Monthly Archives: May 2016

Peak Sport Products Potential Privatization May 25, 2016

Peak Sport Products Potential Privatization May 25, 2016

On May 24, 2016, Peak Sport Products was looking into the potential privatization of the company by the controlling shareholders.  The announcement was vague and came with no other information, therefore the merits of a privatization offer cannot be evaluated.

The talk of an offer points to ownership that believes in the business and the financial statements.  The company has a significant amount of cash on the balance sheet and there were questions surrounding whether the cash on the balance sheet was real as the company issued shares despite a large net cash position.

There is no concrete offer and this could be management just talking up the stock. There is no change to our position and we await more concrete information.

Turk Tuborg: A Turkish Brewer in a Duopoly offering an 8.0% NOPAT Yield 5/21/2016

Turk Tuborg: A Turkish Brewer in a Duopoly offering an 8.0% NOPAT Yield


Turk Tuborg May 21 2016 RCR


Investment Thesis


Türk Tuborg is the second largest company in a Turkish Beer market that is a duopoly.  Along with Anadolu (Anadolu), the two companies have controlled over 99% of the market for many years. There are significant barriers to entry in the form of economies of scale and brand as the Turkish Beer market requires a two way distribution system and there are restrictions on advertising. Türk Tuborg has outperformed Anadolu increasing its market share from 11.5% in 2010 to 31.4% in 2015. The company also increased its pre-tax ROIC significantly from -3.3% in 2010 to 95.2% in 2015. These improvements came just after new ownership introduced a number of new products to the market. The company offers an 8.0% EBIT yield with pricing power leading to an expected return of 13.0% per year, which is attractive given the barriers to entry in the market and the company’s outperformance under current management.


  • Expected annual return between 13.0%-15.5%
  • We will initiate a 4.0% position in Turk Tuborg.


Turk Tuborg Key Stats 5 21 2016 


 Turk Tuborg Key Stats II 5 21 2016


Company Description


Türk Tuborg was founded in İzmir-Pınarbaşı in 1967 with production starting in 1969 through a partnership between Tuborg and Yasar Holding Production. Carlsberg took a majority shareholding of Türk Tuborg in 2001 increasing its stake from 2.24% to 50.01% after purchasing 47.77% from Yasar Holding. This transaction valued Türk Tuborg at roughly USD110 million (DKK960 million). Over the course of the next few years, Carlsberg continued to increase its stake until reaching 95.69% in 2003. In 2008, Israel Beer Breweries Ltd, a Carlsberg partner in Israel and Romania, purchased 95.69% stake from Carlsberg for USD44.5 million valuing Türk Tuborg at USD80 million.  After the purchase, Türk Tuborg retained its license to continue to produce Carlsberg and Tuborg brands. The 4.31% not owned by Israel Beer Breweries is free float with the company listed on the Borsa Istanbul.


Türk Tuborg owns one of the largest breweries in Turkey with 36,000 tons of malt and 333 million liters of beer capacity. The company produces Tuborg (Gold/Amber/Special/Fici), Carlsberg, Skol, Venus Pilsner, and Troy Light for both Turkey and export markets. The company also produces Vole, Thelch, and F5 for export markets.  Türk Tuborg also imports Leffe, Hoegaarden, Guiness, Corona, Weihenstephan, Kilkenny, and Somersby.


Türk Tuborg’s products are sold through direct sales and dealers all over Turkey.  Corona, Leffe Brune, Leffe Blonde, Leffe Radieuse, Hoegaarden, Weihenstephan, Kilkeny, and Guinness brands are positioned at the super premium beer segment. Carlsberg brand is positioned at the premium beer segment. Tuborg Gold, Tuborg Fici, and Tuborg Special brands are positioned at the standard segment, while, Skol and Venus brands are positioned at the economical beer segment in 2015.


In 2015, Türk Tuborg was the second largest player in the market with a 31.4% volume share of the Turkish beer market behind Andalou’s 68.4% volume share.


