Thursday, September 19, 2019

GrafTech

GrafTech

Source: Massif Capital, GrafTech MOI Global Presentation
GrafTech (ticker: EAF) has been in operation since 1886. It went public in 2018 when Brookfield sold 15% of the business, after being taken private in 2015. GrafTech is a backward vertically integrated producer of ultra-high power (“UHP”) graphite electrodes (“GE”), an industrial consumable product used primarily in EAF (“electric arc furnace”) steel production. Around 46% of the world’s steel production is produced through the EAF method, the other 54% being through the BOF (“basic oxygen furnace”). These numbers exclude China, where the BOF accounts for 91% of steel production.

Recent events with increase demand for lithium-ion batteries from EVs, the steel and the graphite electrode industry, have put this company in a position to be able to sell 65% of their 5-year cumulative capacity on take-or-pay contracts, thus almost guaranteeing the company a fixed source of free cash flow 5 years into the future. I believe the supply and demand imbalance will probably we present fro the next 5 years. This report will look into why that may be the case. 

The company have a market cap of $3.9bn, $2bn in debt and $200mm in cash. In the past 12 months that company has generated $750mm in cash – of which $525mm has been returned to shareholders. $99mm in dividends, $203mm in special dividends and $225mm in share repurchases. I estimate that by 2023 the company will have earned about three-quarters of its market cap in FCF, which means you’d be paying almost nothing for the company by that year.

Click here for the PDF write-up.

Conclusion

In terms of the graphite electrode industry we can sum it up by pointing out that there are 5 producers of graphite electrodes worldwide. Only 4 or so produce the kind of UHP graphite electrodes that GrafTech makes. It would take more or less 5 years to build more graphite electrode capacity, and the supply from this would be incremental, i.e. the plant wouldn't be operating at 100% capacity in the first year of operation. Secondly, we can point out that the main product for making GE is petroleum coke. In this industry too there are only 4 major players, with Phillips 66 accounting for almost 60%. Petroleum coke is only something like 2% of the output of a refinery. So more refineries, refinery debottlenecking and capacity expansion from Chinese players which produce subpar anodes is not a threat for now. And again, it would take something like 5 years to build a petroleum coke plant. With all these factors in mind, what we can sum it is that it's quite hard to add capacity immediately.

Because petroleum coke now has a potentially new and huge market (EVs), and thus its supply is constrained and will probably be constrained for the next 5 years, and because that will have an impact on the supply of GE, GrafTech went to their customers and offered them 5 year take-or-pay contracts so as to allow steel companies to make sure they can produce steel. Also, GrafTech is the only company that could do this at pre-determined prices because they're the only backward-integrated company in this industry, thus controlling the cost of their raw material. Competitors have to pay (high prices) market prices for petroleum coke. Steel companies were eager to secure their supply of graphite electrodes so as to not run into the risk of halting their production - it surely helped that these electrodes are essential for steel production, yet only account for less than 5% of the total production cost of steel.

These contracts allowed them to sell two-thirds of their 5-year capacity, the remainder will be sold at spot prices.

Wednesday, August 14, 2019

Cheap Animal Safari Park Operator


Parks! America, Inc

History & Background


Parks! America is an overlooked stock that trades over the counter. The company has a market cap of $10.5M. It’s a small company that operates two animal safari parks, one in Missouri and another one in Georgia. Customers can rent cars at the parks and buy animal food to give to the animals as they drive through the 200+ acres of land where animals roam around.

The company came to be in 2003 when it acquired the assets of Great Western Parks LLC. The acquisition was accounted for as a reverse merger, in which the Great Western Parks was considered the acquirer.

The Georgia parks’ drive-through, which opened in 1991, is located on 200 acres of a 500-acre plot of land. Revenue has almost doubled since 2007 and the pre-tax profit margin expanded by 30%. The Missouri park is on a 255-acre plot of land that is all being used. The park was acquired later on in 2008 for $2M and still runs at a loss.

Business

Together the parks did $5.9M in revenue in 2018, down from 2017 due to poorer weather conditions. 85% of those sales came from the park in Georgia. Based on revenue numbers and ticket prices, I estimate the parks entertained over ~240,000 people in 2018. A number that, according to my estimates, has grown at about 5% p.a. since 2008.

If a park manages to attract a lot of visitors, like Straco, then margins are very, very high. There’s a lot of operating leverage. The Georgia park employs 14 permanent people and up to 25 more during the second and third quarter, which is peak season. Peak season typically accounts for 65-70% of revenue. The Missouri park has 6 full time employees and up to 12 additional employees. This hasn’t changed for ten years.

The company has around 3M in fixed operating expenses, including depreciation. So, if we take the lower ticket prices of Missouri at $18.95 each, then the company would have to sell 156,000 tickets to breakeven. 131,000 at Georgia ticket prices. The incremental margin after fixed costs are covered is very high, so it’s important to estimate what the company’s “tipping point” is. Over the last 11 years, the Georgia park sales accounted for ~80% of sales. Taking this into consideration, the average ticket price is $22.15. Meaning 140,000 tickets would need to be sold to cover fixed costs. I believe the company probably had 260,000 visitors in 2018, the company’s margin of safety is 85%.

