Keck Seng Investments - Heller House Investment Memo - 4-7-16

8/18/2019 Keck Seng Investments - Heller House Investment Memo - 4-7-16

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Heller House Opportunity Fund, L.P.

1111 Brickell Ave, Suite 2135 hellerhs.com 2Miami, FL 33131

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 KS

Before delving into an asset-by asset valuation, below is a bridge to net asset value showing thevarious components of KS’s NAV:


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U.S. Hotels

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.

Sofitel NY

https://www.tripadvisor.com/Hotel_Review-g60763-d208454-Reviews-Sofitel_New_York-

New_York_City_New_York.html

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:

https://www.tripadvisor.com/Hotel_Review-g60763-d208454-Reviews-Sofitel_New_York-New_York_City_New_York.htmlhttps://www.tripadvisor.com/Hotel_Review-g60763-d208454-Reviews-Sofitel_New_York-New_York_City_New_York.htmlhttps://www.tripadvisor.com/Hotel_Review-g60763-d208454-Reviews-Sofitel_New_York-New_York_City_New_York.htmlhttps://www.tripadvisor.com/Hotel_Review-g60763-d208454-Reviews-Sofitel_New_York-New_York_City_New_York.htmlhttps://www.tripadvisor.com/Hotel_Review-g60763-d208454-Reviews-Sofitel_New_York-New_York_City_New_York.html


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Bryant Park

New York Public Library


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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:

6M 6M

U.S. '000 2011 2012 2013 2013 2014

Hotel revenue

Room $ 45,433 $46,686 $49,030 $ 22,200 $ 22,087

Food and beverage 8,106 8,424 10,016 4,792 4,611

Others 1,745 1,596 1,449 684 693

55,284 56,706 60,495 27,676 27,391

Hotel expenses

Room 12,744 13,157 14,011 6,754 6,989

Food and beverage 8,621 9,384 9,875 4,777 4,927

Others 1,180 1,216 1,300 613 633

22,545 23,757 25,186 12,144 12,549

Other operating expenses 16,614 17,364 17,722 8,671 8,844Marketing and selling expenses 3,488 3,800 4,088 1,982 1,993

NOI 12,637 11,785 13,499 4,879 4,005

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:

Price paid (USD) $265,000,000Rooms 398

$/key $665,829$/square foot $901Acquisition cap rate on 2013 NOI 5.1%

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.


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W San Francisco

https://www.tripadvisor.com/Hotel_Review-g60713-d81669-Reviews-W_San_Francisco-

San_Francisco_California.html

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 hostswell-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.5

5 http://www.ktvu.com/news/4669886-story

https://www.tripadvisor.com/Hotel_Review-g60713-d81669-Reviews-W_San_Francisco-San_Francisco_California.htmlhttps://www.tripadvisor.com/Hotel_Review-g60713-d81669-Reviews-W_San_Francisco-San_Francisco_California.htmlhttps://www.tripadvisor.com/Hotel_Review-g60713-d81669-Reviews-W_San_Francisco-San_Francisco_California.htmlhttp://www.ktvu.com/news/4669886-storyhttp://www.ktvu.com/news/4669886-storyhttp://www.ktvu.com/news/4669886-storyhttp://www.ktvu.com/news/4669886-storyhttps://www.tripadvisor.com/Hotel_Review-g60713-d81669-Reviews-W_San_Francisco-San_Francisco_California.htmlhttps://www.tripadvisor.com/Hotel_Review-g60713-d81669-Reviews-W_San_Francisco-San_Francisco_California.html


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Moscone Center

Moscone Center West


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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):

2015 NOI 209,048

Cap rate 6.0% 6.5% 7.0% 7.5% 8.0%Value 3,484,133 3,216,123 2,986,400 2,787,307 2,613,100

Per share:

W San Francisco HKD 5.2 4.8 4.4 4.1 3.9

Sofitel NY 5.1 4.7 4.4 4.1 3.8

Total 10.2 9.5 8.8 8.2 7.7

6 This is a recent deal for various hotels in Manhattan at a 5.4% cap rate:http://www.snl.com/Cache/1001206551.PDF?Y=&O=PDF&D=&FID=1001206551&T=&IID=4019891 7 JLL’s Q4 2015 survey shows New York cap rates at 6.0% and San Francisco at 5.9%:http://www.us.jll.com/united-states/en-us/Research/US-Investment-Outlook-Lodging-Q4-2015-JLL.pdf?dccf6024-e4e8-4930-836f-4444ffd28396 “Among the 14 major U.S. markets surveyed, Boston andSan Francisco are the only markets for which cap rates are not anticipated to increase according to themajority of investors surveyed, as both markets benefit from robust demand dynamics as well asexceptionally high barriers to entry.” See p. 5.

http://www.snl.com/Cache/1001206551.PDF?Y=&O=PDF&D=&FID=1001206551&T=&IID=4019891http://www.snl.com/Cache/1001206551.PDF?Y=&O=PDF&D=&FID=1001206551&T=&IID=4019891http://www.us.jll.com/united-states/en-us/Research/US-Investment-Outlook-Lodging-Q4-2015-JLL.pdf?dccf6024-e4e8-4930-836f-4444ffd28396http://www.us.jll.com/united-states/en-us/Research/US-Investment-Outlook-Lodging-Q4-2015-JLL.pdf?dccf6024-e4e8-4930-836f-4444ffd28396http://www.us.jll.com/united-states/en-us/Research/US-Investment-Outlook-Lodging-Q4-2015-JLL.pdf?dccf6024-e4e8-4930-836f-4444ffd28396http://www.us.jll.com/united-states/en-us/Research/US-Investment-Outlook-Lodging-Q4-2015-JLL.pdf?dccf6024-e4e8-4930-836f-4444ffd28396http://www.us.jll.com/united-states/en-us/Research/US-Investment-Outlook-Lodging-Q4-2015-JLL.pdf?dccf6024-e4e8-4930-836f-4444ffd28396http://www.snl.com/Cache/1001206551.PDF?Y=&O=PDF&D=&FID=1001206551&T=&IID=4019891


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Vietnam Hotels

KS owns two adjacent hotels in Vietnam, the

Sheraton Saigon Hotel & Towers and the

Caravelle Hotel. Both were acquired before

2002. The Sheraton Saigon is 64.12% owned

by KS, while the ownership stake in the

Caravelle is 25%.

These hotels are unusually profitable due to a

combination of very low labor costs, low

capital expenditure requirements (historicalcapex as a percentage of sales have been well

below 2%), and a high contribution from slot

machine revenues. As a result, these hotels

have very high EBITDA margins (33-36% for

the Sheraton, compared with margins in the

low 20s for the U.S. hotels, for instance) and

Sheraton Saigon

Caravelle

Caravelle


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generate substantial free cash flow to the group. Both hotels are well regarded and garner good

reviews from guests:

Sheraton

https://www.tripadvisor.com/Hotel_Review-g293925-d304523-Reviews-

Sheraton_Saigon_Hotel_Towers-Ho_Chi_Minh_City.html

Caravelle

https://www.tripadvisor.com/Hotel_Review-g293925-d306255-Reviews-Caravelle_Saigon-

Ho_Chi_Minh_City.html

In the latest annual report, KS attributes the occupancy decline at the Caravelle to renovations, offset

by higher rates.