In 2011, Türk Tuborg launched the Türk Tuborg Brewmaster project with the goal of delivering product variety to Turkish consumer. The company introduced super premium brands Corona, Guinness, Leffe, Weihenstephan, Kilkeny, and Hoegaarden.  The project has help increase the company’s volume share in the Turkish beer market from an estimated 11.0% in 2010 to 31.4% in 2015.



Barriers to Entry


Within the Turkish beer market the evidence points to significant barriers to entry.


  1. Türk Tuborg and Anadolu have accounted for over 99% of the Turkish beer market for many years. At the end of 2015, these two companies represented 99.8% of the market.  The high and consistent market share points to no significant new entrants or exits from the market.  The duopolistic market structure with a no significant entry or exit from the industry points to significant barriers to entry. Heineken attempted to enter the Turkish beer market, but withdrew in 2006 as it was unable to reach the minimum efficient scale needed to compete.
  2. Distribution is a significant barrier to entry. In 2012, 64% of Turkish beer volume was returnable bottles and kegs making a two way distribution system a requirement to compete in the Turkish beer market increasing the investment requirements and complexity of the required distribution network.
  3. The distribution network required to compete also points to economies of scale as distribution is a fixed cost independent of units sold. Over the past five years, Türk Tuborg has averaged roughly TRY155 million per year in selling, distribution, and marketing expenses. In 2015, both Türk Tuborg (TRY134.3) and Anadolu (TRY137.6) had a gross profit of roughly TRY135 per hectoliter. Just to cover the fixed costs associated with Türk Tuborg’s distribution, a competitor would need to achieve 12% market share.
  4. There are significant advertising restrictions on beer and other alcohol decreasing a new entrant’s ability to building a brand. There is no alcohol advertising on television or radio. Also, alcohol companies cannot sponsor any sports team and, similar to smoking, all alcohol on television or in movies is blurred.
  5. Türk Tuborg seems to have significant pricing power. Since 2008, Türk Tuborg has been able to increase its average selling price by 7% per year. The company’s cash gross margin has increased from 49.0% in 2008 to 60.1% in 2015.
  6. Total Turkish beer market volume has not grown since 2008, decreasing the attractiveness of the market, and increasing the difficulty of entering the market as lower growth often leads to increased competitive rivalry.
  7. Türk Tuborg has little or no working capital requirements. In 2014 and 2015, working capital per unit has been negative and averaged TRY63 million. Negative working capital is a strong sign of a company’s bargaining power over both its suppliers and customers.



While the evidence pointing to barriers to entry are strong, there is evidence against barriers to entry.


  • Türk Tuborg’s recent profitability has been strong with a ROIC averaging over 100% over the past two years, but from 2008 to 2011 ROIC averaged 0%. The lack of inconsistent ROIC is evidence against a competitive advantage.


Overall, the evidence overwhelmingly points to significant barriers to entry that would take years for a new competitor to reach the necessary scale to compete.


Given the evidence points to the presence of barriers to entry, what form do they take? Barriers to entry take the form of economies of scale and brand. Economies of scale are in the form of a two way distribution network that requires a minimum efficient scale of roughly 12.0% just to replicate the smaller of the two large competitors’ annual spend on selling and distribution expenses.  Additionally, large breweries require expensive equipment that is much cheaper on a per unit basis if the depreciation is spread over many units. Additionally, larger brewers can acquire raw materials and package goods cheaper due to the size of their purchases.


Brand advantage also exists. The restrictions on advertising help existing brands as new entrants cannot build a brand to displace incumbents making brands with an existing relationships and positions more resilient and less resistant to change.



Intensity of Rivalry


Given the duopoly within the Turkish beer market, the intensity of the rivalry between will be a significant factor in determining industry profitability.  The industry rivalry seems low.  Since 2011, Türk Tuborg has raised prices on average by 8.4% per year while Anadolu has raised prices on average by 8.0% per year. Since 2008, Türk Tuborg has raised prices on average by 7.2% per year while Anadolu has raised prices on average by 7.1% per year. Price inflation has been during a period of increasing excise tax.  If the intensity of the rivalry was high, both firms would not have increased prices in an attempt to gain market share given the importance of economies of scale in the industry.