Now that scenario assumes there is no revenue coming from renting vans and selling animal food, which the company does. Perhaps 20% of revenue comes from renting vans and selling food, so actual ticket sales are about $4.7M. Meaning that actual visitors per year were more like 210,000. So, you sell the first 140,000 to cover expenses and then the remaning revenue from the 60,000 tickets drop directly to the bottom line. That remaining revenue is roughly $1.5M.

Again, that calculation wouldn't be very useful because one park does very well and the other doesn't. The Georgia park may look something like this: $5.1M in revenue and $4M in actual ticket sales, which translates to around 180,000 visitors. There's probably about $2M in operating expenses. So some 90,000 need to be sold to cover fixed expenses. The remaining revenue from the other 90,000 tickets dropped to the bottom line to the tune of $2M. Actual pre-tax profit was $2.4M. The difference probably results from the high margin on renting the vans and selling animal food, which according to my calculations brought in $1M in revenue.

Over the last 8 years the Georgia park has done very well, with pre-tax profit growing 8-fold on a 2-fold increase in revenues. Company-wide EBIT per share grew 10-fold. Due to little variable costs and price increases, the profit margins expanded dramatically. Part of revenues are from schools and tours, which provide a visible revenue stream into the future.

The Missouri park, however, was acquired in 2008 by the previous management team and, according to the CEO, the park had been under-invested for several years. The company would be better off without this park, for which they paid $1.75M (excluding cash). After factoring what was spent on capital expenditures, management hasn’t recouped the cost of their investment. Management has spent at least $1.4M since the acquisition on capital expenditures. Recent efforts include improving concessions and acquiring a giraffe. The Missouri park is nothing like the Georgia park. It had revenue of $923k in 2018, 50% higher than 8 years ago. By looking at the ticket prices, I estimate ~40,000 visitors visited the place.

So, on a GAAP basis this park has done poorly, but on an “owner earnings” basis (pre-tax profit + D&A – capex) the park has done even worse as management has invested an averaged of $200,000 into the park every year for 8 years.

Competition

Management talks about how this is a “highly competitive” industry, but I don’t think the numbers show that. Let’s talk about potential competitors in Georgia, which is the company’s main asset.

Callaway Gardens, located 5 miles from the Georgia park, is mentioned in the annual report as a threat. Callaway Gardens is a 6,500-acre resort, founded in 1952, that brings ~750,000 visitors every year. It has trails for biking and walking, the world’s largest man-made white sand beach, a butterfly center with many different species of butterflies, and two golf courses. I think this has actually been the reason why the Georgia park was successful and the Missouri one wasn’t, despite Missouri having a larger population. The Callaway resorts attracts people to Pine Mountain, Georgia.

In May 2018, Great Wolf Resorts (over 450 suites), which includes an indoor waterpark, opened 12 miles from the company’s park. Daily tickets go for $75. Again, I think that like Callaway, this will be good for the park. However, we can still look at other amusement parks to get a feel for the impact a waterpark might have.

The closest waterparks are Rigby’s Water World (94 miles), Six Flags Over Georgia (77 miles) and Six Flags White Water (90 miles). The biggest park, by acres, is Six Flags Over Georgia at 290 acres. Over 12x bigger than Rigby’s Water World and 4x bigger than the other Six Flag’s park. These are obviously not perfect comparisons because of the distance - Six Flags over Georgia, the closest park, is a 1h10min drive).

The Georgia park has done quite well depsite the huge Six Flags park being an hour away. Rigby's opened in 2018, and if the Georgia park did well with the aforementioned Six Flags park it will surely do well with Rigby's - a 24 acre park and a 2h drive.

Great Wolf Resorts will have 11 acres of entertainment space, the biggest being the indoor water park which will be over 2 acres. This park is far smaller than all the ones I’ve mentioned above. Except for Rigby’s which opened in 2018, the two other parks have been open for at least 35 years. So, it’s likely Great Wolf Resorts will attract more visitors to Georgia, but it’s hard to tell how many. But I’d bet it’s going to be significantly less than Callaway Gardens. Nevertheless, it’s likely still a positive for the Georgia park.

What is it worth?

Adjusting for non-recurring expenses the company has traded between 4-8x EBIT. Just like when I looked at Straco, over-leveraged peers who haven’t grown EBIT as quickly trade at high multiples. 


Company
2018 EBIT
EBIT Growth last 8yrs
5yr Median EBIT Multiple
Six Flags
$545M
9.5x (7yrs)
18x
Parques Reunidos
$629M
2.0x (5yrs)
27x
Seaworld Entertainment
$143M
2.5x
24x
Cedar Fair
$247M
2.0x
18x
Merlin Entertainment
$419M
1.9x
17x
Village Roadshow
$2.3M
-98%
16x
Park! America
$1.6M
9.3x
6x


The mean of the 5yr median multiples is 18x EBIT, excluding the company. In spite of the Missouri park, company-wide EBIT per share grew 5.6-fold over the last 8 years. The company should we worth at least 8x EBIT for the Georgia park plus the land for the Missouri park. The company’s track record in the Georgia park has been tainted by the losses and investments in the Missouri park. The Georgia park has produced between $2-3M in EBIT in the last 3 years, and there’s about $600,000 a year in corporate expenses for both parks. So, if I assume $2.5M in EBIT going forward less the corporate expenses we have $1.9M in EBIT. At 8x EBIT, the Georgia park is worth $14.8M.