How do we value KS’s Vietnam hotels? The only data point we were able to find on cap rates in this

market report pointed to a cap rate of 9% in mid-2014:8

8 http://www.us.jll.com/united-states/en-us/Research/JLL_Hotel_Investor_Sentiment_Survey_June_2014.pdf

https://www.tripadvisor.com/Hotel_Review-g293925-d304523-Reviews-Sheraton_Saigon_Hotel_Towers-Ho_Chi_Minh_City.htmlhttps://www.tripadvisor.com/Hotel_Review-g293925-d304523-Reviews-Sheraton_Saigon_Hotel_Towers-Ho_Chi_Minh_City.htmlhttps://www.tripadvisor.com/Hotel_Review-g293925-d304523-Reviews-Sheraton_Saigon_Hotel_Towers-Ho_Chi_Minh_City.htmlhttps://www.tripadvisor.com/Hotel_Review-g293925-d306255-Reviews-Caravelle_Saigon-Ho_Chi_Minh_City.htmlhttps://www.tripadvisor.com/Hotel_Review-g293925-d306255-Reviews-Caravelle_Saigon-Ho_Chi_Minh_City.htmlhttps://www.tripadvisor.com/Hotel_Review-g293925-d306255-Reviews-Caravelle_Saigon-Ho_Chi_Minh_City.htmlhttp://www.us.jll.com/united-states/en-us/Research/JLL_Hotel_Investor_Sentiment_Survey_June_2014.pdfhttp://www.us.jll.com/united-states/en-us/Research/JLL_Hotel_Investor_Sentiment_Survey_June_2014.pdfhttp://www.us.jll.com/united-states/en-us/Research/JLL_Hotel_Investor_Sentiment_Survey_June_2014.pdfhttp://www.us.jll.com/united-states/en-us/Research/JLL_Hotel_Investor_Sentiment_Survey_June_2014.pdfhttps://www.tripadvisor.com/Hotel_Review-g293925-d306255-Reviews-Caravelle_Saigon-Ho_Chi_Minh_City.htmlhttps://www.tripadvisor.com/Hotel_Review-g293925-d306255-Reviews-Caravelle_Saigon-Ho_Chi_Minh_City.htmlhttps://www.tripadvisor.com/Hotel_Review-g293925-d304523-Reviews-Sheraton_Saigon_Hotel_Towers-Ho_Chi_Minh_City.htmlhttps://www.tripadvisor.com/Hotel_Review-g293925-d304523-Reviews-Sheraton_Saigon_Hotel_Towers-Ho_Chi_Minh_City.html


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For conservatism, we use the average of 10x free cash flow and a 9% cap rate for the Sheraton, which

is equivalent to a 11.2% cap rate on 2015 NOI.

This 11.2% cap rate equals a P/E multiple of 13x for the Sheraton; so we apply a similar multiple to

KS’s share of profits from the Caravelle to arrive at the value of the Caravelle that accrues to KS.

The result is a contribution to net asset value of HKD 3.71 per share for the Sheraton and 0.45 per

share for the Caravelle. We believe this valuation is conservative given the high cap rate used.

Canada Hotels

KS owns two hotels in Canada: the International Plaza Hotel adjacent to the Toronto airport, and the

Sheraton Ottawa Hotel. The stake in the International Plaza is 25%, while the Sheraton is 50% ownedby KS.

The Toronto airport market is lousy, and the hotel loses money on a GAAP basis. Our understanding

is that KS is pursuing a rebranding of this hotel with a view to selling it (the hotel was branded

Doubletree by Hilton until 2013, but the flag was abandoned due to expensive renovation

requirements). We value this hotel at only $50,000 / key, or $48 per square foot, which we believe is


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appropriately conservative. At this valuation, this hotel contributes only 0.12 per share to net asset

value.


International_Plaza_Hotel_Toronto_Airport-Toronto_Ontario.html

Sheraton Ottawa

The Sheraton Ottawa is very well located, only a few blocks from tourist attractions such as

Parliament Hill:

Parliament Hill

https://www.tripadvisor.com/Hotel_Review-g155019-d183783-Reviews-International_Plaza_Hotel_Toronto_Airport-Toronto_Ontario.htmlhttps://www.tripadvisor.com/Hotel_Review-g155019-d183783-Reviews-International_Plaza_Hotel_Toronto_Airport-Toronto_Ontario.htmlhttps://www.tripadvisor.com/Hotel_Review-g155019-d183783-Reviews-International_Plaza_Hotel_Toronto_Airport-Toronto_Ontario.htmlhttps://www.tripadvisor.com/Hotel_Review-g155019-d183783-Reviews-International_Plaza_Hotel_Toronto_Airport-Toronto_Ontario.htmlhttps://www.tripadvisor.com/Hotel_Review-g155019-d183783-Reviews-International_Plaza_Hotel_Toronto_Airport-Toronto_Ontario.html


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https://www.tripadvisor.com/Hotel_Review-g155004-d182988-Reviews-Sheraton_Ottawa_Hotel-

Ottawa_Ontario.html

Due to increased control over the subsidiary that owns the hotel, KS began breaking out results for

the Sheraton Ottawa in 2015. We estimate the value of this asset using an 8.3% cap rate on 2015 NOI,

which is equivalent to CAD 175,600 per key. We understand this valuation is appropriate for this

market 9. Using the current spot rate for the Canadian dollar, this translates into 0.36 per share.

9 http://www.colliershotels.com/2014/CHIR/Colliers-2014CHIR.pdf and http://cbre-canada.uberflip.com/i/661999-q1-2016-canadian-cap-rates-investment-insights?var=thankyouQ12016

https://www.tripadvisor.com/Hotel_Review-g155004-d182988-Reviews-Sheraton_Ottawa_Hotel-Ottawa_Ontario.htmlhttps://www.tripadvisor.com/Hotel_Review-g155004-d182988-Reviews-Sheraton_Ottawa_Hotel-Ottawa_Ontario.htmlhttps://www.tripadvisor.com/Hotel_Review-g155004-d182988-Reviews-Sheraton_Ottawa_Hotel-Ottawa_Ontario.htmlhttp://www.colliershotels.com/2014/CHIR/Colliers-2014CHIR.pdfhttp://www.colliershotels.com/2014/CHIR/Colliers-2014CHIR.pdfhttp://www.colliershotels.com/2014/CHIR/Colliers-2014CHIR.pdfhttp://cbre-canada.uberflip.com/i/661999-q1-2016-canadian-cap-rates-investment-insights?var=thankyouQ12016http://cbre-canada.uberflip.com/i/661999-q1-2016-canadian-cap-rates-investment-insights?var=thankyouQ12016http://cbre-canada.uberflip.com/i/661999-q1-2016-canadian-cap-rates-investment-insights?var=thankyouQ12016http://cbre-canada.uberflip.com/i/661999-q1-2016-canadian-cap-rates-investment-insights?var=thankyouQ12016http://cbre-canada.uberflip.com/i/661999-q1-2016-canadian-cap-rates-investment-insights?var=thankyouQ12016http://cbre-canada.uberflip.com/i/661999-q1-2016-canadian-cap-rates-investment-insights?var=thankyouQ12016http://www.colliershotels.com/2014/CHIR/Colliers-2014CHIR.pdfhttps://www.tripadvisor.com/Hotel_Review-g155004-d182988-Reviews-Sheraton_Ottawa_Hotel-Ottawa_Ontario.htmlhttps://www.tripadvisor.com/Hotel_Review-g155004-d182988-Reviews-Sheraton_Ottawa_Hotel-Ottawa_Ontario.html


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Best Western Hotel Fino Osaka

KS’s only hotel in Japan was acquired in 2011 for $20.7 million, or around $116k per key. At the time,

this was equivalent to a 7.5% cap rate on trailing twelve month NOI. The hotel was newly opened at

the time and is 96.46% owned by KS. It is very well located, close to the subway and walking distance

to Shinsaibashi, Osaka’s largest shopping area.


BEST_WESTERN_Hotel_Fino_Osaka_Shinsaibashi-Osaka_Osaka_Prefecture_Kinki.html

https://www.tripadvisor.com/Hotel_Review-g298566-d1798409-Reviews-BEST_WESTERN_Hotel_Fino_Osaka_Shinsaibashi-Osaka_Osaka_Prefecture_Kinki.htmlhttps://www.tripadvisor.com/Hotel_Review-g298566-d1798409-Reviews-BEST_WESTERN_Hotel_Fino_Osaka_Shinsaibashi-Osaka_Osaka_Prefecture_Kinki.htmlhttps://www.tripadvisor.com/Hotel_Review-g298566-d1798409-Reviews-BEST_WESTERN_Hotel_Fino_Osaka_Shinsaibashi-Osaka_Osaka_Prefecture_Kinki.htmlhttps://www.tripadvisor.com/Hotel_Review-g298566-d1798409-Reviews-BEST_WESTERN_Hotel_Fino_Osaka_Shinsaibashi-Osaka_Osaka_Prefecture_Kinki.htmlhttps://www.tripadvisor.com/Hotel_Review-g298566-d1798409-Reviews-BEST_WESTERN_Hotel_Fino_Osaka_Shinsaibashi-Osaka_Osaka_Prefecture_Kinki.html


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This has certainly been one of the better performing hotels for KS, with exceptional growth in daily

rates and a steady rise in occupancy. RevPAR growth year-over-year was 22% in 2013, 25% in 2014

and 35% in 2015:

This being a limited service hotel, the daily rates are quite modest (at year-end, the ¥11,763 daily

rate was equivalent to $98). The performance of this hotel is attributable to a soft Ye n, increased

tourism in Japan, and a supply constrained market. These charts from Savills Japan10 illustrates

where Osaka fits among other large cities in terms of occupancy and rates:

10 http://pdf.savills.asia/asia-pacific-research/japan-research/japan-hospitality/jp-hotel-spotlight-03-2016-1.pdf

http://pdf.savills.asia/asia-pacific-research/japan-research/japan-hospitality/jp-hotel-spotlight-03-2016-1.pdfhttp://pdf.savills.asia/asia-pacific-research/japan-research/japan-hospitality/jp-hotel-spotlight-03-2016-1.pdfhttp://pdf.savills.asia/asia-pacific-research/japan-research/japan-hospitality/jp-hotel-spotlight-03-2016-1.pdfhttp://pdf.savills.asia/asia-pacific-research/japan-research/japan-hospitality/jp-hotel-spotlight-03-2016-1.pdfhttp://pdf.savills.asia/asia-pacific-research/japan-research/japan-hospitality/jp-hotel-spotlight-03-2016-1.pdfhttp://pdf.savills.asia/asia-pacific-research/japan-research/japan-hospitality/jp-hotel-spotlight-03-2016-1.pdf


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How do we value this hotel? According to another report by JLL11, hotel cap rates in Osaka are just

over 5%.

