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1127:HK - Lion Rock Group


kab60
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Lion Rock Group, at the current levels, is an opportunity to invest alongside an impressive owner-operator of a South East Asian printing Company, which currently trades well below NCAV.

 

Covid19 had them lower the dividend a little, but around these levels they'd usually return about 13-14 pct. of the current marketcap in dividends annually, so there's positive carry even if one has to wait a while for the market to recognize the value of the Company. David Webb, famed HK-investor, also owns 8 pct.

 

Anyway, judging by the numbers it's a good business in an oldschool industry which isn't going away - with more than above-average management.

 

Lion Rock Group is listed in Hong Kong but print Childrens and Adults book from their locations in China, Malaysia, Australia and Singapore. They do printing, print management and have recently gone higher up the value chain by partly taking over british publisher, and Lion Rock customer, Quarto Publishing (while clearly stating publishing isn't their core historic competence, so they are aware of their strengths and weaknesses and have hired industry folks to help with Quarto).

 

At Quarto, Lion Rock boss CK Lau has taken an active role and cut costs, improved the BS and turned the business somewhat around.

 

Anyway, Lion Rock has been diversifying their print ops away from China in recent years, so they've actually handled the tariff issues quiet well and feel they have an advantage over Chinese printers that struggle with tariffs and cost inflation.

 

To keep this short, at year end they had some 700m HKD of net current assets (quiet a bit of receivables, which they seem to have no problem to collect historically, but among others from Quarto). Versus a market cap of a bit more than 500m today. So a fat discount despite a record of returning money to shareholders (usually plus 70m HKD per year), high inside ownership and fine business economics with high returns on equity despite the "inefficient" balance sheet. It trades at like 3-4xnormalized earnings and 5-8times covid19 earnings (pulled that somewhat out of my ass). Company is actually pretty asset light, a clear strategic decision, so despite revenues dropping 25 pct in H1, pretax earnings "only" down 45 pct.

 

I have a position, anyone else following?

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I've looked at this several times, and the numbers are beautiful. My main concerns always were how sticky are their customers, and do they have enough scale? Their gross margins benefited nicely since acquiring APOL in 2012 and they became more asset light. But it's still a far cry from Cimpress-like margins, even though they serve different verticals. I think that leaves them pretty exposed to huge operating deleverage, even if not as severe as their more asset-heavy peers. I think it also gets pretty tricky when a big chunk of their business (I'm assuming) are short-term contract based and deal with somewhat discretionary products. 

 

That said, it really cheap, and many of these concerns may not quite matter at these levels. 

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I own some Lion Rock in my net-net basket as well. Have u looked at its recent spinoff Left Field Printing (HK:1540)?

Yes, followed it for years but always found Lion Rock as the better bet due to business model, valuation and being CK Laus vehicle as well as Webb owning 8 pct. Lion Rock still owns some 40 pct I believe of Left Field, they spun off a small amount of shares. Left Field was written up on VIC before, thesis revolved around it being valuable as a way to do a backdoor listing in HK. Couldnt really figure out the probabilities of that so went with the cash gusher.

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I've looked at this several times, and the numbers are beautiful. My main concerns always were how sticky are their customers, and do they have enough scale? Their gross margins benefited nicely since acquiring APOL in 2012 and they became more asset light. But it's still a far cry from Cimpress-like margins, even though they serve different verticals. I think that leaves them pretty exposed to huge operating deleverage, even if not as severe as their more asset-heavy peers. I think it also gets pretty tricky when a big chunk of their business (I'm assuming) are short-term contract based and deal with somewhat discretionary products. 

 

That said, it really cheap, and many of these concerns may not quite matter at these levels.

Not sure how sticky it is but unlike Cimpress they don't have to spend a ton on marketing, and their execution is more impressive I'd say. I also think it's less likely capital floods into book printing... Anyway, I don't think it matters much at these levels, and I don't think operating leverage is that bad considering the recent update... Also, their ROE is pretty damn good for such an overcapitalized company. It actually seems like an above average business in a not so sexy industry.

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Are they facing a huge headwind? The demand for adult books, textbooks, etc. are dropping...

Btw, any thoughts on their associate Quarto Group (LSE: QRT)? Is it a good candidate for public LBO play?

I believe they write in one of their AR's how growth of ebooks has stalled and physical books is actually growing a tiny bit. But yeah, this is low to no-growth which can be fine since it doesn't attract much competition. Look at what Quarto publishes, it's non-fiction and a lot of evergreens - let's call it recurring recenue and slap a SAAS multiple on it! Quarto is interesting, but I cant trade it on IBKR. Anyway, Quarto had too much debt for an LBO, but Lion Rock picking it up could make sense if that is what you mean? I believe a bunch of Lion Rocks receivables are owed by Quarto, so I think CK Lau was both opportunistic and schrewd when taking control.

