Retail Holdings (RHDGF)

Retail Holdings (ReHo) is an investment holding company with three assets:

• A 54.1% equity interest in Singer Asia with a combined market value of USD 133.2 m
• Seller notes with a value of USD 19.3 m
• A cash balance of USD 6.5 m

The management’s stated goal is to sale the company’s assets and to distribute the proceeds to shareholders over the foreseeable future.

Singer Asia

Singer Asia has been operating in South Asia since 1851. The company is a retail holding with subsidiaries in Sri Lanka (45.7% of combined sales revenue) Bangladesh (18.9%), India (7.7%), Pakistan (6.2%), and an affiliated company in Thailand (21.1%). These retail businesses sell a wide variety of consumer durable products. In addition they provide consumer credit and other financial services to customers. In these markets, Singer Asia operates nationwide chains of retail stores, supplemented by a network of wholesale dealers. In Bangladesh, Pakistan and Sri Lanka, Singer Asia is the number one retailer of durables for the home with the largest number of stores. Based on a full consolidation of all subsidiaries the company generated USD 435.9 m in revenue and a net profit of USD 26.5 m in 2012. The company has a manageable net debt to EBITDA ratio of 2.4x. Most of their debt is short term and related to their consumer finance business (see below).

The range of products varies by location, but all of the retail businesses offer a core range of home appliances and consumer electronics. Most of the products sold are sourced from Asian third party manufacturers. In some cases, where there are local efficiencies or tax or duty incentives, manufacture or assembly of certain products is carried out by the local operating company. In addition, based on the company’s information certain products and raw materials need to be purchased from international third-party suppliers in USD. As a consequence, though the company will try to recover part of the increased cost by increasing product prices, unfavourable exchange movements have a negative impact on profitability.

As a retailer of products that generally require electricity, Singer Asia profits from an increase in electrification in their markets. For instance, in Bangladesh access to electricity increased from 39.8% in 2004 to 56.6% of the population in 2011, according to the Bangladesh Bureau of Statistics.

The company is also a provider of non-automotive, non-home purchase, consumer credit to middle- and lower-income consumers in Bangladesh, Pakistan, Sri Lanka and Thailand. As of December 2012 they had a total of 708,040 active instalment accounts and an instalment accounts receivable of USD 206.9 m. The average instalment amounted to USD 292.2. Instalments have a maturity of 3 to 36 months. Credit sales create higher margins than cash sales. Hence, this segment is of high importance to Singer Asia. 50.1% of Singer Asia’s sales during 2012 were on credit. Finance charges on consumer instalments alone represented approximately 11.9% of the company’s total revenue in 2012. In addition, customers who purchase products on credit often make regular visits to Singer Asia’s stores to pay monthly instalments. This increases customer traffic in the stores and provides the company with the opportunity to showcase new products to existing clients.  So far the company’s collection experience has been good and improved substantially over the last years. As of December 2012 the percentage of instalment receivables in arrears was only 2.6%.

The table below provides an overview of the consumer credit performance:

Based on the company’s information, Singer Asia’s debt is subject to floating rates in the local markets, whereas the financial earnings from consumer credit agreements with their customers are at fixed rates. As a consequence, increasing borrowing costs will negatively impact the company’s profitability as Singer Asia does not hedge its interest rate risk. Management states, that a 100bps increase in interest rates would decrease net profit by 9.0%. So this is clearly a substantial risk for the company’s future performance. The company currently has entered into loan facilities with 44 financial institutions leading to a diversified source of funding. Borrowings are denominated in the local currencies in each country of operation.

The table below provides an overview of operational data for the last three years:

Singer Asia owns 88 stores. The rest is short term leased. The company is using a multi-channel distribution network with retail stores (61.0% of sales revenue), wholesale (20.9%) and direct selling (18.1%). In addition, the company is currently starting its e-commerce activities. Given the high number of Sri Lankan, Bangladeshi and Pakistani workers in various parts of the world, the company also intends to launch a new web-based service in 2014 to enable them to make purchases while overseas and have the products delivered to their families at home.

