“Get Rich off of the Fastest Growing Country in Asia” Silk Road Investor

This one is probably a few weeks old, going by the share price in the teaser, but it still might be interesting to folks … it is, at the very least, a truly unique investment. Good or bad, you can decide when you know the facts … but certainly unique. The teaser is from Yiannis Mostrous for Silk Road Investor, which we’ve seen a few times in the past — most recently, I think, when he was teasing Lukoil as a Russian investment … an idea which is up about 25% in about eight months.

As you can imagine from the name of his investment newsletter, he focuses on Asian investments — the Silk Road name could conjure up images of everything from far Southeast Asia to China and India, through the -stan countries or through the Arabian peninsula, perhaps even crossing the Red Sea into Ethiopia, and into Mediterranean Europe. But I think he focuses mostly on the greater Asia trade, particularly Russia, China, India and Southeast Asia.

This particular teaser is for the first company to go public from Cambodia, a still severely impoverished country that competes with Vietnam and China in the global textile trade, is heavily indebted, and still often requires help from donor countries to feed its people. But it also has free enterprise … and a democracy, though by most counts an awfully corrupt one. Which means someone is making money. And a few of those folks are blowing their money at casinos, since gambling is almost universally popular across Asia. There are quite a few casinos in Cambodia, but I think there’s only one large one that’s publicly owned and aimed at international visitors — and this teaser is for that company.

Here’s how Mostrous describes it:

“Get Rich Off of the Fastest-Growing Country in Asia—And You Can Buy It For 21¢ a Share”

“When you see how many advantages and tax breaks this company gets, it almost seems unfair. With 100% market share of a crucial part of the fastest-growing tourist trade in Asia, a company this dominant in the U.S. would be illegal. But you can buy as many shares as you want for just 9 times earnings.”

Well, it’s not 21 cents a share anymore — at least, not US cents. So this teaser is probably from about a month ago, when the shares dipped for a little while. I know some of my readers received this teaser from Mostrous in the postal mail in mid-April. But let’s look a little more at the sales pitch.

“It’s an extremely lucrative casino located in what not so long ago was a true hell-hole: Cambodia. To attract the foreign investment required to build it, Cambodia’s president has personally given its operators the most favorable terms of any casino operation in the world … For starters, they have zero competition, by law, until 2035.”

Oooohh, who doesn’t love a nice monopoly? Yummy!

“Yet you can buy this Cambodian monopoly for only 9 times earnings.

“Compare that to the average U.S. gambling stock, which is almost three times as expensive, selling for 25 times earnings. And in Asia’s gambling capital of Macau, casino stocks fetch an average P/E of more than 40!”

And this company has “no restrictions on how big it grows.”

It’s a bit more than 9X earnings now, too, of course … but still certainly cheaper than foreign competitors. It is in Cambodia, though, if you recall — I’d pay more for a casino in Atlantic City or Macau than I would for one in Cambodia, too.

Cambodia boasts 15%+ interest rates, nearly 10% consumer inflation, possible political unrest if people get hungrier thanks to agflation, rampant political corruption (which currently may be benefiting this company, it sounds like), significant human rights concerns, and a per capita GDP of only about $500 last year — which puts it right between Afghanistan and neighboring Laos or Vietnam, and much lower than China’s $2,500. And they’re having elections this summer, which might be a bit chaotic if rice prices continue to escalate, though the ruling party is widely expected to stay in power.

Even worse than Atlantic City, believe it or not.

Don’t worry, I’m not trying to cool your jets, just pointing out that a direct comparison between Macau (or the US) and Cambodia is, well, silly.

More of the exciting sales pitch!

“When there is only one way to invest in Asia’s fastest growing economy you grab it. Cambodia is like Vietnam 10 years ago just as it accelerated into hyper-growth. Tourism is surging at double-digit rates (2007 was a record-breaking year for tourist arrivals)… Chevron is drilling for oil… the country has been accepted into the World Trade Organization… Japan is investing billions into its ports… and real estate prices are rising 30% a year.

“All that adds up to a strong tail wind behind this unique tourist magnet. Net profit rose 54% last year. And years of profits lie ahead because its politically connected owner has managed to secure the longest-term casino license in Asia, valid until the year 2065.

“Contrast that to the new Wynn Casino in Macau. It cost $1.2 billion to build, but starting in 2017, the Chinese government can buy it on one year’s notice for “fair compensation” (whatever that means). And Wynn’s Macau casino license expires altogether in 2022 at which point China can nationalize the operation outright.”