The presence of economies of scale in the industry points to increased intensity of rivalry as one of the drivers of profitability is your size or market share leading competitors to attempt to maintain or increase their share to maintain profitability.


(Capex)/depreciation ratio is used to determine the amount of supply in the industry. If capex exceeds depreciation, industry participants are increasing supply.  If supply increases outpace demand profitability will suffer. Currently, the Turkish beer industry volumes are not growing with total volume estimated at 9.67 million hectoliters since 2008.  The lack of growth in and of itself typically increases rivalry but with the duopoly it is easier to keep track your one competitor making coordination easier. Despite the lack of growth, the industry capex/depreciation ratio has averaged 134%.  A more appropriate capex/depreciation ratio for a no growth, mature industry is somewhere below 75% as less investment goes to the industry leading to depreciation exceeding capex. The capex/depreciation ratio may point to increased rivalry as competitors attempt to fill their new capacity.


The participants sell products that are similar but are differentiated in the form of taste and brand decreasing competitive rivalry as price is an important but not the sole factor in purchasing the good.


Anadolu net debt has ballooned from 0.8 times EBIT in 2011 to 6.1 times EBIT in 2015.  The change in fortunes occurred when SAB Miller and Anadolu created an alliance with Anadolu acquiring some of SAB Miller’s assets in the region and SAB Miller taking a 26.5% stake in Anadolu.  The increase geographical presence and increased debt decreases the Anadolu’s flexibility, but it may lead to an increase intensity of rivalry as Anadolu’s Turkish beer operations are not generating sufficient operating profit to cover interest expenses.


Türk Tuborg’s market share gains also can just after the launch of Türk Tuborg’s Brewmaster project. The increased product offerings may be striking a cord with customers that Anadolu is unable to replicate.


Overall, the intensity of rivalry in the industry is low and expected to remain low but this may change given Anadolu’s market share losses, profitability declines, and increasing debt load.



Bargaining Power of Suppliers


Suppliers have very little bargaining power.  The main inputs into beer are commodity products sold by many sellers where the customers are pure price takers.  This bargaining power is reduced further by the duopolistic nature of the market.  Barley largest use is not beer but animal feed, which accounts for 67% of consumption.  Industrial uses such as beer are the next largest consumer of barley accounting for 21% of total consumption. The variety of uses for barley increases the bargaining power of suppliers.  Hops on the other hand are primarily used for beer.  The United States is seeing high demand for hops due to the trend towards craft beer, as craft beer uses much more hops that traditional beer.  Turkey is not seeing the trend toward craft beer therefore there is a lot less pressure.  Hops have less uses and there is much fewer uses for the product decreasing its bargaining power. Overall, due to the commodity nature of inputs, the numerous suppliers of these products, the limited uses of the products, and the duopoly in the Turkish beer market suppliers have very little bargaining power.



Bargaining Power of Customers


The customers of Anadolu and Türk Tuborg are dealers, distributors and large retail chains.  In 2012, off-premise accounted for 61.5% of sales in the Turkish Beer market, on-premise accounted for 23.2% of sales, and key accounts accounted for 15.2% of sales. Off-premise and on-premise are serviced by dealers and distributors.  In 2014, Anadolu had a network of 170 dealers and 27 distributors in 15 sales regions.  The number of dealers and distributors illustrated the fragmented nature of the customer base decreasing the bargaining power of customers.


Similar to bargaining power of suppliers, the duopoly and differentiated products decreases the bargaining power of customers combined with the fragmentation of the customer base leads to low bargaining power of customers.



Threat of Substitute


The main alcohol substitutes for beer are wine and spirits.  In 2012, Beer accounted for 58% of alcohol consumption within Turkey, spirits accounted for 33% of alcohol consumption, and wine accounted for 9% of alcohol consumption. Beer is the cheapest of all alcohol at a cost of TRY11.26 per liter, wine is the next cheapest at TRY54.67 per liter, and spirits are the most expensive with raki costing TRY73.48 per liter.  While wine and spirits are substitutes for beer, personal preferences are probably the biggest impediment to substitution.  Additionally, the significantly higher cost of wine and spirits makes substitution unlikely.