For conservatism, we apply a 7% cap rate instead, resulting in a value per KS share of 0.98, and

present here a sensitivity analysis table:

2015 NOI (HKD) 24,284

Cap rate 5.0% 5.5% 6.0% 6.5% 7.0% 7.5%

Value to KS 468,487 425,897 390,406 360,375 334,634 312,325

Per share: HKD 1.38 1.25 1.15 1.06 0.98 0.92

11 http://www.ap.jll.com/asia-pacific/en-gb/research/731/hotel-investor-sentiment-survey-15

http://www.ap.jll.com/asia-pacific/en-gb/research/731/hotel-investor-sentiment-survey-15http://www.ap.jll.com/asia-pacific/en-gb/research/731/hotel-investor-sentiment-survey-15http://www.ap.jll.com/asia-pacific/en-gb/research/731/hotel-investor-sentiment-survey-15http://www.ap.jll.com/asia-pacific/en-gb/research/731/hotel-investor-sentiment-survey-15


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Holiday Inn Wuhan Riverside

Like Japan, KS only owns one hotel in China. The Holiday Inn Wuhan Riverside was acquired prior to

2002 and is 41.26% owned by KS.


Holiday_Inn_Riverside_Wuhan-Wuhan_Hubei.html

The performance of this hotel has deteriorated significantly since 2010, with estimated NOI declining

from ~HKD 20 million to only 12.3 million in 2015. This cannot be attributed to foreign exchange

differences since the Yuan has barely moved against the HKD during that period (the five-year change

was only 1.2%). KS explains in its annual report that a decline in business-related travel has hurt the

https://www.tripadvisor.com/Hotel_Review-g297437-d305965-Reviews-Holiday_Inn_Riverside_Wuhan-Wuhan_Hubei.htmlhttps://www.tripadvisor.com/Hotel_Review-g297437-d305965-Reviews-Holiday_Inn_Riverside_Wuhan-Wuhan_Hubei.htmlhttps://www.tripadvisor.com/Hotel_Review-g297437-d305965-Reviews-Holiday_Inn_Riverside_Wuhan-Wuhan_Hubei.htmlhttps://www.tripadvisor.com/Hotel_Review-g297437-d305965-Reviews-Holiday_Inn_Riverside_Wuhan-Wuhan_Hubei.htmlhttps://www.tripadvisor.com/Hotel_Review-g297437-d305965-Reviews-Holiday_Inn_Riverside_Wuhan-Wuhan_Hubei.html


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hotel. We value the Holiday Inn Wuhan Riverside at a conservative 10% cap rate on 2015 NOI, which

results in an estimated value of HKD 123 million ($50k/key) 12. This happens to be the book value

(segment assets less segment liabilities) for the hotel as well. We are told by management that the

value of this hotel, given its good location, exceeds book value, but for conservatism, this is what we

use. The total value per share is only 0.15.

Macau

KS owns a number of properties in Macau, and some of these are carried at values significantly below

their current worth. Macau is a short, 40-minute ferry ride from Hong Kong. Like Hong Kong, it i s a

Special Administrative Region (SAR) of China, and the most densely populated region in the world13.

It has been the subject of intense media coverage14 recently due to the decline in gaming revenues

stemming from a Chinese government crackdown on corruption, which has driven away high rollers.Despite this, Macau remains much larger than Las Vegas in terms of gaming revenues. It also sports

a very high $91,376 GDP per capita.15

Its economy, however, is much less diversified. Las Vegas derived 64% of its resort revenue last year

from nongaming sources compared with less than 10% for Macau, and in 2015 it welcomed 42

million guests to Macau’s 8 million visitors.16 Recent efforts by the government to diversify Macau’s

economy by creating nongaming, entertainment zones, should create long-term benefits.

Below is a schematic17 of Macau and the surrounding areas showing existing and proposed

infrastructure, including the Hong Kong-Zhuhai-Macau bridge, all of which will likely vault Macau

into an even stronger and wealthier economy:

12 We were unable to find market cap rates for Wuhan hotels; 10% feels “right” and given that it coincideswith book value, we believe this is probably appropriately conservative.13

https://www.wikiwand.com/en/Macau 14 http://www.bloomberg.com/news/articles/2015-07-28/gambling-mecca-macau-doubles-down-as-china-growth-slows 15 Las Vegas had 2014 GDP per capita of nearly the same level, at $94,521. Seehttp://cber.unlv.edu/CCEconData.html andhttps://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_pcap_cd&scale_y=lin&ind_y=false&rdim=region&idim=country:MAC:HKG&ifdim=region&hl=en&dl=en&ind=false 16 http://www.lvcva.com/stats-and-facts/ 17 Extracted from http://mpofund.com/wp-content/uploads/2016/02/MPO-IR2016-web.pdf

https://www.wikiwand.com/en/Macauhttps://www.wikiwand.com/en/Macauhttps://www.wikiwand.com/en/Macauhttp://www.bloomberg.com/news/articles/2015-07-28/gambling-mecca-macau-doubles-down-as-china-growth-slowshttp://www.bloomberg.com/news/articles/2015-07-28/gambling-mecca-macau-doubles-down-as-china-growth-slowshttp://www.bloomberg.com/news/articles/2015-07-28/gambling-mecca-macau-doubles-down-as-china-growth-slowshttp://www.bloomberg.com/news/articles/2015-07-28/gambling-mecca-macau-doubles-down-as-china-growth-slowshttp://cber.unlv.edu/CCEconData.htmlhttp://cber.unlv.edu/CCEconData.htmlhttps://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_pcap_cd&scale_y=lin&ind_y=false&rdim=region&idim=country:MAC:HKG&ifdim=region&hl=en&dl=en&ind=falsehttps://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_pcap_cd&scale_y=lin&ind_y=false&rdim=region&idim=country:MAC:HKG&ifdim=region&hl=en&dl=en&ind=falsehttps://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_pcap_cd&scale_y=lin&ind_y=false&rdim=region&idim=country:MAC:HKG&ifdim=region&hl=en&dl=en&ind=falsehttps://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_pcap_cd&scale_y=lin&ind_y=false&rdim=region&idim=country:MAC:HKG&ifdim=region&hl=en&dl=en&ind=falsehttp://www.lvcva.com/stats-and-facts/http://www.lvcva.com/stats-and-facts/http://www.lvcva.com/stats-and-facts/http://mpofund.com/wp-content/uploads/2016/02/MPO-IR2016-web.pdfhttp://mpofund.com/wp-content/uploads/2016/02/MPO-IR2016-web.pdfhttp://mpofund.com/wp-content/uploads/2016/02/MPO-IR2016-web.pdfhttp://mpofund.com/wp-content/uploads/2016/02/MPO-IR2016-web.pdfhttp://www.lvcva.com/stats-and-facts/https://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_pcap_cd&scale_y=lin&ind_y=false&rdim=region&idim=country:MAC:HKG&ifdim=region&hl=en&dl=en&ind=falsehttps://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_pcap_cd&scale_y=lin&ind_y=false&rdim=region&idim=country:MAC:HKG&ifdim=region&hl=en&dl=en&ind=falsehttps://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_pcap_cd&scale_y=lin&ind_y=false&rdim=region&idim=country:MAC:HKG&ifdim=region&hl=en&dl=en&ind=falsehttp://cber.unlv.edu/CCEconData.htmlhttp://www.bloomberg.com/news/articles/2015-07-28/gambling-mecca-macau-doubles-down-as-china-growth-slowshttp://www.bloomberg.com/news/articles/2015-07-28/gambling-mecca-macau-doubles-down-as-china-growth-slowshttps://www.wikiwand.com/en/Macau


