Heller House Capital’s investment thesis on Keck Seng.
High quality real estate assets, fortress balance sheet, management with a history of value creation, and an incredibly cheap valuation under any metric. Reasonable market multiples would result in a stock three times the current price.
Executive Summary of Valuation Discrepancy
Keck Seng (“KS”) owns the W San Francisco and the Sofitel in Midtown Manhattan, both exceptionally well located, prime assets. In addition, it also owns 1.2 million square feet of hotels in Canada, Vietnam, China and Japan, and residential and commercial properties in Macau and Singapore.
The current stock price implies the following:
- A 24% cap rate; applying an 8.1% cap rate would result in a stock price 216% higher1
- Paying for the U.S. properties and getting all 1.2 million square feet outside of the U.S., net of all liabilities, for free
- A price to net asset value multiple of 0.3x (based on an asset by asset mark-to-market valuation), implying a potential triple if the shares traded at NAV
- A price to free cash flow of only 8.9x and a price to earnings multiple of 8.5x.2
Typically, we only find these types of securities if (a) the assets are of poor quality (b) the assets have substantial debt encumbering them or (c) the cash flows are declining. In KS’s case, none of these factors is true. In fact, the assets are of high quality, the balance sheet is fortress-like with a loan-to-value ratio of only 2.5%3, and free cash flows are growing at an attractive rate.4 Furthermore, KS’s controlling shareholders have a history of value creation, growing book value consistently over the past fifteen years. As a result, KS qualifies as an attractive, growing, safe investment with enormous potential upside.
In this report, we will walk through each asset owned by KS, and demonstrate the gap between the current stock price and our estimate of intrinsic value. But first, below is a snapshot of Keck Seng’s book value per share as reported on a GAAP basis (blue bars) and its current share price. The stock is cheap on that basis, with book value at HKD 10.1 and a stock price of HKD 5.75.
However, an asset by asset analysis reveals a substantially higher net asset value. This stems from Keck Seng’s accounting policies, which account for properties at cost, with the exception of a small fraction of the portfolio which is marked to market every year. Marking KS’s entire portfolio to market would result in a net asset value 3x greater than the current share price.
Assets owned by Keck Seng
Before delving into an asset-by asset valuation, below is a bridge to net asset value showing the various components of KS’s NAV:
Keck Seng owns two hotels in the U.S.: the Sofitel NY in midtown Manhattan, and the W San Francisco in SoMa. Both hotels are 100% owned by KS.
The Sofitel is KS’s newest asset, having been acquired in August 2014. It is very well located, on West 44th Street between 5th and 6th Ave:
KS paid a 5.1% cap rate on 2013 NOI for the Sofitel. This is not a bargain purchase like other acquisitions KS has made in the past. However, we believe that the superior location and quality of this asset will allow the company to enjoy an adequate return over what it expects to be a long-term holding period.
At the time of acquisition, KS financed part of the purchase through a mortgage, representing a conservative 29% loan-to-value ratio on that property.
Summary financials and acquisition numbers for the Sofitel:
Because the Sofitel is now lumped together with the W San Francisco and reported in the U.S. segment, we no longer have broken out financials post-acquisition. Here are the acquisition metrics for the Sofitel:
RevPAR for this hotel was down 3.6% in 2015 versus the prior year, on higher occupancy (88.1% vs. 86.8%) and lower ADR ($366.30 vs. $385.70). KS is reportedly in negotiations with Sofitel to invest in a renovation of the hotel, with the aim of increasing the daily rates charged by the hotel.
The W San Francisco was acquired in 2009 from an overleveraged Starwood. The deal had been in the works for a year, and after the market began recovering, Starwood tried to back out of it but the sale and purchase agreement had already been signed.
The purchase price was $90 million, representing a 15.1% cap rate on 2008 NOI. Since then, NOI has recovered and grown alongside RevPAR:
The hotel is very well located, in the SoMa (South of Market Street) section of San Francisco, across the street from the Moscone Center, a 700,000 square foot convention center which frequently hosts well-known events for the tech industry such as the Google I/O and Apple Developers Conference. The center is undergoing a $500 million expansion that aims to increase meeting space by an additional 305,000 square feet. The center is so popular and hotel space so constrained, that Salesforce was exploring the option of renting a cruise ship to provide additional accommodations for convention participants.
How much are the Sofitel NY and the W San Francisco worth? Based on recent comparable acquisitions of hotels in the upper scale tier, but below full luxury hotels, we believe that an appropriate valuation is a cap rate of 6.5% on 2015 NOI67. We apportion this based on the room split, resulting in HKD 4.76 per share for the W and HKD 4.69 per share for the Sofitel. This split is arbitrary, since we don’t have more granular NOI numbers for each hotel. The total should be roughly in line with market values.
Below is a sensitivity analysis showing what these hotels might be worth using different cap rate assumptions (values in HKD ‘000 except per share amounts):
See full PDF below.