Singer Asia has a royalty bearing license to the owner of the Singer trademark, allowing the company to use the Singer name. The royalty paid to the owner is set at 1.0% of Singer Asia’s consolidated revenue. The royalty paid was USD 3.4 m in 2012. Based on my understanding this royalty is directly paid by Singer Asia and not its subsidiaries. Singer Asia, in turn, has entered into royalty bearing license arrangements with third-party licensees in Malaysia and Australia. The company were paid USD 1.2 m in 2012 leading to a net payment of USD 2.2 m.

Except from a small investment in an Indian company (Brand Trading), all of Singer Asia’s subsidiaries/affiliated companies are listed on their local stock exchanges. The table below presents the current market values of Singer Asia’s holdings:

ReHo is currently holding 55.9% in in Singer Asia. Apart from that, UCL Asia Partners, a private equity Fund, owns 42.5% and 1.6% is owned by Singer Asia’s CEO, Gavin Walker, reflecting the exercise of a portion of his options. Should he exercise all of his options, his equity stake in Singer Asia would increase to approximately 4.8%, the ReHo shareholding would decline to approximately 54.1% and the Fund’s stake would decline to approximately 41.1%. As a consequence, I suppose a 54.1% shareholding for ReHo.

Based on a 54.1% share in Singer Asia, the market value of ReHo’s stake is USD 141.5 m. Based on ReHo’s information there is no outstanding debt at Singer Asia or ReHo.

However, we also have to consider the royalty payments for the Singer trade mark. To keep it simple, I have chosen the following approach: net royalty payments make up approx. 5.8% of Singer Asia’s EBT on a fully consolidated basis. Hence, I assume that the equity value of the subsidiaries/affiliated companies would decrease by 5.8%, if they had to pay the royalties by themselves. This leads to an adjusted market value of ReHo’s holding in Singer Asia of USD 133.2 m (USD 141.5 m x (1-0.058).

ReHo is currently working on monetizing the investment in Singer Asia, either through a listing and subsequent sale of the shares or through a private sale of the company. Lately, Singer Asia through its intermediary holding company, Sweco Holdings, planned an IPO in Singapore, but this has not been successful so far . There is a preliminary IPO prospectus available providing very good information about the company.

Seller Notes

In September 2004, ReHo completed the sale of the Singer worldwide sewing business and of the ownership of the Singer trademark to SVP Holdings (SVP) a subsidiary of KKR, the private equity firm. The total consideration consisted of approximately USD 65.1 m in cash, USD 22.5 m of unsecured, subordinated, promissory notes and the pay off of approximately USD 47.0 m of debt. Hence, Singer Asia’s royalty bearing license for the use of the Singer trademark stems from this transaction.

There have been some issues with the solvency of SVP in the past as management outlines in the 2012 annual report:

“In 2009, as a result primarily of the economic downturn and its impact on the worldwide sewing market, SVP defaulted with respect to certain financial covenants in its principal credit agreement. Consequently, an event of cross-default occurred with respect to the SVP Notes. However, in May 2010, following and as a result of amendments of the respective credit agreements, SVP cured all outstanding defaults with respect to the credit agreements and paid ReHo all past due interest curing the default with respect to the Notes. At that time, in consideration for an extension of maturity of the Notes from October 2010 (for one third of repayment) and October 2011 (for the balance of the principal) to February 2014 (for all of the principal), SVP agreed to an increase in the interest rate on the Notes from 10.0% to 11.0%, effective October 2010, and from 11.0% to 12.0%, effective October 2011. For the period from October 2010 to maturity date, SVP has the option of paying biannually at least approximately 58% of the interest in cash, respectively, and accruing the unpaid portion of the interest, with the accrued interest being subject to interest charges as mentioned above and payable at maturity along with the principal. Improvements in SVP’s operating performance in 2010 and 2011 enabled SVP, in June 2012, to successfully restructure its debt obligations. To provide additional liquidity to facilitate growth, the size of the overall facilities were increased, while maturities were extended from 2013/2014 to 2017/2018. Reflecting improvements in operating performance, SVP’s increased financial flexibility, and the extension in the maturity of SVP’s senior debt, ReHo agreed, in June 2012, to extend the maturity of the Notes from February 2014 to September 2018, without any increase in the interest rate. The interest rate on the Notes remains at 12.0%. … SVP is current in all of its obligations to the Company. For the June and December 2012 and June and December 2011 interest payments, SVP elected to make the minimum cash interest payments and to accrete the balance of the interest due.”