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1

2

2

1

Ocean Gardens

Luso Int’l Bank Bld


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Properties classified as investment properties (marked to market yearly by KS)

These are the only properties KS marks to market on its balance sheet. Here is a summary of the

properties in this group:

Group's

Interest Type

No. of

units

Gross

floor

area

(sqm)

Gross

floor

area (sf)

Floor

area,

group's

part

(sqm)

Floor

area,

group's

part (sf)

Floor area,

min interest

(sf) AddressLuso InternationalBank Building 100.00% Office 40 2,812 30,264 2,812 30,264 -

1, 3 and 3A Rua do Dr.Pedro Jose Lobo, Macau

Ocean Plaza, I and II 70.61% Comm 47 8,782 94,525 6,201 66,744 27,781 Ocean Gardens, Macau

Ocean Tower 70.61% Office 19 4,618 49,703 3,260 35,095 14,608 Ocean Gardens, Macau

Total 16,211 174,492 12,273 132,103 42,389 [A]

Value at 12/31/2015 (HKD ‘000) 778,000

Value at 12/31/2015 (USD ‘000) 100,321

$ / SF $575

HKD / SF 4,459 [B]

HKD / m2 47,993

Estimated minority interest, HKD ‘000 188,996 [A] x [B]

The locations of these properties are noted in the schematic above (the Ocean Plaza and Ocean Tower

are in the same location as the Ocean Gardens residential units, which we value below).

Because we value every other asset net of minority interests, we do not deduct the full minority

interest on KS’s balance sheet so as to not double count. Therefore, for these assets we estimate what

minority interest should be, using the mark-to-market HKD per square feet valuation and multiplying

that by the square footage not owned by KS ([A] x [B] above).

The Luso International Bank Building above is very well located next to the main attractions in

Macau18.

18 https://goo.gl/maps/BHqXbEBZuAB2

https://goo.gl/maps/BHqXbEBZuAB2https://goo.gl/maps/BHqXbEBZuAB2https://goo.gl/maps/BHqXbEBZuAB2https://goo.gl/maps/BHqXbEBZuAB2


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The other buildings, Ocean Plaza and Ocean Tower, are located in Taipa, a short drive south acrossthe bridge. Ocean Tower is where Keck Seng’s corporate offices are located (on the 4 th floor). Cotai,

adjacent to Taipa, is where most new casino developments are happening in Macau. Ocean Gardens

is a development made on reclaimed land in the late 1990s by the family that controls KS.

Since these properties are revalued yearly by independent appraisers using market rents and cap

rates, we take these valuations at face value, but verify them against other sources (below). Net of

minority interests, these properties contribute 2.29 per KS share.

It should be noted that the gross yield on valuation – rents received by these properties divided by

property values – is extraordinarily low at 3.6% in 2015 (in the three years prior to that the gross

yields on valuation were between 2-2.9%, while rents have nearly doubled).

This is unusual to those of us used to cap rates – which is net operating income divided by property

values (i.e., rents received less expenses) – of at least 6% or 7%.

We have been unable to find detailed real estate reports for Macau property (although there are short

ones19) but we note that a London-listed fund (Macau Property Opportunities Fund, or MPO Fund)

19 http://pdf.savills.asia/asia-pacific-research/macau-research/mo-residential-09-2015.pdf

http://pdf.savills.asia/asia-pacific-research/macau-research/mo-residential-09-2015.pdfhttp://pdf.savills.asia/asia-pacific-research/macau-research/mo-residential-09-2015.pdfhttp://pdf.savills.asia/asia-pacific-research/macau-research/mo-residential-09-2015.pdfhttp://pdf.savills.asia/asia-pacific-research/macau-research/mo-residential-09-2015.pdf


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with investments in Macau has its properties valued by Savills Macau and consistently uses similarly

low cap rates.20

We trust these valuations because they are consistent with values we have observed in KS’s

residential transactions, which are held for sale. To check those valuations, we use publicly available

statistics from DSEC, the statistics and census office of Macau. These statistics corroborate not cap

rates, but the implied $/square foot numbers. Because DSEC shows a lot of transactions over the

years at these $/square foot numbers, we are comfortable with the implied low cap rates because

that is how the market actually prices these assets in real arms-length transactions. We will go over

all of this in depth below.

Properties classified as held for sale (held at cost by KS)

KS’s management built a number of buildings in Ocean Gardens, Taipa, in the late 1990s, with someproperties (Aster Court and Bamboo Court) having been completed in the mid-2000s. Over the years,

KS has harvested these investments by selling individual units for multiples of their cost. During this

period, Macau real estate values have skyrocketed, in conjunction with the vast growth of the gaming

industry in the region, low incremental supplies of housing, very low unemployment rates, and very

high GDP per capita.

Below is a photo of Ocean Gardens dated 2013 21. The author visited the properties in 2015 and can

attest they look substantially the same.

20 Keck Seng’s valuers are Jones Lang LaSalle while MPO Fund uses Savills.http://mpofund.com/investors/publications/financial-results/ 21 More photos available athttps://www.dropbox.com/sh/5yeq9s8dvrctvw7/AAAdKsjVj68I2hpotHXZbkpga?dl=0

http://mpofund.com/investors/publications/financial-results/http://mpofund.com/investors/publications/financial-results/https://www.dropbox.com/sh/5yeq9s8dvrctvw7/AAAdKsjVj68I2hpotHXZbkpga?dl=0https://www.dropbox.com/sh/5yeq9s8dvrctvw7/AAAdKsjVj68I2hpotHXZbkpga?dl=0https://www.dropbox.com/sh/5yeq9s8dvrctvw7/AAAdKsjVj68I2hpotHXZbkpga?dl=0http://mpofund.com/investors/publications/financial-results/


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As mentioned earlier, the preferred means of arriving in Macau is through a 40-minute ferry from

Hong Kong, or by plane. Macau’s airport however is quite small, with a capacity for only 6 million

passengers per year and only one runway. It is operating near capacity, with 5.8 million passengers

in 201522.

Hong Kong International Airport, on the other hand, is also operating at capacity, but can process 68

million passengers per year. It’s among t he top three busiest airports in Asia23. There are plans to

add a third runway to increase capacity24.

Hong Kong and Macau authorities had an idea: wouldn’t it be great if there were a bridge connecting

Hong Kong’s airport directly to the gaming facilities in Macau? This thinking led to the Hong Kong-

Zhuhai-Macau bridge25 project, which began in 2009. The entire link will be 31 miles long when

completed and significantly shorten travel time for tourists (who take the ferry) and freight throughthe Pearl River delta (which takes the much longer way around, cutting travel time from 4.5 hours to

22 https://www.wikiwand.com/en/Macau_International_Airport 23 https://www.wikiwand.com/en/Hong_Kong_International_Airport 24 https://www.wikiwand.com/en/Hong_Kong_Airport's_Third_Runway andhttp://www.scmp.com/news/hong-kong/economy/article/1888008/hong-kong-airport-third-runway-proposal-take-hk5-billion-loan 25 http://www.hzmb.hk/eng/

https://www.wikiwand.com/en/Macau_International_Airporthttps://www.wikiwand.com/en/Macau_International_Airporthttps://www.wikiwand.com/en/Macau_International_Airporthttps://www.wikiwand.com/en/Hong_Kong_International_Airporthttps://www.wikiwand.com/en/Hong_Kong_International_Airporthttps://www.wikiwand.com/en/Hong_Kong_International_Airporthttps://www.wikiwand.com/en/Hong_Kong_Airport's_Third_Runwayhttps://www.wikiwand.com/en/Hong_Kong_Airport's_Third_Runwayhttps://www.wikiwand.com/en/Hong_Kong_Airport's_Third_Runwayhttp://www.scmp.com/news/hong-kong/economy/article/1888008/hong-kong-airport-third-runway-proposal-take-hk5-billion-loanhttp://www.scmp.com/news/hong-kong/economy/article/1888008/hong-kong-airport-third-runway-proposal-take-hk5-billion-loanhttp://www.scmp.com/news/hong-kong/economy/article/1888008/hong-kong-airport-third-runway-proposal-take-hk5-billion-loanhttp://www.hzmb.hk/eng/http://www.hzmb.hk/eng/http://www.hzmb.hk/eng/http://www.hzmb.hk/eng/http://www.scmp.com/news/hong-kong/economy/article/1888008/hong-kong-airport-third-runway-proposal-take-hk5-billion-loanhttp://www.scmp.com/news/hong-kong/economy/article/1888008/hong-kong-airport-third-runway-proposal-take-hk5-billion-loanhttps://www.wikiwand.com/en/Hong_Kong_Airport's_Third_Runwayhttps://www.wikiwand.com/en/Hong_Kong_International_Airporthttps://www.wikiwand.com/en/Macau_International_Airport


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40 minutes). The much larger Pearl River Delta Economic Zone is a major reason for the bridge as

well.26 As can be expected with any massive and complex engineering project, this one is over budget

and delayed, with the latest projections pointing to a late 2018 opening.27

Once the bridge does open for business, KS’s management expects a new cyclical peak in Macau real

estate values, and they have therefore held off on selling more units in Ocean Gardens until the bridge

is completed. From the 2015 annual report:

The economic growth was reduced in 2015 as a result of significant decrease in Macau’s gaming revenue.Real GDP fell 17% in real terms in 2015 as compared to 2014. Tourism arrivals to Macau, however,dropped only slightly to 30.7 million in 2015, as compared to 31.5 million in 2014. As several large-scalehotel and entertainment projects as well as public construction works were still ongoing, unemploymentremained extremely low at 1.9% at the end of 2015.