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  • 3 weeks later...

I think this article answers why/ how physical books have been holding up so well:

 

https://www.vox.com/culture/2019/12/23/20991659/ebook-amazon-kindle-ereader-department-of-justice-publishing-lawsuit-apple-ipad

 

For those who want the TLDR version: Price fixing between Apple and the big publishing houses pretty much kneecapped discount pricing for e-books.

 

And I think Lion Rock has been an indirect beneficiary of this arrangement. I don't know how long this industry dynamic will hold, but I suspect that it is a key factor to think about when considering an investment in the company (and any other companies in the industry).

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That's an interesting point, thanks for sharing. Regarding an investment in Lion Rock Group I don't think it matters much. A lot of the books they print are coffee table books so not what you'd usually consume on a Kindle. I also suppose the current weakness is a matter of lack of growth, covid19 fears and general HK resentment more than fears around a new pricing structure.

 

For me the case is that it's a high ROIC, asset light business throwing off cash and trading below NCAV with a pretty formidable management. And unlike a lot of value traps in HK, these guys are pretty good at unlocking value and returning cash to shareholders. So even if it never rerates one might be able to clip a 12-14 pct. yield annually.

 

It's a 5 pct. position for me, which is my smallest, mainly because I've seen so many of these HK Companies trade in the gutter for too long and opportunity cost is very real. But the yield is now so large and the value so screaming that I couldn't resist.

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I own a bit of Left Field Printing. It's their Australian subsidiary. Used to be on the ASX but they moved it to HK. I like that historically they've upstreamed the cash to Lion Rick via dividend, so I share in that. My problem historically with cigar butt type businesses is the management goes and spends the money on other things.

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I agree on that. I just don't think this is a a cigar butt business. The economics are quiet formidable although growth is harder to come by, but that's where their savy M&A skills come into the equation. Key man risk is real, however, as this is definitively not a business that any idiot can run like MO, and CK Lau is pretty old (almost 70 I believe). But he just survived getting a round of covid19, so he might be a tough nut. Anyway, why do you prefer Left Field? Simply to minimize the risk of bad capital allocation? I agree Left Field is interesting, I just find Lion Rock to be the better, more diversified play - and cheaper last time I looked.

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  • 2 weeks later...

Board meeting on the 31st of August. I'd be surprised if they didn't announce a dividend. They should do 30m in H1 despite covid19, and H2 is usually their best period so around 8xcovid19 earnings and something like 4x"normalized earnings". It trades around NCAV, so you get a resilent and asset light business, which has just been battle-tested, "for free". I understand why people shy away from a lot of HK companies that are optically cheap (I do), since it seems impossible to get access to the value, but this Company has paid out 219m in dividends from 2017-2019 (40 pct. of the current market cap) - and increased the dividend some 50 pct. in five years.

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  • 2 weeks later...

Results out, pretty good I'd say (34m profit), but no dividend - bummer. Outlooks seems fine, they seem well positioned, still trading around NCAV. Joker is whether receivables will be impaired, but historically they seem to have managed those well enough and they don't seem worried. I'm not either.

 

Still, one might be double counting a bit if one values cash at face value and the business as a multiple of earnings. They seem to have generous payment terms, thus essentially financing their customers somewhat, so fair to haircut NCAV. Not that it should matter much here (hopefully).

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  • 1 month later...

Lion Rock Group just bought some of the CK Lau's (CEO) shares in Quarto Group at a fair price (one might argue they're very undervalued). Anyway, perhaps what is more interesting is that Lion Rock Group also bought a chunk of shares from a British fund at 100p/share versus the current price of 57/share. Quarto is extremely illiquid, but it might signal that Lion Rock Group thinks Quarto is significantly undervalued. Last year there also was an approach from a potentiel buyer at 100/share. I can't trade Quarto Group at Interactive Brokers nor any of my other brokers, so perhaps an idea for someone else. Seems undervalued considering the catalog of titles, and it seems operations are turning around - despite a hit from covid19.

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Lion Rock Group just bought some of the CK Lau's (CEO) shares in Quarto Group at a fair price (one might argue they're very undervalued). Anyway, perhaps what is more interesting is that Lion Rock Group also bought a chunk of shares from a British fund at 100p/share versus the current price of 57/share. Quarto is extremely illiquid, but it might signal that Lion Rock Group thinks Quarto is significantly undervalued. Last year there also was an approach from a potentiel buyer at 100/share. I can't trade Quarto Group at Interactive Brokers nor any of my other brokers, so perhaps an idea for someone else. Seems undervalued considering the catalog of titles, and it seems operations are turning around - despite a hit from covid19.