The Missouri park loses money, so we’ll just assume the only thing of value is the land. Comparable land sales point to a value of at least $5,000 an acre. There’s 255 acres. So that’s worth $1.2M.

So, both parks are worth almost $16M. There’s another $1.2M in net cash. The total equity value is $17.2M. This gives me a prices per share of $0.23 vs. the current price of $0.14.



At today’s prices, you get a company in which management owns over 50%. If I adjust the market cap for $1.2M in cash and the Missouri land, I’m getting a park that has grown EBIT 9-fold over the last years for less than 5x EBIT.

Another way to look at is: if the company continues to generate about $1.3M in operating income (Missouri park will hurt earnings), then after paying interest expense and taxes you are left with about $1.2M in cash. In 3 years time there will be $4.5M in cash. Or almost half the market cap.

  • Market cap: 10,000,000 
  • 2022 Net Cash: 4,500,000 
  • 2022 Market Cap (adj. for net cash): 5,500,000 
  • Free Cash Flow: 1,200,000
  • Price to 2022 FCF: 4.6x

I would say that despite the company being very dependent on Callaway Gardens, because both parks are in very rural places, I still think this is a decent business and deserves more than an 8x multiple. However, uncertainity about future capital allocation decisions worries me. Management has continously put money in Missouri where it has, in my view, been very poorly spent. Last year pre-tax profit was $1.4M, a simple closure of the Missouri park would take that pre-tax profit to $2.4M. 

Other Events

James Elbaor, a shareholder who owns 5% of the outstanding stock through Marlton Wayne LLC has suggested, through letters to the board, that the company should, (1) return $1.5M to shareholder through a special dividend or, (2) do a modified dutch auction tender, and create a Special Committee of independent board members to explore all strategic alternatives (i.e. possibly sell the company).

Another large shareholder, Nicholas Parks, who owns 12% of the outstanding stock, issued a 13D saying he entered into discussions with a private equity firm so that possibly the PE firm would buy his stock.

Risks
  • There’s the risk the company keeps ploughing money into the Missouri park that seems to haven no chance of success (as they have been for as long as they’ve acquired it). $1.4M (and counting) in cash that could’ve have gone to shareholders.
  • Risk of another poor acquisition like the Missouri park.
  • Company is incorporated in Nevada, which is always a red flag for a company that doesn’t do business in Nevada
  • The PCAOB found Parks! America’s auditor, called Tama, Budaj & Raab, P.C., to have some “deficiencies” in their work
    • “the auditor issued an opinion without satisfying its fundamental obligation to obtain reasonable assurance about whether the financial statements were free of material misstatement.”

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Recommended write-ups: 



Tuesday, July 23, 2019

Keweenaw Land Association

Keweenaw Land Association

Summary

Keweenaw owns 184,000 acres of timberland and 401,841 acres of mineral rights, mostly located in the Upper Peninsula of Michigan. This type of investment is what I would describe as an asset play, the company’s value is really in the difference between the value of the timber it owns and the price you can buy the stock for. The market is pricing the company at a significant discount to the value of its standing timber, despite timber being an asset class that, long-term, delivers returns similar to those of the S&P500. 

There’s 1.3M shares outstanding and 184,000 timberland acres, that’s 0.14 acres per share. The company has an appraisal done every 3 years of the value of its timberland.  In 2018 an appraisal was done and depending whether you use a DCF or a sales comparison approach you get different values. Using the sales comparison approach – which uses recent transactions as a guide – the timberland is worth $160M. Or $870 per acre. Multiplied by 0.14 you get $122 a share. Subtracting net debt, you get $112 a share of timber. The market currently values the company at $71 a share. 

The reason I prefer the sales comparison approach is because it’s based on sales that were done in the past in the very region Keweenaw owns land. The income capitalization approach, which is essentially a DCF, relies on the appraiser making much more subjective assumptions about discount rates, etc. Different discount rates will make the value of the timber fluctuate very widely. 

Timber is a unique asset because, over time, it will appreciate in value due to the growth of the tree along with the fact that the underlying land also increases in value. Whilst prices can be volatile, returns for owners don’t need to be. The harvest is like the dividend yield on a stock. Owners can simply reduce harvest and “save” the earnings for later, similarly to how a company can retain earnings and put them to work at a more opportune time. 


History

Keweenaw’s background traces back to the period after the Civil War, when Congress provided a land grant to help finance the construction of a shipping canal across the Keweenaw Peninsula of Upper Michigan. 

A company by the name Portage Lake & Lake Superior Ship-Canal Company was supposed to build the canal. But after experiencing financial setbacks, the assets of the company, including the 400,000-acre land grant, were purchased in a bankruptcy auction, by the company's creditors. From there, the Lake Superior Ship Canal Railway and Iron Company was formed. In 1891, that very company sold the completed ship canal to the U.S. government, and the remainder of the assets, including the land grant, was transferred to the company’s successor, the Keweenaw Association, Ltd. Later the company was renamed Keweenaw Land Association.