Against this background, income from leasing of properties has grown to HK$90.9 million in 2015, an increaseof 28.8% as compared to HK$70.7 million in 2014.

There was no sale of properties in Macau during 2015, as it is the view of the directors that thecompletion of the Hong Kong-Zhuhai-Macau Bridge will have a strong positive impact on the value ofresidential properties in Macau. The directors therefore consider that the Group should continue to closelymonitor property market conditions, and to conduct sale of properties at a time and price that will optimizeprofits for the group. In the meantime, properties held for sale in Macau are leased to maximize profits.(Emphasis added.)

Because of the rise in property values in Macau, our estimated value for these properties is much

higher than the values reflected in KS’s balance sheet, which are at cost. Our estimates are

corroborated in two ways. First, we show in the table below how KS has consistently harvested itsproperties held for sale, every year selling at higher multiples of cost, primarily due to property

appreciation in Macau. Second, we can access Macau’s statistics office records (DSEC) to look at

residential transactions in Taipa and estimate where the Ocean Gardens units should trade when

they are eventually sold.

26 https://www.wikiwand.com/en/Pearl_River_Delta_Economic_Zone 27 See http://www.scmp.com/content/search/zhuhai%20macau%20bridge andhttps://www.wikiwand.com/en/Hong_Kong%E2%80%93Zhuhai%E2%80%93Macau_Bridge

https://www.wikiwand.com/en/Pearl_River_Delta_Economic_Zonehttps://www.wikiwand.com/en/Pearl_River_Delta_Economic_Zonehttps://www.wikiwand.com/en/Pearl_River_Delta_Economic_Zonehttp://www.scmp.com/content/search/zhuhai%20macau%20bridgehttp://www.scmp.com/content/search/zhuhai%20macau%20bridgehttp://www.scmp.com/content/search/zhuhai%20macau%20bridgehttps://www.wikiwand.com/en/Hong_Kong%E2%80%93Zhuhai%E2%80%93Macau_Bridgehttps://www.wikiwand.com/en/Hong_Kong%E2%80%93Zhuhai%E2%80%93Macau_Bridgehttps://www.wikiwand.com/en/Hong_Kong%E2%80%93Zhuhai%E2%80%93Macau_Bridgehttp://www.scmp.com/content/search/zhuhai%20macau%20bridgehttps://www.wikiwand.com/en/Pearl_River_Delta_Economic_Zone


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Macau property appreciation – Ocean Gardens

HK$’000 unless noted 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015Properties held for sale 268,169 305,326 238,833 207,428 335,671 331,842 332,767 324,278 306,190 303,384 283,527 280,658 280,658 280,658Square footage 1,050,903 1,090,948 987,145 315,754 502,599 497,325 478,790 473,271 456,446 452,739 426,790 423,083 423,083 423,083HKD / SF (remaining cost) 255 280 242 657 668 667 695 685 671 670 664 663 663 663$ / SF (remaining cost) $ 33 $ 36 $31 $85 $86 $86 $90 $88 $86 $86 $86 $ 86 $ 86 $ 86Rental inc from properties 36,044 42,756 54,666 62,616Rental yield on cost 12.7% 15.2% 19.5% 22.3%Rental yield on sales price 1.7% 1.5%Rent in $ / SF $11 $ 13 $ 17 $ 19Cost of prop’s sold during yr (95,014) (136,762) (55,988) (34,298) (19,538) (4,687) (15,377) (8,489) (18,088) (2,806) (19,857) (2,869)Proceeds sale of properties 151,988 223,033 162,330 180,201 98,587 25,160 82,053 47,695 106,339 17,191 129,597 24,686Multipl e of cost 1.6x 2.9x 5.3x 5.0x 5.4x 5.3x 5.6x 5.9x 6.1x 6.5x 8.6xUnitsOcean Ind. Centre, Phase II 3 3 3 3 3 3 3 3 3 3 3 3 3 3Ocean Park 6 6 6 5 5 5 5 5 5 5 5 5 5 5Heng Fa Chuen (HK) 2 2 2 2 2 2 2Poplar Court 4 4 2

Rose Court 3 3 3 3 3 3 3 3 3 3 3 3 3 3Begonia Court 19 19 4 4 4 4 4 4 4 4 4 4Orchid Court 36 36 36 19 2 2 2 2 2 2 2 2 2Lotus Court 1Sakura Court 42 42 42 42 42 42 37 36 32 31 24 23 23 23Syringa Court 4Kapok Court 3 1Lily Court 37 33 32 29 29 29 29 29 28 28 28 28 28 28Dahlia Court 7 2Cattleya Court 47Magnolia Court 1Beijing Riviera 197 195 198ster Court (Lot W) 40 40 40 40 40 40 40 40 40 40

Bamboo Court (Lot W) 40 40 40 40 40 40 40 40 40 40otal 364 394 328 107 172 170 165 162 157 156 149 148 148 148ross floor area (sq ft)

Ocean Ind. Centre, Phase II 22,921 22,921 22,921 22,921 22,921 22,921 22,921 22,921 22,921 22,921 22,921 22,921 22,921 22,921Ocean Park 12,438 12,438 12,438 10,550 10,550 10,550 10,550 10,550 10,550 10,550 10,550 10,550 10,550 10,550

Heng Fa Chuen (HK) 1,812 1,812 1,812 1,812 1,812 1,812 1,812Poplar Court 5,576 5,576 2,374Rose Court 11,121 11,121 11,121 11,121 11,121 11,121 11,121 11,121 11,121 11,121 11,121 11,121 11,121 11,121Begonia Court 50,103 50,103 10,548 10,548 10,548 10,548 10,548 10,548 10,548 10,548 10,548 10,548 10,548 10,548Orchid Court 94,932 94,932 94,932 50,103 10,548 5,274 5,274 5,274 5,274 5,274 5,274 5,274 5,274 5,27Lotus Court 1,792Sakura Court 155,694 155,694 155,694 155,694 155,69 155,69 137,159 133,452 118,624 114,917 88,968 85,261 85,261 85,261Syringa Court 4,120Kapok Court 3,090 1,030Lily Court 68,981 60,993 58,996 53,005 53,005 53,005 53,005 53,005 51,008 51,008 51,008 51,008 51,008 51,008Dahlia Court 9,414 2,108Cattleya Court 63,935Magnolia Court 1,503Beijing Riviera 608,909 606,782 616,309ster Court (Lot W) 113,200 113,200 113,200 113,200 113,200 113,200 113,200 113,200 113,200 113,200

Bamboo Court (Lot W) 113,200 113,200 113,200 113,200 113,200 113,200 113,200 113,200 113,200 113,200otal 1,050,903 1,090,948 987,145 315,754 502,599 497,325 478,790 473,271 456,446 452,739 426,790 423,083 423,083 423,083

Number of units sold 18 66 221 15 2 5 3 5 1 7 1Square footage sold 25,393 103,803 671,391 39,555 5,274 18,535 5,519 16,825 3,707 25,949 3,707vg size of unit(s) sold 1,411 1,573 3,038 2,637 2,637 3,707 1,840 3,365 3,707 3,707 3,707vg size of remaining units 2,769 3,010 2,951 2,922 2,925 2,902 2,921 2,907 2,902 2,864 2,859ost / SF $ 694 $69 $7 $64 $114 $107 $198 $138 $97 $99 $100ale pri ce / SF $1,131 $201 $35 $320 $612 $571 $ 1,114 $812 $597 $644 $859

The table above shows how KS has harvested its Ocean Gardens development over the years. Note

how the multiple of cost has risen over time as property prices have increased (note that cost / square

foot was likely distorted until 2004, when a large number of units were monetized in Beijing; since


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then, sales have been primarily in Macau). Only recently has KS started disclosing rental incomes for

this group of properties held for sale. The yield on cost in 2015 was 22.3% compared with cap rates

for sold properties in 2012-2013 of 1.5-1.7%. We can also compare $/SF for sold properties with

transactions in DSEC (below) to further buttress our valuation.

