it through and become developers and real estate managers — so that’s one risk, because they’re new to this. They’ve been a contract manufacturer for almost 50 years and have been thinking about becoming a property developer for about a year. That’s a far cry from Larry Silverstein, who was the first big investor in Qianhai earlier this year when the special economic zone/free trade area was initially set up — his Silverstein Partners redeveloped the World Trade Center in New York. Silverstein’s involvement got a lot of attention because it was a big bid and it probably ramped up the value of all the neighboring land, but it was also a much more valuable location than Nam Tai’s.

Nam Tai’s land is in the broader special economic zone of Shenzhen, and it’s being rezoned to high-end commercial development, but it’s in an area called Gushu in Bao’an, ten miles from the Qianhai “free trade zone” that’s being proposed as a financial services center. If Qianhai ends up being the next Wall Street then being ten miles away would be a substantial boost for the Bao’an district where Nam Tai’s property is, but not the same as being there — 10 miles from Wall Street doesn’t quite get you to Yonkers, but it does get you to Newark, NJ. Of course, Shenzhen was a tiny town of 30,000 people just a few decades ago, so you never know what might happen.

I’m sure Ferris is being much clearer in discussing the risks with his subscribers than in the promotional piece, but this is a company that will have to get government approvals for their specific plans, raise the development capital, and manage a pretty huge construction project over the next several years (really, probably over the next decade). That means you have to make a lot of guesses about what the cash flow or value might be, and whether or now they’ll get financing (particularly given the volatile nature of development and real estate financing in China, where there are still tons of bad loans on the books and plenty of oddball projects like the “ghost cities” that have been partially built but never lived in) in addition to guessing about how the changing face of Shenzhen will impact them.

It becomes a bit of a less risky bet when you consider how well financed Nam Tai is right now — they do have better than $250 million in cash at the moment, about $5.60 a share, and perhaps more if they were able to get anything out of the sale of their remaining operating equipment and machinery in the Spring (they closed up shop in April, so we’ll know quite a bit more when they release their second quarter results on August 4) — though they have also been doing a small share buyback and continuing to pay a nominal dividend, which I’d think is a bit silly for a company contemplating a long-term, several-hundred-million-dollar development project.

Other risks? They’re controlled by their founder Ming Kown Koo, who aside from not being a “real estate guy” is 70 years old and reportedly owns 12% of the company. Ferris says part of the reason he went to meet with this man was to simply speak with him face to face and reassure himself that the man and company were trustworthy and not a Chinese accounting scandal in the making — that wouldn’t be my primary concern for such a longstanding company with substantial private ownership and a long and successful track record in their old business, but it’s always a risk and it’s always the first thing investors ask about a China stock.

Ferris talked mostly about the Jones Lang Lasalle scenarios and recommendations in his April presentation, and his interpretations of the scenarios for the Gushu/Bao’an project were for it to have a net present value of anywhere from $106 to $266 million, depending on the mix of apartments/office/commercial space and how high-end they went on development, and on how much of the property they “sell” instead of leasing/managing. That’s above and beyond the cash balance at Nam Tai and includes the development costs, which would probably require substantial debt financing even if NTP uses much of their cash balance, so Ferris then added the current cash balance to those “net present value” calculations to assess the potential for the stock. That’s where the 40-90% return comes from — and most of that is long-term, requiring the project to actually get built and generate cash flow, unless the market suddenly falls in love with Chinese real estate again and wants to get a piece of this “pure play” on Shenzhen real estate values.

So what we end up with is a stock that yes, should have a pretty limited downside because they have cash on the books equal to almost their market cap, which would mean it should be pretty surprising if the stock falls much below $5.50 anytime soon (it’s at $7.20 as I type). On the other hand, they’re just on the verge of starting a massive project that will be consuming cash for three years before they generate any revenue (unless they can pre-sell a lot of apartments, should that be part of their final plan), and it would probably take outside factors — big developments nearby starting to bear fruit, other big investors going in — before the stock gets valued dramatically higher.

I am a little bit tempted by this one, and it seems pretty well-run and interesting so far at this early stage in their evolution, and I haven’t done nearly as much research as Dan Ferris on this or visited or interviewed management… but we’re still talking about a company whose primary asset is a defunct factory complex in a working class section of town that has potential but is not yet desirable for the upscale development they want to do — there are many ways this could play out over the next ten years, but it takes a leap of faith to see it creating a cash-flow gushing commercial/office complex within five years without any missteps or expensive problems along the way. At $7 it’s interesting and the downside protection of cash is compelling, which might make it “safe” enough to accept that the low-end development value scenario from Ferris would mean just a 40% return in four years, but after reading it through again the upside isn’t clearly exciting enough to have me slobbering just yet. Your opinion may differ, of course, and I hope you’ll share your thoughts with a comment on this article.

Have a great weekend, everyone!

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July 28, 2014 10:44 am

Chinese property is a huge bubble and going to bust. There’s no hope for this sector in the near future.