Timber as an Asset Class

Timber is usually classified into either softwood or hardwood. The name, however, doesn’t have anything to do with the hardness of the timber, it merely indicates which species of tree the timber comes from. Around half of US softwood timber goes into new home construction, and one third goes into repair/remodeling market. In terms of US hardwood, which covers most of Keweenaw’s land, around half is used for furniture, cabinets and flooring and molding/millwork. The company’s standing timber inventory in terms of volume (in cords) is as follows: 81% pulpwood and 19% sawtimber. Even though pulpwood makes up the bulk of the volume, sawtimber makes up the bulk of the value.

Timber returns haven’t been very good in the last few years compared to the period before 2007. From 1987 to 2007, returns were in the order of 10% p.a., whereas in the period between 2008-2015 returns were ~4% p.a. What contributed to a decline in returns? One factor was the decline in housing construction, which lowered high-quality timber prices. In the U.S. housing starts went from 2M in 2005 to about a quarter of that in 2009. The second factor was really low inflation since the recession. In half of the years when timber had high returns inflation was over 3%. For comparison purposes, over that same period the S&P500 returned 12% p.a.

Return in timberland = (Profit from harvest / appraisal value) + tree growth rate after harvest + rate of inflation.

In 2018 more timber was harvested than in any other year. There's a question of whether management will cut trees down too fast or not. If the trees grow 4% a year, then they should have grown by 160,000 cords in 2018. Management harvested 70% of the growth. So, the trees grew 1.2% after harvest, the (profit / appraisal) adds another 1.8% return, and inflation was 2%. All in all, the return was 5%. With an inflation rate of 2-3% returns can range from 5% to 7%.

Business

Keweenaw sells different kinds of timber, and the price between the most expensive (which accounts for 2% of sales volume) and the least expensive is wide. Over three-quarters of KEWL’s sales volume is pulpwood, (i.e. used to make paper and cardboard boxes), which is the cheapest kind of timber. The most expensive kind of timber might be used for furniture, flooring, etc., and this type of timber may be exported. On the contrary, cheaper types of timber will not be exported or taken by trucks to far away mills because the cost of transportation is very significant. So, like with a cement company – despite cement being a commodity like timber – there is a locality-based moat, because of the cost of transportation. 

Given the implications above, almost 2/3 of the volume of their timber is sold to regional mills. Contracts with mills range from 3 months to 2 years, which set a specified number of logs and pulpwood to be sold with the price is subject to market pricing at the time. 

Overall, in 2018 the company sold over 111,000 cords (1 cord is 3.6m²), which resulted in more than $14.2M in sales. The cost of producing this was $10.4M, less SG&A which was about $1.6M, you get an operating income of $2.2M. EBITDA from timber operations was $2.7M. Both operating and gross margins have been steady. Since 2003, the company only lost money in 2003, because of over $2M in non-recurring expenses associated with the Cornwall Capital proxy fight, settling employee contracts and costs associated with investigating an eventual conversion into a REIT with an investment bank. 

The company’s revenue averaged almost $10M between 2011 and 2015, and over $12M between 2016 and 2018. Gross margins are 30%+ and operating margins are 10%+. In recent years both revenue and operating margins have expanded and that’s due to increased harvesting. Harvesting from the company’s lands decreased very substantially, under previous management, when prices for timber softened due (1) drop in housing starts and (2) low inflation. If we go back to 2011 the harvest volume was almost 90 thousand cords and it went down to 70 thousand. Since then it has gone up to 110 thousand cords, with a substantial increase last year when Cornwall Capital took control of the company. 


What is the whole company worth?

The timberland is worth $160M and there’s $5.6M in cash and $18M in debt. This doesn’t include mineral royalties associated with the Highland Copper Company, where initial production is expected in 2021. In total you have a company that’s worth $112 share, and you can get it today for $71 a share.

The company is cheap, now the question is whether they can service the debt. The company has a lot of debt relative to its cash earnings, but not by the lender’s standards, who measures indebtedness as a percentage of the timber value.


The Debt

Keweenaw’s debt breaks down as follows: $13.7M out of $25M drawn in a five-year revolver, due on December 2021. This LoC was used by previous management to buy land in 2017. Because more than half of the total line of credit has been drawn, it carries interest of 4% p.a. The portion that has not been drawn carries an interest of 0.0875%. This line of credit carries a covenant whereby the principal balance cannot exceed one third of the value of the timberlands owned by Keweenaw. Using the $870 per acre value of the timberland, the principal balance is less than 10% of the value of the timberlands. 

There's also an option to term out the loan. Essentially the repayment period for the long can be extended. Whilst I don’t know into how long the loan would be converted into, I know that if it was converted today, the company would pay 3.5% p.a. in interest on the $13.7M.

In addition to this LoC, the company also has a $4.5M loan, due on December 2026, with carries a fix interest rate of 3.05% p.a. Including this $5M loan, debt to timberland value, is less than 12%.