As mentioned, volumes in the Turkish Beer market have stagnated at 9.66 million hectoliters since 2008.  During this period, Türk Tuborg’s revenue increased by 23.69% per year driven by increased volumes (15.41% CAGR) and increased price (7.17% CAGR). Despite the lack of volume growth, Türk Tuborg’s volumes increase from 1.1 million hectoliters in 2008 to 3.0 million hectoliters in 2015 with growth coming at the expense of Anadolu’s volumes (8.5 mhl in 2008 to 6.6 mhl in 2015). Given the lack of volume growth in the market, growth from volume increases will eventually slow as Anadolu should retaliate in an attempt to win back volume share given the importance of economies of scale on profitability.


Türk Tuborg’s ASP (7.2% since 2008) increases are more sustainable given the duopoly in the Turkish Beer market and the relative cheapness of beer to substitutes.


Many often quote Turkey’s low per capital consumption of beer and alcohol as a potential source of growth. Turkey consumes beer at 17% of the EU average. This statistic is misleading as Turkey is predominantly Muslim and there are estimates between 40% and 80% of the population do not drink alcohol, which is unlikely to change.  Assuming 75% of the population does not drink alcohol, the per capita consumption is 67% of the EU average for beer consumption.  With a religion that forbids alcohol consumption playing a large role in the society, there is not going to be a significant growth from increased per capita consumption.  Additionally, the current ruling party has a religious slant and has increasing excise tax and advertising restrictions in an attempt to “protect” the public from themselves.


There is a potential for increased penetration of beer companies’ distribution channel as there are only 1.1 off-premise outlets per 1,000 people well below regional peers.


Turk Tuborg Off Premise Channel 5 21 2016





In 2008, Israel Beer Breweries Ltd, a Carlsberg partner in Israel and Romania, purchased 95.69% stake from Carlsberg from USD44.5 million giving Türk Tuborg a total enterprise value of  USD80 million.  The company is owned by Central Bottling Company, which has held the Israel franchise for Coca Cola products since 1968.


Israel Beer Breweries has done a good job of increasing the intrinsic value of the company since acquiring its ownership position. Since 2008, revenues have increased by 23.69% per year as volumes increased by 15.41% per year and prices increased by 7.17% per year. The volume increases are particularly impressive given volumes have not grown in the Turkish Beer since 2008.


The company has significantly outperformed its main rival Anadolu. Since 2011, Türk Tuborg has taken almost 19% volume share, increasing its share from 12.5% to 31.4%. Over that period, the company’s ROIC increased from 1.1% to 95.2% while Anadolu’ Turkish Beer operation’s ROIC decreased from 76.5% to 29.3%, illustrating the importance of economies of scale on profitability.

Turk Tuborg vs Anadolu Efes 5 21 2016


Since 2008, Türk Tuborg’s ASP premium averaged 5.9%.

Turk Tuborg ASP Premium 5 21 2016


Türk Tuborg’s market share gains came during a period where the ASP premium declined.

Turk Tuborg ASP Premium + Volume Share 5 21 2016


It seems Türk Tuborg’s products are viewed as premium products by the public given the consistent ASP premium relative to Anadolu.  With Türk Tuborg prices decreasing relative to Anadolu, consumers may see themselves getting a higher quality product at a more attractive price.  The price premium returned in 2015, yet Türk Tuborg continued to gain market share, which seems to invalidate the theory of consumers purchasing due to the decrease in Türk Tuborg’s premium.


Over the review period, Türk Tuborg’s cost of goods per unit increased by 3.7% while Anadolu’ cost of goods sold increased by 14.3%. Anadolu’ Turkish Beer operations still produce goods cheaper than Türk Tuborg but there has been a significant convergence of costs. Anadolou producing goods cheaper makes sense given the presence of economies of scale in the industry allowing the company to obtain a discount for raw materials purchased in bulk and spread depreciation over a greater number of units.