My interpretation of the Lion Rock filing is that they bought the shares at this inflated price to enlarge the free float of Quarto. Quarto did a rights offering (open offer) earlier this year and as a result they ended up with a free float that was too small and Quarto was now violating a stock market rule. By Lion Rock buying the shares, the British fund now owns less than 5%. As a result, the remaining shares in the hands of the British fund now count as part of the free float, because they are no longer deemed to be a substantial holder. So, this purchase seems more of a creative trick to get around Quarto's free float problem. They could've picked up 400k extra shares at half price by being patient in open market purchases, but that would've only made the float smaller and exacerbated Quarto's problem.

 

The positive side to me is that they do still value Quarto's public listing and don't seem to look to delist the company at this time.

 

I own some Quarto. Unfortunately I bought my shares a couple of years ago, so a losing position for me currently. I think C.K. Lau will be able to turn it around. Hopefully the company will have a disaster free year in the near future.

 

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Yes, that is how I read it as well. But the volume is almost nonexistant and they cite how building a large stake would be difficult. Either way, I think Quarto looks potentially very cheap, and CK Lau has a good track record of fixing businesses it seems. At the same time, he knows he's not a publisher, so he seems aware of where he lacks the necessary skills and thus where he needs to get help - which be seems to have gotten with Quarto. Which broker do you use if you don't mind?

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  • 1 month later...

It just means they don't need a lot of capex to run their operations and that they deliver a high return on invested capital, so they're able to return large amounts of capital to their owners. On top of that they are way overcapitalized with net current assets equal to around the current marketcap. So it is almost (but not really) like you get the operating business for free.

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They sure do, but they're organized in there different segments with print manufacturing being just one (and eating the most capex). The other two are print services management and recently publishing (via Quarto). Whether one adjust for most of their excess cash or not they make a very fair return on their capital. The annual reports are quiet good, they lay out their thoughts pretty clearly, and I'd say execution is pretty stellar. This is their forward looking statement from the most recent AR:

 

PROSPECT:

 

We  are  transforming  from  a  China  based  printer  to  a  multinational  group  comprising  printing, print management and publishing. Looking  ahead,  we  expect  more  publishing  houses  will  shift  their  print  production  away  from China. In the next 3 years, the major focus for our printing business is to ramp up the capacity of our plant in Malaysia to add 50% of that of our flagship plant in China. This will not be easy as there are supply chain and logistical challenges in Malaysia, but we are confident that the operation at the new plant will reach critical mass to become financially sustainable.

 

The  print  management  business  at  APOL  and  Regent  has  been  the  cornerstone  of  our  asset-light  policy.  We  are  leveraging  that  know-how  in  supply  chain  orchestration  and  applying  it  in  Quarto  with  some  successes.  We  will  be  investing  in  more  technological  tools and systems at Quarto to extend our supply chain orchestration capability. On  the  publishing  front,  we  have  made  significant  inroads  into  returning  Quarto  to  financial  health,  improving  the  print  management  capability,  and  establishing  electronic  systems  to  access  business  data.  However,  a  lot  more  work  is  required  to  transform  Quarto.

 

As a printer, we are mindful that we do not possess the publishing business DNA, and  we  are  making  this  transformation  with  a  degree  of  adaptability.  We  are  confident  that,  with  Quarto’s  strength  in  global  sales  coverage,  print  production  efficiency  and  laser-focus publishing program, we will be in a leadership position in not so distant future.

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  • 3 months later...

Quarto extended bank debt, borrows another $10m (now $23m in total) from Lion Rock Group. Between $23m in borrowings and 104m HKD in receivables at FY19 Quarto better get their house in order. Not too worried, Quarto seems to be making progress, but clearly worth following.

 

https://www.londonstockexchange.com/news-article/QRT/announcing-new-bank-facility/14867546

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  • 1 month later...

Annual results out the other day, net income down from 154m to 116m HKD. Dividend is back, half-year dividend 5c on 82c stock. Left Field Printing struggling, Quarto seems to be doing better. Still think it's too cheap around NCAV considering how much cash it throws off and returns and how well management have done vertically integrating and establishing a presence outside of China. Definately not a business any idiot could run though.

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Their discussion about importance of scale and the onshoring momentum (particularly to Europe) is interesting. How do they stack up on both? I like how they've been proactive in diversifying their production bases and vertically integrating the publishing and manufacturing sides. But is it enough/ is it translating to better pricing power?

 

On a more granular level, net income attributable to owners in 2020 and 2019 is 104m and 139m respectively. Of this year's figure, ~70m (~55m after-tax) of that was from pandemic subsidies and FX gains. So their underlying profit for the year is closer to like 40m - 50m. Their working capital management for the year was strong, which allowed for higher cash conversion to the balance sheet. But working capital management is only a temporary balm and eventually the business needs to pickup.

 

Anyways I don't want to nitpick and miss the forest for the trees. But considering the tough industry and challenging business momentum, I think a higher level of precision becomes important. 

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