In the last 7 years, the lowest EBITDA the company generated from timber operations was $1.2M and the highest was $2.7M. The highest being in 2018 was due to higher volume, and in 2015 it was due to higher high-quality timber prices. The highest was $2.1M in 2015, and whilst volume was almost a third lower than it is today, prices were higher, and the increase prices translated into a larger gross margin that fell to the bottom line. The EBITDA margin has ranged from 13% to 24% over those same 7 years.

If prices remain constant and harvesting decreases to 80,000 cords (almost 30% less than 2018), EBITDA would be north of $1M. This seems reasonable given that I don't think Cornwall will be under-harvesting.

Investors might worry about the debt and claim that because of it, the company deserves to trade for less than its assets are worth. If we assume there’s a 50/50 chance of the company going bankrupt, then we should apply a 25% discount to net asset value. Which would mean the stock would be worth around $84 a share. But I think the odds the company has of surviving are more like 90/10, which means of 9% discount is appropriate. 


The Key Variables

The first key variable is servicing debt. If debt isn’t serviced none of the other variables matter. Debt has been discussed above. The second and third key variables are (1) inflation and (2) housing starts, because these inputs will affect higher-quality timber prices – of which Keweenaw has a lot – over the next few years. High-quality timber accounts for 23% of volume and almost 40% of sales. The more profitable timber is the one most related to housing construction, so housing becomes and important input for prices.

Other variables include the fact that prospective buyers of timberland have been net sellers for the past few years. And so, management thinks this is not the right time to sell the company. For the past 18 years sales to REITs or Institutional investors have ranged from 300,000 to 600,000 acres in size, so there is a market for KEWLs large piece of land to be sold in one go. There’s also been a notable trend over since at least 1995, in which timber land has shifted from paper/lumber companies to investors/REITs. However, since 2006 transactions have been of smaller nature, with 2 notable exceptions in which in each case more than 280,000 acres were sold. Today, investors are looking for high-quality properties which fares well with KEWL’s high-value northern hardwood.

Lastly, there’s the risk of Cornwall Capital selling out a price below what the company is really worth. Cornwall manages $320M (according to SEC's Investment Advisor Public Disclosure) has a 26% stake in the company, and as of 2018 they control the company. This may be a catalyst. However, there’s also no way Cornwall can sell their position over a reasonable period of time considering the dollar volume of shares transacted each day. Because of that, they may get “rid” of Keweenaw at a lower price than a owner would accept. 


Conclusion

The first question on my mind is whether Keweenaw will be able to service its debt. If interest expense runs at $700k per year, there’s enough cash to cover 8 years of interest expenses.  Besides that, EBITDA from timber operations was the lowest in 2013, at $1.2M, when prices were roughly 10% lower (production mix was very similar) and harvesting was less than two-thirds of what it is today. So, I think it’s reasonable to assume EBITDA of more than $1M. 

Cornwall has also showed an appetite towards monetizing non-core assets (i.e. the land the company owns not used for timber). In 2018 land sales were almost $1.5M. That’s as much as the previous management sold, combined, in the previous 7 years. There’s about 11,000 of non-productive land that will be sold to improve the balance sheet. I estimate that land, which is mostly conservation land and some lake/river frontage, is worth another $8M.

In terms of management I'm inclined to think it’s of higher quality than it was before Cornwall took control, but it's hard to make judgements based on a one-year performance.. Nevertheless, the previous directors that had been with the company for 25+ years didn’t do much for shareholders, except for entrenching themselves on the board. Board expenses were 2-4% of revenue. With all directors owning virtually no equity in the business, shareholders have been treated unfairly with a stock that hasn’t not appreciated in value for over one decade.

Timber is an attractive asset class that has had similar returns to the S&P500 over the long-term. By buying Keweenaw you’re buying timber at a large discount to its appraisal value. A stock should only trade at a large discount to NAV if, (1) the stock’s returns are going to be below the market’s long-term return or/and, (2) there’s a high possibility that most of the company’s value won’t flow to shareholders. 

Today you can buy Keweenaw for the same price as 12 years ago, when the appraised value per acre was $400. The timber, net of debt, is worth $112 a share, whereas the current stock price values it at $68 a share, ~60% lower. If the common stock is worth $112 a share, and you buy it at $68 a share, and after 3 years Mr. Market realizes it’s actually worth $112 a share, you’re looking at a 16% p.a. return.

I believe this type of a risk-reward situations is quite attractive. Keep in mind we’re using timber valuations per acre from 2018, which are the lowest in a long time. In 2012 there was three-quarters of today’s acreage and the valuation per acre 5% lower. In 2015 there was 10% less land and the valuation per acre was almost 10% higher than it is today.



Thursday, May 30, 2019

Cash-cow China Aquarium Operator

S$ 1 = US$ 0.72


Background 

Straco Corporation develops and acquires assets in touristic locations, and the founder and his wife collectively own 55% of the shares, with the other big shareholder being a state-owned enterprise. As of today, they own and run two aquariums in China (Shanghai Ocean Aquarium and Underwater World Xiamen), a cable car in Lintong Mountain and a giant flywheel in Singapore. In 2018, they received 4.98mn visitors with the majority being locals. 