This agreement clearly contradicts with the management’s strategy to sale ReHo’s assets and to liquidate the company in the foreseeable future. As maturity has been extended from 2014 to 2018, a potential liquidation of the entire company in the near term has become unlikely. An earlier exit from this investment will be possible, if KKR decides to sell SVP, which requires redemption of the notes. As there is no established market for the SVP Notes, a disposition of the notes to a third party seems to be unlikely.

From an economic perspective the restructuring did not lead to an improved position for ReHo compared to the original terms of the notes. Given the risk implied, a 12% interest rate of which up to 42% can be paid in kind for a 5 year maturity seems to be rather low. On the contrary, there is no foreign exchange risk to this investment. In addition, based on the company’s information SVP seems to have recovered from the downturn and strengthened its capital structure which has increased the probability of a repayment in 2018.

Concurrent with the restructuring, in 2012 SVP made a cash payment to ReHo of USD 5.0 m in consideration for a reduction in the outstanding principal amount of the Notes by USD 5.9 m, representing a 15.0% discount to notional value. I will make use of this transaction to value the outstanding notes. Principal on the SVP Notes as of June 30, 2013 was $22.7 m. Based on a 15% discount the value of the outstanding notes is USD 19.3 m.

Valuation

ReHo has currently approx. 5.3 m shares outstanding. I came up with a market value for ReHo’s share in Singer Asia of USD 133.2 m or USD 25.16 per share. In addition, a value of USD 19.3 m for the SPV Notes translates into USD 3.64 per share. Last but not least the company has USD 6.5 m in cash or USD 1.23 per share. This leads to a NAV of USD 30.03 per share. At a current price of USD 19.25 the share is offering a 56% discount to NAV.

Conclusion

From my perspective chances are good that ReHo will realize an IPO of Singer Asia over the next couple of years. The business profits from a rising middle class in its markets and has performed very well so far. In addition, Singer Asia’s CEO is highly incentivized to get the company listed on the stock exchange as he will eventually hold 4.8% of the share capital before any capital increase due to the IPO. However, rising interest rates increasing inflation and weak currencies in Singer Asia’s markets present a high risk to the company’s future performance. During the last twelve months the currencies of Singer Asia’s markets have already lost substantially against the USD leading to higher import prices for raw materials and consumer goods. A more restrictive monetary policy of the Fed and ECB could intensify this development in the emerging markets leading to a prolonged economic downturn.

The Seller Notes coming from the sale of the Singer worldwide sewing business to KKR in 2004 should have a better risk return profile. In addition, it is a bit disappointing that the management was not able to re-negotiate a shorter maturity given their stated goal to liquidate the company. Nevertheless, SVP was able to repay approx. 20% of the notional in 2012 and seems to make progress in its operating activities. Apart from that, the notes only represent approx. 12% of NAV.

Overall, I believe that ReHo’s stock price is currently trading at a large discount to NAV due to potential economic risks in Singer Asia’s markets. The fact that the company is only quoted on the OTC market and lacks high liquidity is also playing a major role. However, based on my analysis, Singer Asia has a relatively high quality business model and a strong position in its markets.

I regard the current discount to NAV as to high. Over the long term I believe that management will be able to liquidate the company and to provide cash payments to shareholders substantially above the current share price. Therefore, I will establish a 3% position for the portfolio with a share price limit of USD 20.0. Liquidity is very low and it might take approx. 33 trading days to build the position assuming Wertart Capital trades one third of daily volume. Please click here for more information on WertArt Capital and the virtual portfolio.

Disclaimer

The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always do your own research!