Hotung Investment Holdings - Nothing Ventured, Nothing Gained
- We initiate coverage on Hotung with a BUY recommendation and a TP of SGD2.00 (14% upside).
- Hotung, a pioneer in Taiwan’s venture capital industry, has an established track record of profitability. However, it has historically traded at low valuations, as the market probably has not known or understood its business model.
- A 100% payout policy has resulted in cumulative dividends of SGD70m paid over the past five years. The stock offers attractive forward yields of c.10%.
- We see good value at present levels, with the stock currently trading at 0.5x FY17F P/BV.
- Continued share buybacks or a partial capital reduction could serve as catalysts for the stock. Our TP is based on a FY17F P/BV of 0.6x.
- Hotung is one of the pioneers in the venture capital business, with over 30 years of investment and fund management experience. The group operates primarily in Taiwan, China and Silicon Valley and has listed 200 companies on major exchanges around the world.
- Leveraging on the company’s investment expertise accumulated over the years, Hotung invests in innovative and promising businesses globally, across a variety of industries that aim to improve general living standards. Its fund management business manages third- party funds as well as the funds generated from its venture capital business. Since 2011, the Taiwanese Government has engaged Hotung to participate in its investment programme – which is a testament to its experience and sound investment strategies.
- Besides its experienced management team, Hotung also leverages on the guidance and network of a team of investment advisors that include industrialists and political leaders. Some of its past and present investment advisors include:
- Dr Min-Shyong Lin, founder of Asia Pacific Microsystems;
- Dr Chih-Kung Lee, current Minister of Economic Affairs of the Republic of China;
- Mr Lei Jun, founder and CEO of Xiaomi;
- Mr Xu Xiaoping, founding partner of ZhenFund, one of China’s high-profile angel investors.
A pioneer in Taiwan’s venture capital industry.
- Hotung is one of the pioneers in Taiwan’s venture capital business, with almost 30 years of investment and fund management experience under its belt. The group – which operates primarily in Taiwan, China and the Silicon Valley – has listed some 200 companies on major exchanges around the world.
- Led by an experienced management team, it invests in a broad range of industries that cover sectors from biotechnology, e-commerce, agriculture to smart home key components. The group also has an in-house fund management arm that manages third-party funds, as well as funds generated from its venture capital business.
- To manage its investment risks, Hotung focuses on companies that are past the start-up phase and are in the expansion or mature stages of development. Typically, profits are made upon portfolio exits – either through a trade sale or an IPO process. The group has built up a solid track record and has stayed consistently profitable in the past decade, except in 2008 when impairments spiked up due to the global financial crisis.
High yield play.
- The group’s dividend policy is to distribute the majority of its earnings. In line with this, the average payout ratio during the last five years was 97%, with some SGD70m in dividends distributed during this period.
- The high payout ratio has translated into a high yield for the stock, which traded at a yield range of 8-11%. We forecast a forward yield of 10% over FY17-18, as the group continues to maintain a regular pipeline of exits and new investments.
It is cash-rich – cash holdings represent 64% of market cap.
- Historically, Hotung has maintained strong liquidity, with a net cash position. In recent years, cash has piled up further, with the proceeds from portfolio exits. Out of its asset base of TWD7.4bn as of end-2016, cash and cash equivalents totalled TWD2.1bn (SGD96m) – which represents 64% of its market capitalisation.
- Backing out its cash, the implied price an investor is paying for its underlying investments is 30 cents on the dollar.
Value-accretive share repurchases.
- With the stock trading at a 50% discount to its book value, management has embarked on an active share buyback programme. It has bought back 23% of the outstanding shares in the last decade. These buybacks are highly accretive and provide another avenue for the company to return value to shareholders.
- Following the global financial crisis in 2008, Hotung’s P/BV has steadily re-rated to 0.5x from 0.3x, as it established a track record of profitability and generous dividend payouts.
- While venture capital investments are inherently hard to predict in terms of the timing of exits, we believe Hotung’s broad portfolio of companies across multiple industries and its tilt towards later-stage investments has helped to smoothen its earnings volatility.
- Moreover, with the large cash pile at its disposal, Hotung has additional levers to return capital via value-accretive share repurchases or a partial capital reduction to return excess cash.
- We continue to see good value at the current levels, with the stock trading at 0.5x P/BV and offering a yield of 10%. As a comparative measure, Hotung’s peers are trading at an average P/BV of 1.4x.
- Our TP of SGD2.00 is based on a 2017F P/BV of 0.6x.
- Hotung reported a net profit of TWD318m (2015: TWD419m) which was above our expectations, primarily due to lower impairment provisions.
Balance sheet and cash flow.
- The group ended FY16 with net cash of TWD2,080 (or SGD95m), and with shareholder’s equity of TWD7,298 (or SGD322m).
- Due to the drag from a high cash position, Hotung’s ROE is in the 5% range. Stripping out the cash drag, we estimate an underlying return of investment of 7-8%.
- In line with its policy of paying out substantially all of its profits, the group declared TWD301m in dividends. This translates to a DPS of SGD0.139, and a 97% payout ratio.
Susceptible to economic cycles in the Greater China region.
- More than 90% of Hotung’s investments are in the Greater China region, with many of its investee companies in the early stages of growth. A prolonged economic downcycle could cause these companies to be financially stressed and necessitate the taking of impairment losses by Hotung, as witnessed during the 2008 global financial crisis.
Intensifying competition may hinder investments.
- With more venture capitalists and investors turning their attention to the expanding start-up scene in Greater China, the intensifying competition may limit the investment opportunities for promising start-ups.