It’s important to note that it was only in 2002 that Macau ended the monopoly system for gaming

licenses, opening up the opportunity for the arrival of Wynn Resorts, Las Vegas Sands, Galaxy

Entertainment, among others.28 At this point it is likely that KS’s management began throttling back

on property sales given the expected further development of Macau.

DSEC

Macau’s government-run statistics database is a very useful source of data on the economy and on

real estate transactions.29 The database reports numbers in HKD/square meter so we will use thismetric going forward.

As can be seen in the table above, KS marks its remaining units at HKD 663 per square feet or HKD

7,140 per square meter. A full 90% of these units (by area) are properties in Ocean Gardens, Taipa.

The remaining 10% are split in two properties. The first, Ocean Industrial Centre, Phase II, is an

industrial property in Macau. We value this at $250 / SF, which we feel is appropriately conservative,

although we do not have direct comps30. Ocean Park is a residential property in Singapore. Recent

transactions at Ocean Park seem to have been around $900-1,200 per square feet 31. We convert the

lower end from Singapore dollars to arrive at $667 / SF for this piece.

The remaining 90% of units, in Ocean Gardens in Macau, can be compared with the DSEC database

for transactions in “Jardins do Oceano, Taipa” (Ocean Gardens). Below we chart these transactions.

28 https://www.wikiwand.com/en/Gambling_in_Macau 29 http://www.dsec.gov.mo/TimeSeriesDatabase.aspx?lang=en-US 30 If we’re wrong, it does not materially affect our thesis.31 http://www.propertyguru.com.sg/project/ocean-park-293 andhttps://www.dropbox.com/s/5zjty7r2v56rpil/Ocean%20Park%20transactions.PNG?dl=0

https://www.wikiwand.com/en/Gambling_in_Macauhttps://www.wikiwand.com/en/Gambling_in_Macauhttps://www.wikiwand.com/en/Gambling_in_Macauhttp://www.dsec.gov.mo/TimeSeriesDatabase.aspx?lang=en-UShttp://www.dsec.gov.mo/TimeSeriesDatabase.aspx?lang=en-UShttp://www.dsec.gov.mo/TimeSeriesDatabase.aspx?lang=en-UShttp://www.propertyguru.com.sg/project/ocean-park-293http://www.propertyguru.com.sg/project/ocean-park-293http://www.propertyguru.com.sg/project/ocean-park-293https://www.dropbox.com/s/5zjty7r2v56rpil/Ocean%20Park%20transactions.PNG?dl=0https://www.dropbox.com/s/5zjty7r2v56rpil/Ocean%20Park%20transactions.PNG?dl=0https://www.dropbox.com/s/5zjty7r2v56rpil/Ocean%20Park%20transactions.PNG?dl=0http://www.propertyguru.com.sg/project/ocean-park-293http://www.dsec.gov.mo/TimeSeriesDatabase.aspx?lang=en-UShttps://www.wikiwand.com/en/Gambling_in_Macau


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The chart shows the dramatic rise, and recent fall, of property prices in Macau 32. The fall has been

strongly correlated with the decline in gaming revenues, although the number of visitors to Macau

has remained very stable33. We feel our valuation is conservative, as it sits at a 35% discount to recenttransactions and a 54% discount to the peak. At $552 / SF, it also has an implied cap rate of 3.5%. By

32 Technically, these numbers are in MOP / square meters, but since the Macau Pataca is pegged to the HKDand the ratio is very close to 1:1, we simplify the presentation and show the chart in HKD.33 We share a number of other statistics in useful charts here:https://www.dropbox.com/s/9955i16h8018ddl/Macau%20statistics%20-%20PUBLIC.pdf?dl=0

https://www.dropbox.com/s/9955i16h8018ddl/Macau%20statistics%20-%20PUBLIC.pdf?dl=0https://www.dropbox.com/s/9955i16h8018ddl/Macau%20statistics%20-%20PUBLIC.pdf?dl=0https://www.dropbox.com/s/9955i16h8018ddl/Macau%20statistics%20-%20PUBLIC.pdf?dl=0


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comparison, MPO Fund marks its Waterside residential properties at a cap rate of 2.4% and $1,408

/ SF.34

At cost, these properties held for sale are only 0.60 per KS share. At our valuation, they would be

worth 3.75 per share, a multiple of 6.3x cost.

Given the supply and demand characteristics of residential housing in Taipa, it is very likely that the

completion of the Hong Kong-Zhuhai-Macau bridge will indeed lead to a rise in values for the Ocean

Gardens properties. Below is a sensitivity analysis table (we keep the industrial and Singapore

properties at their current valuations, and only apply the HKD / sqm values below to Ocean Gardens):

Sensitivity analysis on Ocean Gardens valuations

HKD / sqm 46,100 50,000 60,000 80,000 100,000

Total value (group's part) 1,277,212 1,376,889 1,632,470 2,143,632 2,654,795

Per share 3.75 4.05 4.80 6.30 7.80

Remaining NAV items

The only remaining NAV items are cash (4.19 per share), “other assets” on the balance sheet (0.47

per share) and all liabilities and minority interests not already deducted, at -7.74 per share.

Our total NAV estimate therefore stands at HKD 18.19 per share, and as we have hopefully

demonstrated along the way, we believe this is based on current market valuations.

Calculation of free cash flow Our bridge from net income to free cash flow is presented below. A few items should be noted.

KS has substantial non-controlling interests due to partial ownership of many properties. The

overall split is about 70.3% of net income accruing to shareholders of KS, so we use this split

for free cash flow as well. While an asset-by-asset free cash flow estimate would be more

accurate, we have performed the exercise and the outcome isn’t materially different.

The hotel industry uses 4% of sales as an estimate of capital expenditures. We use this across

all sales figures. Again, this is likely off, as it overestimates capex (since a large portion of sales

come from non-hotel properties), but the result shouldn’t be materially off.

We deduct non-recurring items such as the increase in mark-to-market in property values,interest income on bank balances, and losses from trading securities (although this last item

is immaterial).

34 Waterside is located in Macau proper (and has extensive high end shopping on the ground floor), is muchnewer more attractive than Ocean Gardens, and probably deserves a to be valued at a large premium.


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Free cash flow bridge (2015)

35

Total net income 325,756

(+) D&A 130,112

(-) Increase in fair value (35,000)

(-) Other revenue (33,885)

(+) Other losses 2,738

= FFO 389,721

% attrib to shareholders 70.3%

FFO to shareholders 273,933

FFO per share36 0.81

Capex % of revenues 4.0%

(-) Capex (77,583)

= FCF 312,138

FCF to shareholders 219,400

FCF per share 0.64

FCF yield 11.2%

We note that this calculation of free cash flow results in free cash flow per share of 0.40, 0.55, 0.55 in

2012, 2013 and 2014, respectively.

Calculation of cap rate and leverage

Cap rates are one favored way of calculating real estate values. Hopefully we have demonstratedthough our sum of the parts analysis above that our NAV estimate of over HKD 18 per share is

conservative.

On a consolidated basis, we can also calculate an implied cap rate by dividing EBITDA by enterprise

value37.