Together these assets cost S$226mn, some were acquired, and some were developed. Last year they generated S$64.9mn in pre-tax profit. In the past Straco’s management – which is nimble because of the large stake the founder has – has acted opportunistically by buying or developing assets in Asia, with a focus on China. The two aquariums, SOA and UWX, help bring the point forward. If these two assets were valued as separate entities, they’d both be worth ~8 times what they cost Straco. If I take what they paid for UWX in 2007, S$12.7mn, and what it’s worth today considering it generates S$9.8mn in pre-tax profit, I get a CAGR of 20.9% on the investment.

Most of Straco’s costs are fixed by nature, about S$53mn. That means that if we take revenue per visitor of S$25, we can see that they could have much less visitors and still not lose money. 

The group’s increase in revenue and profit over the last 10 years, was driven in part by the 10.7% growth p.a. in visitors, an increase in ticket prices and a higher margin on incremental revenues. Straco’s EBITDA margin per visitor has averaged 61% over the last five years, substantially higher than the 53% margin over the previous four-year period for which I have data. Further evidence of the value of the incremental revenues is shown by the fact that revenue per visitor has compounded at 2.7% p.a. since 2008, whilst profit per visitor compounded at 6.8% p.a. from S$5 to S$9 over the same period. 

Aquariums

Straco’s main assets are the aquariums that account for 66% of revenue and 88% of profits, so that’s what we’ll focus on first. 

SOA opened to the public in 2002 and it’s located near Shanghai’s financial center, where it was developed for S$55mn. The company secured this prime piece of real estate land with a 40-year lease, with an option to renew. The government collects rent in the order of 6.5% of revenue, even though this means rent is scales proportionately with revenue growth, it also means that if the government is making good money there isn’t much incentive to not renew the lease.

SOA boasts ~2.2mn visitors a year. Generally, the bigger the aquarium the more visitors it attracts, but only up to a certain point. SOA has a turnover of S$65mn, which is 80% of aquarium revenues, and a pre-tax profit of S$47mn. These businesses have got inherently high fixed costs, about 85% of total costs are fixed, and so after fixed costs are covered, the marginal cost of having another visitor is basically zero. Both aquariums’ profit margins went from the high forties 10 years ago and stabilized around the low seventies for the past 5 years. 

The average ticket (assuming 60% of tickets are adult tickets) is RMB 140. That’s almost 50% higher than the average price of a ticket to SOA at date of the IPO. Changfeng, another nearby aquarium, has also showed the ability to increase prices over time. Here the average ticket price went from RMB 72 to RMB 112, a 55% increase but from a much lower ticket price. This is part of the reason why SOA and UWX’s profits have grown at 14.7% p.a. since 2008.

Ticket prices for SOA are allowed to increase at a rate of around 15% every 3 years, subject to the final approval of the Municipal Price Administration Bureau. The pricing power evidenced by these parks is most likely due a few factors such as, (i) the growth in China’s GDP over the years, along with a low population growth, meant that per capita income increased a lot, (ii) 11.0% p.a. growth in the number of domestic tourists visiting Shanghai between 2005-2017 (iii) 9.7% p.a. growth in the number of overseas tourists visiting Shanghai between 2000-2017 (iv) investments in new experiences for visitors in the aquarium. The quality of tourism in China has also improved, as shown by the number of five-star hotels in Shanghai, which almost doubled between 2008-2016 and yet occupancy rates rose 24% to 68%.

The other aquarium belonging to Straco, UWX, which opened in 1999, is located on an the Gulangyu island and was bought in 2007 for S$12.7mn. It has a turnover of S$15.4mn and profits of S$9.8mn. So today it’s worth about 8 times more than what management paid in 2007. When the company bought it had 600,000 visitors annually, and today I estimate it has roughly 900,000 visitors. This aquarium, accessible by ferry, is about half the size of SOA and has an average ticket price of RMB 114. 

In 2011, the aquarium had crossed one million visitors, however the government implemented some restrictions on Oct. 2014 on the number of tourists in certain touristic places. The ultimate goal of the government’s decision was to establish the Gulangyu island as a UNESCO heritage site. This obviously hindered the aquariums stellar track record as the number of ferries was reduced, and ultimately caused revenue to fall by about 20% from the peak.

Competition

Shanghai Changfeng Aquarium, which is the main attraction within the Changfeng park, was purchased by Merlin Entertainment Group in 2012. The aquarium is 10,000 square meters, half SOA’s size. The average price of a ticket is RMB 112 versus RMB 140 for Straco. Those prices look very different compared to 15 years ago when the average ticket price for the Changfeng aquarium was RMB 72 versus Straco’s RMB 94. 

Then there’s the Haichang park and Disneyland. The former is a cross breed of SOA and Disneyland and opened in 2018. Disneyland opened in 2016. The adult ticket price for Haichang is RMB 420, 20% cheaper than Disney’s high season ticket. Disneyland had 11mn visitors in 2017, that’s half the visitors that Disney’s most popular park in Florida has. And unlike what conventional wisdom might dictate, these parks may actually help Straco in the long run, particularly Disneyland because of its brand name and its ability to attract a lot of tourists. If I look at the biggest aquariums in the US, what I see is that even though there’s all these parks like Disneyland, Six Flags, etc. close by, the number of people going to the aquariums has actually been pretty stable over past 20 years or so. Only another aquarium being built close by would affect it. However, it’s important to keep in mind these results are probably positively skewed. This is because aquariums that eventually closed because of theme/amusement parks get removed from the sample.