Since 2011, Türk Tuborg has been able to decrease operating expenses per unit by 1.9% per year while Anadolu’ operating expenses have increased by 10.1% per year. Türk Tuborg is much more operational efficient with operating expenses per unit at TRY74.6 compared to Anadolu TRY93.4.  In 2011 and 2008, Anadolu’ operating efficiency was well ahead of Türk Tuborg’s but declining volumes and cost inflation lead to the increase in operating expenses per unit increased.


Türk Tuborg’s operating efficiency is the key differentiator allowing the company to generate an operating profit per hectoliter that is 35% greater than Anadolu, not an insignificant gap.


Türk Tuborg also has a big advantage on capital efficiency in 2015 as working capital per unit is TRY-23.4 compared to TRY76.5 at Anadolu.  Fixed assets are similar with Anadolu having a slight advantage as expected given the presence of economies of scale as larger breweries can spread fixed capital investments over a larger number of units. As the volume differential has shrunk, so has the difference in fixed capital efficiency.
Overall, Türk Tuborg’s ROIC is much higher than Anadolu in 2015 at 95.2% compared to 29.3%, a change from 2011 and 2008 where Anadolu’ ROIC averaged 82.4% compared to an average ROIC of -6.2% at Türk Tuborg in 2011 and 2008.


Overall, management has done well operationally increasing volumes, ASP, operating margins, capital efficiency, and ROIC.


The company has not allocated capital to anything but the business.  There have been no dividends meaning net debt has decreased from TRY42 million to a net cash position of TRY313 million.  Cash is starting to build up on the balance sheet at almost 2 times operating income so the company could start returning that cash to shareholders in the form of a dividend.


There are no corporate governance issues other than related party transactions at 5.8% of sales and 4.8% of assets but it is nothing too significant.





Given the existence of the barriers to entry, the best method of valuing Türk Tuborg is based on earnings. Our preferred valuation method is IRR, using the company’s current free cash flow yield plus expected growth. At the close of business on May 20, 2016, the company was trading on a current free cash flow yield of 5.4%.  Given the pricing power in the industry the company can expect at least 5.0% increases in prices and if it can continue to grow volumes at 5.0% per year than it offers a 15.3% expected return.


Valuing the company using current EBIT yield plus and organic growth rate, the company is trading on an EBIT yield of 8.0% with pricing growth of 5.0% bring the current expected return to 13.0%. Given the strength of the barriers to entry within the industry, a 13.0-15.0% return using conservative estimates is very attractive.



Why is it Cheap


The stock is cheap due to economic and political issues within Turkey.  It also has a very small free float and illiquid with an average trading volume of USD137,000 over the past six months.





Türk Tuborg has been gaining market share and outperforming Anadolu significantly.  Anadolu Turkish beer operations have seen deteriorating profitability.  The combination of market share gains and deterioration of profitability may lead to Anadolu increasing the intensity of rivalry to win back market share and profitability.


Turkey has one of the highest excise taxes on alcohol in Europe, which is 3.91 times the European average. This is making alcohol more expensive and suppressing demand in the country leading to the stagnation in volume since 2008. From 2002 to 2013, Turkish excise tax increased by 6.63% per year. Given the ruling party’s religious slant, it would not be a surprise to see a continuation of excise tax increases.


There are increasing restrictions on alcohol in Turkey. Retail alcohol sales licenses are limited between the hours of 10 am and 6 pm, as well as completely ban alcohol advertising and promotions of alcohol-related products. New licenses for the sale of alcohol are restricted. There is an ever increasing shift towards prohibition.


There is political risk in Turkey with it becoming more dictatorial. The increasing restrictions on freedom may bring a reaction.


A slowdown in macroeconomic growth or tourism is a short term risk.

Universal Health May 9, 2016 Overpaying for an Acquisition + Share Issuance = Enough is Enough?

Universal Health May 9, 2016 Overpaying for an Acquisition + Share Issuance = Enough is Enough?