35 http://www.keckseng.com.hk/Files/Announcement/2015/LTN20150924472.pdf 36 FFO is funds from operations, another metric used to value publicly traded real estate. KS trades at a P/FFOmultiple of 7.1x, which is also quite undervalued. The flaw in this metric is that it does not consider leverage,or the amount of debt the company carries. This isn’t a problem for KS, with its very underleveraged balancesheet.37 EBITDA is earnings before interest, taxes, depreciation and amortization, and is equivalent to the netoperating income of a property; enterprise value is the market cap of a company, plus debt and less cash,which is equivalent to the value of a property.

http://www.keckseng.com.hk/Files/Announcement/2015/LTN20150924472.pdfhttp://www.keckseng.com.hk/Files/Announcement/2015/LTN20150924472.pdfhttp://www.keckseng.com.hk/Files/Announcement/2015/LTN20150924472.pdfhttp://www.keckseng.com.hk/Files/Announcement/2015/LTN20150924472.pdf


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Implied cap rate (2015)Total net income 325,756

(+) D&A 130,112

(+) Taxes 96,417

(+) Interest expense 34,105

(-) Increase in fair value (35,000)

(-) Other revenue (33,885)

(+) Other losses 2,738

= EBITDA 520,243 [A]

Current stock price HKD 5.75

Shares outstanding 340,200

Market cap 1,956,150

(+) Total debt 1,942,625

(-) Cash (1,790,706)

(+) Minority interests 96,784

= Enterprise value 2,204,853 [B]

Implied cap rate 23.6% [A] / [B]

Estimated NAV 18.2

Cap rate at est. NAV 8.1%

The cap rate implied by the current share price is 23.6%, which represents a dramatic undervaluation

relative to real-world real estate transactions. As noted on the first page, the median cap rate for hotel

companies listed in the U.S. is 7.6%, with luxury hotels being valued towards 6% cap rates and limited

service hotels at around 9-10%. Since we have valued KS on an asset by asset basis, our target price

of HKD 18.2 already incorporates individual cap rates for each property. On a consolidated basis, our

target price would represent a cap rate of 8.1% for the whole company, which is another way to

determine that 18.2 is indeed a reasonable target price.

A similar calculation would have resulted in cap rates of 66%, 57% and 17% in 2012, 2013 and 2014,

respectively, using the HKD 5.75 stock price noted above. The reason for the higher numbers was

due to a lower enterprise value, since KS took a mortgage to purchase the Sofitel NY, enlarging

enterprise value but growing EBITDA modestly, given the tight cap rate at which that acquisition wasmade.

It should also be noted how solid KS’s balance sheet is. The estimated NAV of 18.2 per share can be

compared with total debt per share of 5.7 for an LTV of 31%; however, including cash we arrive at

net debt per share of 0.4 for an LTV of 2.5%.


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Source of mispricing

It is always important to understand why a security is undervalued, so here we list some reasons we

believe KS trades at such a wide discount to intrinsic value:

No analyst coverage As far as we are aware, there are no sell-side analysts who cover KS.

Securities without sell-side coverage tend to fall through the cracks and frequently trade at

low valuations.

Small cap status The current market cap of KS, at HKD 5.75 per share, is $252 million, quite

small by U.S. standards, and too small for most institutional investors to take a position.

Limited float The controlling family owns 74.82% of the shares outstanding, which means

that there is only about $63 million of free float available. It is our understanding that the

listing rules in Hong Kong require that at least 25% of the shares remain freely traded, so this

may preclude further stock buybacks38.

Lack of awareness by investment community We believe this idea was completely unknown

to the majority, if not all, western market participants, until it was posted in an excellent

write-up, to which we are indebted for the idea39.

Misperception regarding take under risk One common objection to this investment idea is

that the controlling shareholders could take the company private through a lowball bid,

depriving minority shareholders of the full value of their shares. Hong Kong law allows 10%

of the minority to block any such attempt, making it very difficult for such a take under

attempt to succeed40.

Unfocused investor relations effort KS does not employ IR professionals or prepare investor

presentations, hold conference calls, or conduct roadshows. Despite this, the company does

hold annual meetings and is responsive to shareholders through email and phone calls.

Cyclicality of the hotel business

The data below is from Smith Travel Research and the U.S. Department of Labor. Over time, ADR and

RevPAR have done well compared to CPI, but one can note the cycles of rising ADR/RevPAR leading

to a rise in supply, resulting in a down cycle, and so forth.

If this chart holds, we should be bracing for an increase in supply and another downturn. We are

already witnessing this in markets like New York (see links under the Risks section below). Supply

38 https://www.hkex.com.hk/eng/listing/listreq_pro/listreq/equities.htm although the company does have astock buyback authorizationhttp://www.keckseng.com.hk/Files/Announcement/2015/LTN20150424436.pdf 39 https://valueinvestorsclub.com/idea/Keck_Seng_Investments/114379 40 http://www.scmp.com/comment/insight-opinion/article/1436426/new-companies-law-will-boost-hong-kongs-competitiveness

https://www.hkex.com.hk/eng/listing/listreq_pro/listreq/equities.htmhttps://www.hkex.com.hk/eng/listing/listreq_pro/listreq/equities.htmhttps://www.hkex.com.hk/eng/listing/listreq_pro/listreq/equities.htmhttp://www.keckseng.com.hk/Files/Announcement/2015/LTN20150424436.pdfhttp://www.keckseng.com.hk/Files/Announcement/2015/LTN20150424436.pdfhttps://valueinvestorsclub.com/idea/Keck_Seng_Investments/114379https://valueinvestorsclub.com/idea/Keck_Seng_Investments/114379https://valueinvestorsclub.com/idea/Keck_Seng_Investments/114379http://www.scmp.com/comment/insight-opinion/article/1436426/new-companies-law-will-boost-hong-kongs-competitivenesshttp://www.scmp.com/comment/insight-opinion/article/1436426/new-companies-law-will-boost-hong-kongs-competitivenesshttp://www.scmp.com/comment/insight-opinion/article/1436426/new-companies-law-will-boost-hong-kongs-competitivenesshttp://www.scmp.com/comment/insight-opinion/article/1436426/new-companies-law-will-boost-hong-kongs-competitivenesshttp://www.scmp.com/comment/insight-opinion/article/1436426/new-companies-law-will-boost-hong-kongs-competitivenesshttp://www.scmp.com/comment/insight-opinion/article/1436426/new-companies-law-will-boost-hong-kongs-competitivenesshttps://valueinvestorsclub.com/idea/Keck_Seng_Investments/114379http://www.keckseng.com.hk/Files/Announcement/2015/LTN20150424436.pdfhttps://www.hkex.com.hk/eng/listing/listreq_pro/listreq/equities.htm


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appears constrained in Vietnam, which is the other large contributor to KS’s profitability, but this

cannot be expected to last forever.

Risks, uncertainties, and why this may not work out

One risk to the hotel industry is Airbnb. In 2015 Airbnb booked 80 million room nights and

$1 billion in revenues41. Hilton Worldwide mentioned in their Q4 2015 conference call that

they still do not see “any material impact from it” and that they believe Airbnb is a real

business that will be around for a very long time, but they will coexist with hotels. On the one

hand, Airbnb increases supply, probably mostly in high ADR markets 42. On the other hand,

41 https://www.youtube.com/watch?v=1Bj_QwX7hGk 42 Sotherly Hotels 2015 Q4 conference call: “While we don’t disagree that Airbnb presents a new alternative tothe traditional hotel model, we have not seen any disruption in our markets to-date. We believe the negativeAirbnb effect will be experienced primarily in the top-five high rate gateway markets where a low-costalternative is an attractive option.” LaSalle Hotels Q4 2015 conference call: “So it’s hard to say exactly what’sgoing on there. There is not the greatest data out. But what I would tell you is that, it’s almost like any newsupply. While our customers are not necessarily the customers that would be staying at a no-frills limitedservice hotel, to the extent that you add no frills limited service hotels to market, that supply takes from

ADR

Occupancy

RevPAR

CPI

Rooms added(gross), RHS

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

80

100

120

140

160

180

200

220

240

US Lodging Industry Trends: 1992 - 2015Data indexed, 1992=100, except rooms added

https://www.youtube.com/watch?v=1Bj_QwX7hGkhttps://www.youtube.com/watch?v=1Bj_QwX7hGkhttps://www.youtube.com/watch?v=1Bj_QwX7hGkhttps://www.youtube.com/watch?v=1Bj_QwX7hGk


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there are many things Airbnb cannot do, such as host conferences, offer superb room service,

and deliver a consistent, branded, superior guest experience that only hotels can deliver. We

believe there is no doubt Airbnb is sucking dollars from the hotel industry. So while the risk

may not yet be material, perhaps the operative word is “yet” and it’s certainly a risk we’re

firmly focused on.

New York is undergoing supply additions and the market is soft 43. On the other hand, land

values are high enough that alternative uses are already being sought by some hotel owners,

such as conversions into retail (for street level), time share and residential.

Vietnam concentration: around 46% of the profits to shareholders of KS come from its

properties in Vietnam, depending on how one allocates corporate overhead; another 31%

comes from the U.S. and 16% from Macau, deducting the mark-to-market gain in fair value.So while in terms of net asset value the company is weighted towards the U.S., in terms of

profits it is weighted towards Vietnam.

