Saturday, January 12, 2013

Subcontinent Consumer with a Margin of Safety

I recently attended a McKinsey & Company presentation on the "Five Global Forces of Innovation" that will drive the global economy for the next several decades.  One of the five forces is what they call "the great rebalancing", essentially how the emerging economies will catch up to developed economies, especially with respect to the creation of a consumer driven middle class.  This isn't a new or groundbreaking concept, as it's been forecasted for many years, however it's a great long-term trend to keep in mind when searching for investing opportunities.

With that backdrop in mind, Retail Holdings NV ("ReHo") presents a compelling emerging market investment opportunity with a reasonable margin of safety and a potential liquidation catalyst.  Retail Holdings NV is a holding company incorporated in Curacao with no operating activities and three main assets:
  1. 56.13% equity interest in Singer Asia Limited
  2. Seller notes, arising from the sale of the Singer worldwide sewing business and trademark in 2004
  3. Cash and cash equivalents at the holding company level with no external debt outstanding
Below is an excerpt from the 2011 Annual Report which outlines how the management thinks of the value of Retail Holdings:
"The Company's net asset value at December 21, 2011, attributable to ReHo Shareholders, was $87.6 million, equivalent to $16.51 per Share outstanding.  This essentially reflects the book value of the Company's investment in Singer Asia, the notional amount of the SVP Notes and the cash at the ReHo holding companies.  Using the $157.1 million Market Valuation for Singer Asia attributable to the ReHo shareholders, the $26.8 million notional value amount of the SVP Notes, and the $2.9 million in cash at the ReHo holding companies, the corresponding figure would be approximately $186.8 million, equivalent to $35.20 per Share.  There can be no assurance that the Company's shareholders will ever realize either the $16.51 per Share or the $35.20 per Share amounts given the substantial contingencies and uncertainties"
With that valuation framework, I'll dive a little deeper into Singer Asia and the SVP Notes.

Singer Asia Limited
Retail Holdings' main asset is a 56.13% equity stake in Singer Asia Limited.  Singer Asia Limited has ownership stakes in 5 separate publicly traded consumer durable product companies located in Bangladesh, India, Pakistan, Sri Lanka, and Thailand.  The Singer brand name is most highly associated with sewing machines, and in 2004 Retail Holdings sold the trademark and sewing machine business to SVP (fka KSIN Holdings), more on this transaction later.  Singer Asia, through its subsidiaries, now is a premier seller of consumer products (think washing machines, refrigerators, televisions) for the home, and as the emerging middle class continues to desire home conveniences of developed market consumers, Singer should be positioned capture a good amount of this long-term growth trend.  

Singer Asia's major subsidiaries are all publicly traded in their respective countries, providing easy assistance in valuing each:

The value to Singer Asia comes out to $240.55 million, with Retail Holding's 56.13% ownership of Singer Asia coming out to $135.02 million (or more than 20% above the current market capitalization alone).  In a sense the value of these underlying publicly traded companies is hidden like a Russian nested doll, with the 5 publicly traded companies partially nested within Singer Asia, and then Singer Asia partially nested with Retail Holdings. 

SVP Notes
In September 2004, Retail Holdings sold the Singer sewing business and trademark to SVP Holdings ("SVP", fka KSIN Holdings) for $65.1 million in cash, and $22.5 million of unsecured notes ("SVP Notes") which it still holds.  The question is how much are the SVP Notes currently worth?

During the 2008 bear market, SVP's operations were negatively impacted by the economic downturn resulting in an Event of Default in October 2009.  SVP cured the Event of Default in May 2010, and is now current on the notes.  As a result of the default, the interest rate on the notes increased from 10.0% to 12.0%, with minimum cash interest payments of 7% with the remaining being capitalized.  SVP has elected to pay these minimum cash interest payments since the Event of Default, and has capitalized the remainder.  These notes are clearly still distressed and unlikely to be equal to par.

In the June 30th semi-annual report, Retail Holdings disclosed they had made the following transaction with SVP:
"In June 2012, as part of an increase and extension of the financing facilities at SVP, ReHo agreed to extend the maturity of the SVP Notes from February 2014 to September 2018.  The interest rate on the SVP Notes remains at 12% with a minimum cash interest payment of 7% of the outstanding principal.  Concurrent with the refinancing, SVP made a cash payment to ReHo of USD 5,000 thousand in consideration of a reduction in the principal amount of the SVP Notes by USD 5,882 thousand, representing a 15% discount to notional value."
This transaction reduced the principal value of the remaining SVP notes to $21.598 million.  While extending the maturity hopefully gives SVP enough runway to eventually make good on the entire amount, the 15% discount is a reasonable benchmark of the current value of the SVP notes.  

Adding together Retail Holdings three primary assets:
  1. Singer Asia Limited = $135.02 million
  2. SVP Notes (discounted 15%) = $18.36 million
  3. Cash at the holding company level = $9.8 million (per the June 30, 2012 report)
Totaling three up yields an NAV of $163.18 million (or $30.74 per share), representing a 31% discount to the current market capitalization of $112.38 million.  

Medium-Term Liquidation 
If the discount to NAV and long term trend of the emerging middle class aren't enough, there's also the potential hard catalyst of the liquidation of the company.
"ReHo's strategy is to maximize and monetize the value of its assets, with the medium-term objective of liquidating the Company and distributing the resulting funds and any remaining assets to its shareholders."
Besides owning roughly 25% of the shares outstanding, CEO Stephan Goodman also has a special bonus in place to liquidate the company:
"ReHo has put in place a special bonus program for the Company's Chief Executive Officer which provides a cash award following the liquidation, dilution, wind-up, merger or sale of the Company, in the event that aggregate dividends and distributions to shareholders, including any final dividend or distribution, exceed a certain threshold amount."
Retail Holdings has economic trends at its back, a significant discount to NAV, and a potential value realization catalyst of a liquidation.  What's not to like?

Disclosure:  No current position, but will likely add shortly.

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