On May 9, 2016, Universal Health agreed to purchase 36.38% of Jilin Wenhui Capsules Limited for RMB270.3 million placing an enterprise value on Jilin Wenhui of RMB743.0 million.  The company is a new high-tech enterprise that conducts research and development, manufactures, and sells hollow capsules, and is a leading capsule manufacturing enterprise in terms of scale in northeastern China. Jilin Wenhui Capsules current annual output of medical hollow capsule was approximately 15.0 billion, with plant capsule capacity of approximately 6.0 billion and plant gelatin (modified starch) capacity of approximately 5,000 tonnes. To complete the transaction, Universal Health issued 400,000 shares at a price of HKD0.725.


In 2015, Jilin Wenhui had a net asset value of RMB26 million, profit before tax of RMB6.99 million, and profit after tax of RMB5.34 million.  Universal Health purchased price places a valuation on Jilin Wenhui at 28.4 times book value and 139.1 times earnings.  These are astronomical figures in the absence of further information to analyze Jilin Wenhui. It seems the company is just throwing money away and paying anything to main growth something that is often seen with serial acquirers.  Universal Health is all over the place with its capital allocation.  We will be exiting our position in Universal Health as soon as possible.


While it is unfortunate we made mistakes on Universal Health and Miko International, the best teacher is pain and these mistakes will strengthen our investment process. There are a number of lessons that we have taken from the Universal Health and Miko International mistakes.


  1. Entry positions should be less aggressive allowing us to gain a better understanding of the company over time. This strategy would have prevented the gains we saw in PC Jeweller but downside protection is just as important if not more important than upside potential.   Less aggressive position sizes also pay respect to our ignorance and the limits of our knowledge.  We still believe in concentrated portfolios but small cap investing particularly in Emerging Markets bring additional risks and additional diversification is needed.  We still believe in concentrated portfolios 20-30 companies but oversized positions that investors can take in larger, well established companies may not be as prudent in smaller companies.
  2. We need to put more emphasis on why a stock is cheap. If it has tremendous operating history and good current earnings yet is extremely cheap, it may be a value trap, particularly in China.
  3. Focus needs to be on companies with long history of operations and being publicly traded. Both Miko International and Universal Health IPO’d over the past few years and they had not been operating for decades.
  4. Capital allocation is crucial and missteps should be viewed with extreme caution. Miko International issued shares at extremely cheap valuations with significant net cash balance.  A major red flag, which we overlooked.
  5. Along these lines, while strong financial health is crucial to any investment case, very large net cash positions is a potential sign of poor capital allocation at best and fraud at worst.
  6. When management starts selling your should probably start selling too as they have much more information about the company than you.
  7. Stay away from serial acquirers particularly in industries where there is n strategic logic for acquisitions.
  8. Chinese companies seem to be a different breed where financial statements cannot always be trusted. As outside investors, the primary evidence is financial statements of the company and competitors.  We look for additional evidence from independent sources to corroborate financial statements but it is not always there.  If financial statements cannot be trusted, you cannot invest.  Given the risk, we will be requiring additional evidence with Chinese companies and holding them at lower weights.

Honworld May 6, 2015 Cheap Financing or Something Else?

Honworld May 6, 2015 Cheap Financing or Something Else?


On May 6, 2016, Honworld Group announced a RMB133 million investment in its wholly owned subsidiary Lao Heng He from CD Fund in exchange for an estimated 3.5% of Lao Heng He’s capital. The actual percentage that CD Fund receives will be determined by a valuation report that will be released over the next three months.   The funds will be used to construct a natural ecological brewing production base in Wuxing Area, Huzhou City, Zhejiang Province, PRC (the investment project).