Currency risk: t he Vietnamese dong has been a depreciating currency against the U.S. dollar

for many years44, which stimulates tourism and makes goods and services cheaper, but

doesn’t bode well for the transfer of profits to KS. The currency however is considered

cheap45 and KS management transfers all cash from Vietnam to banks in Hong Kong and

Macau as soon as practicable to avoid currency risks.

Further currency risk: KS reports in HKD and while the HKD is pegged to the U.S. dollar, there

have been speculations about the peg being broken46. By all accounts, the HKD is among the

most undervalued currencies in the world; that coupled with capital flows into Hong Kongshould be reflected in a higher value for the HKD against the U.S. dollar should the peg break.

If that happens, an unhedged investment in KS will rise in value since the shares are

denominated in HKD, while net asset value and profitability would decline given a

whatever the closest competition is, who ends up bringing down rates, creating availability and then everyoneultimately becomes more price sensitive.”43 See http://www.nytimes.com/2015/03/04/realestate/commercial/hotel-market-staggers-in-new-york-city.html also http://www.bloomberg.com/news/articles/2015-02-20/nyc-hotel-glut-leading-to-slowdown-in-room-rate-increases and https://commercialobserver.com/2016/02/hersha-hospitality-says-supply-glut-weakens-growth-in-nyc-room-revenues/ 44 http://www.xe.com/currencycharts/?from=VND&to=USD&view=10Y 45 http://www.economist.com/content/big-mac-index 46 http://blogs.wsj.com/briefly/2016/01/25/hong-kongs-dollar-peg-next-in-the-firing-line-the-numbers/

http://www.nytimes.com/2015/03/04/realestate/commercial/hotel-market-staggers-in-new-york-city.htmlhttp://www.nytimes.com/2015/03/04/realestate/commercial/hotel-market-staggers-in-new-york-city.htmlhttp://www.nytimes.com/2015/03/04/realestate/commercial/hotel-market-staggers-in-new-york-city.htmlhttp://www.nytimes.com/2015/03/04/realestate/commercial/hotel-market-staggers-in-new-york-city.htmlhttp://www.bloomberg.com/news/articles/2015-02-20/nyc-hotel-glut-leading-to-slowdown-in-room-rate-increaseshttp://www.bloomberg.com/news/articles/2015-02-20/nyc-hotel-glut-leading-to-slowdown-in-room-rate-increaseshttp://www.bloomberg.com/news/articles/2015-02-20/nyc-hotel-glut-leading-to-slowdown-in-room-rate-increaseshttp://www.bloomberg.com/news/articles/2015-02-20/nyc-hotel-glut-leading-to-slowdown-in-room-rate-increaseshttps://commercialobserver.com/2016/02/hersha-hospitality-says-supply-glut-weakens-growth-in-nyc-room-revenues/https://commercialobserver.com/2016/02/hersha-hospitality-says-supply-glut-weakens-growth-in-nyc-room-revenues/https://commercialobserver.com/2016/02/hersha-hospitality-says-supply-glut-weakens-growth-in-nyc-room-revenues/https://commercialobserver.com/2016/02/hersha-hospitality-says-supply-glut-weakens-growth-in-nyc-room-revenues/http://www.xe.com/currencycharts/?from=VND&to=USD&view=10Yhttp://www.xe.com/currencycharts/?from=VND&to=USD&view=10Yhttp://www.xe.com/currencycharts/?from=VND&to=USD&view=10Yhttp://www.economist.com/content/big-mac-indexhttp://www.economist.com/content/big-mac-indexhttp://www.economist.com/content/big-mac-indexhttp://blogs.wsj.com/briefly/2016/01/25/hong-kongs-dollar-peg-next-in-the-firing-line-the-numbers/http://blogs.wsj.com/briefly/2016/01/25/hong-kongs-dollar-peg-next-in-the-firing-line-the-numbers/http://blogs.wsj.com/briefly/2016/01/25/hong-kongs-dollar-peg-next-in-the-firing-line-the-numbers/http://blogs.wsj.com/briefly/2016/01/25/hong-kongs-dollar-peg-next-in-the-firing-line-the-numbers/http://www.economist.com/content/big-mac-indexhttp://www.xe.com/currencycharts/?from=VND&to=USD&view=10Yhttps://commercialobserver.com/2016/02/hersha-hospitality-says-supply-glut-weakens-growth-in-nyc-room-revenues/https://commercialobserver.com/2016/02/hersha-hospitality-says-supply-glut-weakens-growth-in-nyc-room-revenues/http://www.bloomberg.com/news/articles/2015-02-20/nyc-hotel-glut-leading-to-slowdown-in-room-rate-increaseshttp://www.bloomberg.com/news/articles/2015-02-20/nyc-hotel-glut-leading-to-slowdown-in-room-rate-increaseshttp://www.nytimes.com/2015/03/04/realestate/commercial/hotel-market-staggers-in-new-york-city.htmlhttp://www.nytimes.com/2015/03/04/realestate/commercial/hotel-market-staggers-in-new-york-city.html


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predominance of non-HKD assets owned by KS. This risk can be hedged by a short position

in the HKD.

This stock may never re-rate to a more appropriate cap rate and may remain cheap.

Factors mitigating risks

It is simply too cheap Assuming the current level of free cash flows can continue and grows –

and given the company’s solid balance sheet, there is little reason to imagine why free cash

flows would decline over a long enough period of time (excluding short term declines due to

currency movements or hotel industry cyclicality), then the stock is already very cheap,

trading at a double digit free cash flow yield.

Low risk business and low risk balance sheet This security is the archetypal “sleep well atnight” investment with low business risk and low balance sheet risk.

Further reading

The company’s annual reports can be accessed at http://www.keckseng.com.hk/Eng/Reports.htm

and a list of all announcements at http://www.keckseng.com.hk/Eng/Announcement.htm.

Catalysts

The completion of the Hong Kong-Zhuhai-Macau Bridge may lead to further divestments of

property in Macau. Should all properties be divested we expect at least HKD 3 per share to

“show up” on the company’s balance sheet (our estimated value of 3.75 per share less the

0.60 at which the assets are currently valued), and possibly more; there is a possibility thatthe entire current market cap of KS may materialize on the balance sheet once these assets

are sold.

More value-creating activities by management such as new developments in Macau or other

property acquisitions or divestments.

http://www.keckseng.com.hk/Eng/Reports.htmhttp://www.keckseng.com.hk/Eng/Reports.htmhttp://www.keckseng.com.hk/Eng/Reports.htmhttp://www.keckseng.com.hk/Eng/Announcement.htmhttp://www.keckseng.com.hk/Eng/Announcement.htmhttp://www.keckseng.com.hk/Eng/Announcement.htmhttp://www.keckseng.com.hk/Eng/Announcement.htmhttp://www.keckseng.com.hk/Eng/Reports.htm


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Important Legal Disclaimer

All information provided herein is for informational purposes only and should not be deemed as arecommendation to buy or sell any security mentioned.

Heller House may currently or in the future buy, sell, cover or otherwise change the form of its investment inthe companies discussed in this memo for any reason. Heller House hereby disclaims any duty to provide anyupdates or changes to the information contained here including, without limitation, the manner or type of anyHeller House investment.

Past performance is not necessarily indicative of future results. All investments involve risk including the lossof principal. It should not be assumed that any of the securities transactions or holdings discussed herein wereor will prove to be pro�itable, or that the investment recommendations or decisions we make in the future will

be pro�itable or will equal the investment performance of the securities discussed herein. Speci�ic companies

or securities discussed in this memo are meant to demonstrate Heller House’s investment style and the typesof industries and instruments in which we invest and are not selected based on past performance.

The analyses and conclusions of Heller House contained in this memo are based on publicly availableinformation. Heller House recognizes that there may be con�idential or otherwise non-public information inthe possession of the companies discussed in this memo that could lead these companies to disagree with HellerHouse’s conclusions.

The analyses provided include certain statements, assumptions, estimates and projections prepared withrespect to, among other things, the historical and anticipated operating performance of the companies. Suchstatements, assumptions, estimates, and projections re�lect various assumptions by Heller House concerning

anticipated results that are inherently subject to signi�icant economic, competitive, and other uncertainties and

contingencies and have been included solely for illustrative purposes. No representations, express or implied,are made as to the accuracy or completeness of such statements, assumptions, estimates or projections or with

respect to any other materials herein.This document is con�idential and may not be distributed without the express written consent of Heller Houseand does not constitute an offer to sell or the solicitation of an offer to purchase any security or investmentproduct.

Documents

Keck Seng Investments - Heller House Investment Memo - 4-7-16