And here’s a bit that sounds particularly interesting:

“Here’s another stunner: this stock comes with an insurance policy that pays 75% of the stock’s value if there is any political disruption in Cambodia that hurts this company.”

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Hmmm … insurance against that Cambodian political risk? Really?

There’s more to the teaser, in case you’re not yet drooling and calling Yiannis to give him your credit card number …

The company has a monopoly on casinos within a couple hundred mile diameter around Phnom Penh, which is the major city and airport location in the country.

Net income has doubled in the past three years, per the teaser, and the stock yields 7%.

There’s more, but that’s probably enough, eh?

The Thinkolator waits for a quick translation from the Khmer … and tells us that this is …

NagaCorp. The company is listed in Hong Kong at ticker 3918, last trade HK$2.05 — equivalent to US 26 cents — was up about a percent on the day. This is also on the pink sheets at NGCRF with very light volume (the “grey market” as they call it, which is even more illiquid than most pink sheets names), where it traded on Thursday for 30 cents (no Friday price reported as of this writing), an unusually large premium over the HK price — if you do happen to like NagaCorp (after doing your careful research) and want to buy on the pink sheets instead of calling your broker to make a buy in Hong Kong, I’d be careful not to overpay by more than a penny or so for the convenience — a premium of four cents on a 26 cent stock means you’re paying close to 15% more than the traders in Hong Kong.

Volume is actually very light everywhere, partly because it’s low profile and small and partly because the CEO owns so much of the company — 3918 only trades about a million shares a day in Hong Kong and NGCRF probably well under 100,000 shares a day on the pink sheets, so Gumshoe readers could easily move this stock if just a few folks jumped in at once … be careful, and note that even if you do decide you want to buy, it won’t necessarily be easy to sell at a price you like in the future.

And, full disclosure here, I do own shares of this one and I have a limit order in for some more if the shares dip. That does not mean that I’m urging you to go out and buy shares, I consider this a risky flier on a decent company with uncertain prospects as far as their long term competitive advantage, but a nice enough valuation and yield that I’m willing to invest as a bet on their interesting potential over the long term (several years). I’ll hold through some volatility for this one, and wouldn’t be shocked to see the shares go down 30-50% if their earnings (and therefore the dividend) take a hit — many investors seem to be holding this for the dividend, which is probably why the price has been fairly stable over the past year (this is relative, it has been stable only for a thinly traded small-cap frontier market stock).

So that’s my disclosure — what about the company?

NagaCorp owns NagaWorld, which is a hotel/casino complex outside Phnom Penh.

My fingers do not want to type Phnom Penh. Hope I spelled that correctly.

They do have that lease until 2065, and they do have a monopoly zone around the city until 2035, though the rule of law has not been particularly strong in Cambodia and I don’t know how much confidence to have in that monopoly. It looks like the monopoly area doesn’t include slot machines or similar machine gaming, since there are apparently also some small-time gaming halls for locals in the city itself (not a big deal, since the vast majority of their revenue comes from table games and tourists). I expect that sweetheart deal probably should be safe for at least a decent period of time, since there isn’t much sign that big casino operators are interested in Cambodia at the moment and the company management is tied in closely with the government, but I don’t really know.

The company is controlled not by the public shareholders, but by the founder and CEO Chen Lip Keong, who owns about 67% of the company (and also controls a few other public companies, mostly Malaysian-listed). I expect this is the reason for their nice dividend policy, which aims to disburse at least 50% of earnings — the owner can get a nice outlay from the company without selling shares. I generally like when companies are run by insiders who own a lot of shares and like to pay themselves with dividends, but I’d prefer to have that number be 30% instead of near 70%, just to give at least a little bit of leverage to outside investors.

The company makes much of its profit from table games, and they are increasing the number of tables fairly dramatically — up to 300 tables by 2009 from the current 100+ (the scale is not what you’re probably used to from Macau or the US — this casino is much smaller than most of those, and the hotel has fewer than 700 rooms). They subcontract for a few of those tables and for all their slot machines and similar gambling machines, which cuts their upside somewhat but brings in a steadier cash flow from the lessees who run those games — and they’re subcontracting more with Poibos, a Korean firm, to operate a new table game room this year for guaranteed revenues of $25 million a year and up, for ten years. They do indeed have permission to expand as much as they want, and to add as many games as they want without needing new licenses, though that doesn’t necessarily mean that the market will bear that expansion.