The bulk of Straco’s visitors relates to the aquarium in Shanghai, and the majority of total visitors are domestic. If we look at the growth rate of domestic tourism to Shanghai and Straco’s visitor growth rate, over the last 5 and 10 years, there seems to be some correlation. In the last 5 years, domestic tourism grew 4.9% p.a. vs. the company’s 5.3% p.a., over the last 10 years it grew 12.5% p.a. vs. the company’s 10.7% p.a. growth. 

Value of Aquarium Operations (SOA 95% owned)

Revenue: 81,000,000
Pre-tax profit: 57,400,000
After-tax profit: 40,180,000
Value (@ 15x earnings): 602,700,000
Value per share: 0.70

If I add back non-cash expenses and deduct capex, the aquariums earned S$59.9mn and S$62.9 in pre-tax profit in 2018 and 2017, respectively. Using a 30% tax rate and a 15x multiple on cash flow, value per share of these operations would be S$0.73 and S$0.78 per share, respectively. 


Giant Observation Wheel & LCC
Singapore Flyer

The Singapore Flyer went through a myriad of issues before Straco bought it. It 75% was owned by the developer and the 25% was owned by Orient & Pacific Management. The project was formally announced in 2003 when the developer and the Singapore tourism board signed an agreement whereby the tourism board was to buy the land under which the observation wheel was going be built. The tourism board leased it to Singapore Flyer Pte Ltd for 30 years, with an option to renew. The wheel was supposed to be completed by 2005 but the developer ran into funding problems and by September of that year the project was revived after receiving S$240mn from two German banks. 

By then the shareholders were an investment vehicle headed by the chairman of the company (60%), the developer (30%) and Orient & Pacific (10%). Later in 2007, the chairman acquired the developer’s share as well thereby controlling the lion’s share. By 2013 the company went into receivership. Subsequently, it went into talks with Merlin Entertainment which eventually broke down. Straco ended up buying 90% of the wheel in 2014 for S$140mn, with the remaining being owned by WTS Leisure, a private bus company in Singapore.

The Singapore Flyer is a good business, but it was poorly managed since the beginning. A number of factors contributed to this, (i) tourism agencies were given generous discounts and very favorable credit terms (ii) operators were selling their tickets to walk-in visitors which they got at steep discounts. Besides tackling the issues laid out above, Straco made other changes like (i) bulk tickets were valid for 6 months, they cut it to 1 month and (ii) insurance coverage was secured at a lower premium. 

But that’s not all. The wheel – which is located in the Singapore Marina bay where the Formula One night race is held – has about 82,000 square feet of retail space. Existing rentals were paying 50% of the market rate and some tenants hadn’t paid rent for months. According to the latest annual report, the property is worth S$46mn, S$560 per square foot. It consists of a 3-storey terminal building and a 2-storey carpark. 

The observation wheel did S$5.0mn in pre-tax profit on revenue of S$31.9mn last year, despite being closed for 2 months due to technical issues. A normal year should probably look more like S$40mn in revenue, with about S$10mn in profits. With a little bit of margin for maintenance down-days it has capacity for ~2.7mn visitors every year, and I estimate it receives 1.2mn visitors annually, with an average ticket price of S$25. The London eye has 32 capsules (as opposed to Singapore Flyer’s 28) and has about 3.5mn visitors, with a ticket price of S$41. And unlike the aquariums in China, 80% of visitor to the Singapore wheel are foreigners.

Value of Wheel Operations (90% owned)

Revenue: 40,000,000
Pre-tax profit: 18,000,000
After-tax profit: 12,600,000
Value (@ 15x earnings): 189,000,000
Value per share: 0.22
Value to Group (90%): 0.20

If I add back non-cash expenses and deduct capex the wheel earned S$8.8mn and S$18.7 in pre-tax profit in 2018 and 2017, respectively. Using a 30% tax rate and a 15x multiple on cash flow, value per share of these operations would be S$0.11 and S$0.22 per share, respectively. The wheel is definitely closer to being worth S$0.22 a share, the S$0.11 masks that true earning potential of the wheel considering it was closed for two months in 2018.

LCC

The cable-car is Straco’s oldest asset, it opened to the public in 1993, but the least significant one to the company, bringing in 4% of pre-tax profit. It can take 1,200 passengers per hour, halfway up the Lintong Mountain, which is a 10min drive from the famous Terracotta’s Museum which had 2mn visitors in 2002. 

The number of visitors to the cable-car has increased over time and revenue has grown at 12.5% p.a. LCC’s original S$5.2mn investment paid off very well. Last year the cable-car brought in S$4.9mn in revenue and S$2.5mn in pre-tax profit. 

However, Straco has owned exclusive development rights to build replicas of major historical buildings since 2001, at the original site which is exactly where the cable-car leaves visitors. The project is estimated to cost about S$20mn. And yet only in 2018 did they finally obtain approval from the provincial government to begin construction. In the prospectus management talked about completing these buildings by the beginning of 2006. 