The transaction is conditional upon the satisfaction of the following conditions:


  1. from the date of the Investment Agreement to the date of the Completion, there is no material adverse event that will adversely impact on the business prospects, assets, and financial condition of Lao Heng He;
  2. the articles of association of Lao Heng He has been amended according to the terms of the Investment Agreement;
  3. all internal approvals of Lao Heng He, Huzhou Chen Shi, Honworld, and Huzhou Nantaihu with respect to the entry of the Investment Agreement have been obtained;
  4. Lao Heng He has obtained the relevant undertaking documents from Huzhou City Wuxing Finance Bureau for the Investment Project;
  5. Lao Heng He has obtained the approval from the relevant local government authorities for the Investment Project; and
  6. CD Fund completing its due diligence on Lao Heng He. Use of Proceeds Lao Heng He shall ensure that all proceeds of the Capital Investment to be used in the implementation of the Investment Project.


Honworld’s wholly owned subsidiary, Huzhou Chen Shi agreed to repurchase the equity interest of Lao Heng He to be owed by CD Fund within 8 years after the payment of the Capital Investment.  CD Fund is according to the repurchase schedule under the Investment Agreement. Under the agreement, the CD Fund with receive minimum returns of a dividend at an annual rate of return amounted to 1.2% of the Capital Investment. No dividend payments need to be made by Lao Heng He until 20 March 2018. On 20 March 2018, the CD Fund shall be paid the total dividend accumulated then the CD Fund will be paid a yearly dividend on or before 20 September every year after 20 March 2018.


Lao Heng He is a wholly-owned subsidiary principally engaged in the manufacturing of cooking wine, soy sauce, vinegar, soybean sauce products and other condiments products. Lao Heng He’s unaudited key income statement accounts are below.

May 6 2016 Lao Heng He Results


In 2016, the company accounts for 97% of Honworld’s revenue, 97% of its net profit before tax, and 89% of its total assets.


CD Fund, a wholly-owned subsidiary of China Development Bank, was established on 25 August 2015 and is principally engaged in the investment of financial bonds.


The investment will be reported as a financial liability on the company’s balance sheet as there will be no gain or loss as the company can repurchase the equity interest.


Assuming it was a straight investment in the company, it values Lao Heng He at just over 14 times pre-tax profit. The deal seems like a very cheap way of funding the company’s investment assuming it can repurchase the investment at a cost in eight years.  It also avoids diluting the company’s existing shareholders through rights issues or issuing additional shares to raise capital needed.   The company provided no additional details about the investment project.


As highlighted before, the company’s focus on maintaining such a high inventory level is not allowing the company to self fund its growth.  The vast majority of the company’s inventory is work in progress and the gross margin generated on aged products does not cover the cost of ageing products leading to a lower ROIC for the company, as illustrated in our initiation report.


This event has little change on our view that Honworld has a strong brand and economies of scale giving it a very strong competitive advantage.  The company is growing very rapidly and is run by a passionate owner operator with the only downside being the allocation of capital to inventory. We are in the process of decreasing our position size but as stated we are not selling below HKD5.00 per share.

Peak Sport Products Position Size May 7, 2016

Peak Sport Products Position Size May 7, 2016


We have decreased our position size in Peak Sport products by just under USD2.9 million slightly below our intended target of USD3.0 million at an average price of HKD1.92. Peak Sport is now a 2.0% cost position.

Universal Health Position Size May 6 2016

Universal Health Position Size May 6 2016


Yesterday, we completed the sale of just over USD2.0 million in Universal Health shares that we previously announced we would make.  We sold 21.573 shares at an average price of HKD0.735. As of yesterday’s close, Universal Health is now a 2.5% position, which is more appropriate for the risk reward associated with the investment.

Universal Health Initiation Report September 8, 2015

Universal Health Initiation Report September 8, 2015

Below is a link to the Universal Health Initiation Report, formerly Company 9/8/2015, from September 8, 2015, along with the initial investment thesis.

Universal Health 2211 HKG Initiation Sept 8 2015 RCR





Universal Health International Holding Group (Universal Health) is a Chinese pharmaceutical distributor and pharmacy operator. The company trades on an EBIT/EV yield of 24.0% despite above industry growth, in an industry growing at 20% per annum, and superior profitability with a four year average ROIC of 43%.


