In a previous article, I wrote about the Timberland case study, one of the two detailed case studies of Li Lu's early investments that he shared during his 2006 lecture at Bruce Greenwald's Value Investing Course at Columbia University.
The other investment case Li discussed in depth was his investment in a South Korean listed company called Hyundai Department Store H&S (which nowadays trades under (XKRX:069960, Financial)).
Idea generation
Li came across Hyundai Department Store H&S while reading the Standard & Poor's manual for Korean stocks.
Is it cheap?
The company had pre-tax earnings of $31 million and was trading at a market cap of $60 million, or roughly two times pre-tax earnings. The manual also included the following interesting observation:
"Sales slightly increased and the operating result was stable. Increasing number of Korean tourists going abroad helped improve the result of travel business division. Operating income remains low under the low margin business structure. But the stock investment holdings show strong performance, which leads to strong equity method gain and ordinary income. Hyundai Department Store and Hyundai Home Shopping both have higher market capitalization than the company. The financial structure is in a good shape based on rising asset value of lease real estate."
Business prospects
The manual describes the prospects of the business as the follows:
"Low growth prospects for corporate business. But 60-70% of the corporate sales is generated within the Hyundai group, which guarantees steady profits based on fixed customers. Possible gains from the investment shares of the SOs. Strong results of Hyundai Department Store and Hyundai Home, Shopping and rising asset value of lease real estate stand out. Expected to maintain excellent financial stability. Posesses ample cash equivalent without any borrowing. The value of assets including shares of Hyundai Department Stores and Hyundai Home Shopping is also good."
What's in the book?
The company had a book value of $230 million to $240 million, of which $180 million were fixed assets. It also had $70 million in current assets, which was basically all cash. Included in the $180 million in fixed assets was a wholly owned hotel, recorded at $30 million on the book. The company also owned 13% of a department store recorded on book at $30 million. The department store was also listed and included in the manual. Li looked up the value of the department store and found out that it had a market cap of roughly $600 million. So the company's 13% ownership in the department store was worth roughly $80 million but recorded on the balance sheet at only $30 million – an undervaluation of $50 million. On top of the hotel and department store, the company owned three cable companies, including the second largest cable company in Korea. It also had some other real estate assets.
Is it a good business?
The company's return on equity was 14.6%, not great but decent. It doesn't take inventory and operates like a hotel or a shopping mall. They take rents based on the top line of merchant sales. It was unlikely to grow very fast but was very stable because more than half of the revenue was almost guaranteed from a related party. Again, it was not a fabulous business but a good enough one.
Field research
Li then went to South Korea and visited the company and its properties. He found that they were centrally located and looked upscale. He also inquired about recent similar commercial real estate transactions in the area and concluded that the assets on the book were worth at least three to four times recorded book value.
Putting it all together
This is a company that was trading at two times pre-tax earnings. Earnings were stable. Book value of the assets was significantly below market value. By paying $60 million, Li got $30 million pre-tax income and $320 million worth of assets. Insiders owned 50% of the company.
After all the work, he bet big on the company. The stock was at trading at 12 Korean won ($0.01) per share and shot up to â‚©70 per share within a year and half.
Read more here:
- Case Study: Li Lu's Investment in Timberland
- Hillhouse's Zhang Lei - Be a Friend of Time Part 5
- Hillhouse's Zhang Lei: Be a Friend of Time - Part 4
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