Management hoped with this project that (i) visitors to LCC would increase and (ii) price to LCC could double to include a visit to the palace. So, management assumed they could charge RMB 60 for a visit to the palace. A ticket to the Terracotta Warriors museum costs about RMB 120. I estimate, based on revenue numbers and ticket prices, that LCC has about 580 thousand visitors every year. If two in ten people who visit LCC pay an extra RMB 60 to see the palaces, I expect about S$1.3mn in extra revenue. 

Value of LCC (95% owned)

Revenue: 4,900,000
Pre-tax profit: 2,500,000
After-tax profit: 1,750,000
Value (@ 15x earnings): 26,250,000
Value per share: 0.03


If I add back non-cash expenses and deduct capex the cable-car earned S$1.7mn in pre-tax profit in 2018. Using a 30% tax rate and a 15x multiple on cash flow, value per share of these operations would be S$0.02.



Valuation

Looking at a business with a lot of non-cash expenses (depreciation and amortization) one should look at cash-flow adjusted for capex ("profit" from here on) rather than earnings. Telcos are always valued on cash flows because of the huge depreciable asset base. 

The company’s market cap is S$660mn, and S$165mn is in net cash. Normalized pre-tax profit might be something like S$77mn, S$73mn excluding non-controlling interests. . You can buy the company today for 7x normalized pre-tax profit, adjusted for cash. Or 11x last year's after-tax profit.

What are peers valued at? 


Revenue (in $000s)
Debt (in $000s)
Market Cap
Revenue Growth (5yr CAGR)
FCF Growth (5yr CAGR)
Price to FCF
Merlin Entertainment
1,688,000
1,300,000
3,870,000
5.8%
-11.42%
27
Six Flags
1,463,000
2,106,000
4,340,000
9.1%
4.0%
16
SeaWorld
1,372,290
1,540,184
2,530,000
-0.9%
-0.7%
16
Cedar Fair
1,349,000
1,663,193
2,800,000
3.1%
-4.9%
18
Straco
85,897
27,636
481,546
9.2%
8.4%
12


What multiple does Straco deserve? The key things to consider are the following; ~90% of pre-tax profit comes from two assets; Straco visitor growth seems to have some correlation to the tourism growth in Shanghai and number of tourists to Shanghai has increased at 5% p.a. over the last 4 years, so we’ll assume a 2% p.a. growth in Straco’s aquarium visitors; Straco will probably be able to increase prices on SOA tickets; and management has a good track record. 

Unlike the companies listed above, Straco is first-and-foremost much smaller and in a net cash position. It has also grown FCF by 16% p.a. since 2008. Straco was the company that grew FCF the quickest, and yet it’s median price-to-FCF was the lowest at 12x over the last 5 years. Straco also carried a lot less debt than similar peers, which grew revenues by taking on a lot of debt. Straco deserves a higher multiple than the average, but I also think those companies are quite expensive today. 

Really, the biggest risks to, in my opinion, are two fold. First, the group’s main assets, SOA and UWX, account for 90% of pre-tax profit. If another aquarium is built next to either one, particularly SOA - which accounts for 80% of aquarium revenues - it could have a serious impact on the company's earnings. However risky that is, I believe it's unlikely another aquarium is built close to SOA, considering it's located close to the financial center of Shanghai which is a highly built-up area. It’s also unlikely another aquarium would be allowed to be built in the Gulangyu island. The second risk would be operating leverage, which works both ways. The observation wheel, for example, was closed for two months and because of that it did S$8.8mn in earnings in 2018 versus S$18.7mn in 2017. 

The Chinese tourism industry has grown a lot, partially driven by household consumption growing at 10.9% p.a., and today the proportion of urban households in terms of the total is 58%. A dramatic change from 1990 when 75% of all households were rural households. There are many reasons to believe why the number of tourists visiting China will increase over time, both foreign and domestic, and Straco will be there to take advantage of that. Disneyland, for example, will attract a lot of Chinese people eager to experience the park.

Taking the balance sheet, the track-record, the risks and the fact that over 70% of the company's revenue comes from one aquarium - which is in a very good, highly-built up, location, improving the likelihood of sustained earning power - I would say that Straco is worth at least 15x profit. 

Normalized after-tax profit is around S$54mn, which multiplied by 15 equals S$810mn. Add in S$165mn in net cash and you’ve got S$975mn. ~50% higher than today’s prices. 

Assuming the current run-rate in visitors and earnings, 5mn visitors and about S$50mn in cash earnings per year, in 3 years there's another S$250mn in cash. ~50% would be distributed to shareholders. So, in 5 years you'll have ~S$125mn worth of special dividends, plus another S$125mn on the balance sheet. Net cash on the balance sheet would be S$290mn. 

Adjusted for the special dividend and the net cash on the balance sheet in 5 years, today you can buy the company for <4.9x 2022E. 


[Note: I had previously talked about Straco's ability to increase the nÂș of visitors to aquariums quite significantly - basing my capacity expectations for aquariums on management's estimate of the number of people the aquarium could hold. However, after sharing the idea with another investor and a more thorough look at reviews, there doesn't seem to be much room to expand the number of visitors. This is further confirmed by looking at visitors per sq. m., which are quite high at SOA and around average for UWX.]