The shares have traded relatively near this price range for the past year — roughly from $HK 1.50 to 3. There are about two billion shares outstanding, so the market cap is just a bit over $US 500 million. Net profit was $US 50 million last year, so the PE ratio is in the range of 10, a bit above at the moment. That ratio has moved down over the past few years as earnings have climbed much faster than the share price (this includes the financial statements from before they went public, so it might not mean that much). The dividend was US$30 million for the last 12 months, which is right around 6% at current prices, and a 60% payout of earnings. That’s awfully high, and tells me that they may be more focused on profitability and paying off shareholders than on paying for dramatic expansion.

They could always dilute shareholders or raise debt or take on more subcontractors to fund expansion … and if Cambodia ends up starting up a stock exchange, as the government is trying to do (in cooperation with the operators of the South Korean exchange), they might be able to list there and raise some more local funds as well. That’s all just speculation. It appears to me that they’re most likely to sublease gaming areas to other companies as a way to expand in the future with reliable revenue streams, but that really depends on whether these relatively new strategies work out well for both sides.

They don’t make any money from the hotel, and only a smidge from food, drink and entertainment — gambling brings in all the earnings. That means the “luck” of the casino can come into play, since gambling income from casino owners can fluctuate widely, though from what I read it’s in the range of 2-4% for most companies. NagaWorld is well over 3% as of their last filings.

That structure is quite different from most big gambling centers, where income from hotel and non-gaming entertainment has become a significant part of the income statement.

What are the risks, aside from the fact that we’re talking about Cambodia?

Well, even with a growing (but very small) affluent class in Cambodia, they rely on outside visitors and tour groups for much of their business — and gambling junkets are a hugely competitive business in Asia, so the company pays higher commissions to tour group operators than do many other casinos in other countries, in order to draw more “mid tier” gamblers (NagaWorld pays a commission of probably between 1-2% on the initial chip buy of the visiting gamblers to the tour group operator who brought them there). Relatively few of their gamblers are local walk-ins or tourists that come in separate from the gambling junketeers, though that might grow with the increase in Cambodian tourism, and last year was the first one in which revenues from their special tables for tour group visitors were less than half of total revenues (still 45% or so). The VIP tables for tour groups bring in more sales per player, but at a lower margin because of those commissions.

If other casinos compete more aggressively for these relatively smaller fish, it might be tough for NagaWorld to keep their market share or improve it if they’re fighting against more experienced companies with more appealing properties, and beyond that, these kinds of tour groups are considered more recession-prone than local gambling, should the economies of the region tumble.

And I wouldn’t hold out much hope that this will become a glamorous destination to compete with Macau, Singapore or the other big gambling resorts — compared to the big multinational gaming companies, I expect NagaWorld will probably remain a local, mid-tier competitor that, to some extent, flies under the radar and attracts middle class gamblers primarily from within Indochina and from nearby Chinese cities. I don’t think that’s bad, but it should temper the more aggressive expectations you might get from reading a teaser ad. Kind of like owning Indian reservation casinos in Minnesota versus owning casinos in Vegas, they can both make money but they have very different markets.

You can see the company’s annual reports for the last two years, as well as some other filings and information, on their website at www.nagacorp.com, all of which is available in English. And they do most of their business in US dollars, despite the fact that they’re located in Cambodia and trade in Hong Kong, so there’s not much fluctuation due to currency and the numbers should be pretty easy to understand.

Oh, and that “insurance policy?” It does exist, there is a policy with Lloyds of London through 2009. According to the analyst from Sun Hung Kai Financial, it protects against regime change, withdrawal of license, civil unrest or similar events … but the analyst notes that this compensation would be equivalent to HK$ 0.56 for common shareholders, so that’s about a quarter of the share price, not 75% as teased.

So … a smallish company that has tight government connections and a dominant shareholder who can do essentially whatever he wants.

Volatile shares, but a pretty low valuation and a dividend.

And a growing business, though not growing in a straight line, and with some challenges to their high margins.

A publicly traded company in a country that has very few such institutions, and high country risks … remember that Vietnam is maybe 10 years ahead of Cambodia, depending on who you ask, but is still considered a fringe “frontier” emerging market by many people.

I’ll leave you with a quick quote from an article that ran on Forbes.com in October of 2006, when these shares first floated on the Hong Kong exchange (the shares are up about 50% from that IPO):

“… the company might seem attractive, at least to those investors willing to gamble that the political and economic situations in Cambodia will remain stable and that the government will enforce Naga’s exclusive right to operate a casino. All in all, it’s a bit of a gamble.”

I’ve already noted that I have a small position and may buy more, though this is money I expect I have a fair chance of losing, and I’m looking out several years for this, not several months … What do you think?