Universal Health is best in class among Chinese pharmaceutical distributors and pharmacy operators in terms of growth, profitability (ROIC), and acquisitions, a key activity in the consolidating pharmaceutical distribution and retail market.  The company has a number of unique, complimentary activities strengthening its competitive position ensuring profitability can be sustainable.  The company has high quality management with significant share ownership, no significant corporate governance issues, and a net cash position equal to 37% of the company’s market cap and 2.41 times trailing twelve month (ttm) operating profit.


The market is pricing in no growth and a reversion from a 2014 ROIC of 39% to the cost of capital within ten years creating little downside but tremendous upside if the company can maintain its profitability and continue to grow at 20% per for the next five years.

Grendene Initiation Report November 19, 2015

Below is a link to the Grendene, formerly known as Company 11/29/2015, initiation report  from November 19, 2015.

Grendene SA Initiation November 19 2015




Grendene is a Brazilian plastics manufacturer and one of the largest footwear producers in the world.  The company built multiple competitive advantages in the domestic market and the company is trying to replicate these advantages in the export market.  Within the domestic market, it is a low cost operator with scale advantage due to heavy investments in advertising, product development, automation, and process improvements.  It produces a low priced experienced good and has built a strong brand allowing for pricing power. Grendene’s exports are at the low end of the cost curve ensuring the company stays competitive in export markets.


The company is run by owner operators with strong operational skills and an understanding of its competitive position who treat all stakeholders with respect.  It also has consistently generated stable, excess profit even during periods of industry stress and has a net cash balance sheet.


Despite the company’s strengths, there is upside to the bear case scenario of no growth and trough margins with the company trading on a 10.1% NOPAT yield and an 8.5% FCF yield. Total estimated annualized return over the next five years is 15-17%. Grendene seems to be undervalued.

Peak Sport and Universal Health Position Sizes May 3 2016

Peak Sport Products and Universal Health Position Sizes May 3 2016

We have reduced our position in Peak Sport Products by USD4.64 million slightly above our target sales of USD4.5 million at an average sale of HKD2.1098 or inital blended cost on Peak Sport positions is HKD2.0826 so we are able to reduce our positions without a loss.   We are reducing our position size by a further USD3.0 million.  The company reported weaker than expected operational data in China, and after the Miko International fiasco, the share issuance in June 2015 with a significant amount of net cash on the balance sheet raises concerns about the cash.  Given we view Peak Sport as a deep value position, a 2.0% position size is a more appropriate given the concerns over management credibility and slowing growth.


Universal Health is another Hong Kong listed Chinese company that we described as Company 9/18/15 in the past. This is another deep value holding where we put too much faith in financial statements.  Management pledged shares without notifying the stock exchange and subsequently were forced sellers causing the share price to fall by just under 60% on one day. The company also sold 20% of the company to a financial buyer who subsequently sold almost half its position the following.  It seems as if the shares were pledged to the financial buyer who promptly sold the shares. The company followed this by reporting poor 2015 results.  Loss aversion stopped us from selling earlier.  It probably is the culprit in why we held Miko as long as we did.  We are decreasing our position size in Universal Health by USD2.0 million to roughly a 2.0% position size.


Miko International Resignation of Auditor May 3, 2016

On April 22, 2016, Miko International’s Auditor KPMG resigned due to disagreements over Miko’s annual results.   In its resignation letter KPMG was awaiting satisfactory information relating to the following matters:

1. Receipt of the draft 2015 consolidated financial statements from management.

2. Access to original bank statements in respect of one of the group’s bank accounts to be provided directly to us by the bank, which had a year end balance of RMB400 million, together with supporting documents in respect of security given over some of the group’s bank accounts.

3. In respect of the group’s distribution channels, information relating to how the acquisition price was determined in respect of the distribution channels acquired during 2015 at a cost of RMB107 million, the signed valuation report and supporting documents in relation thereto, as well as supporting agreements and information relating to amendments made during the year to certain other distribution arrangements.

4. In respect of the prepayment of RMB13 million as at 31 December 2015 for the group’s enterprise resource management system supporting information is awaited relating to the determination of the purchase price.

5. In respect of the acquisition of a property in Shanghai during 2015, information is awaited in respect of the determination of the acquisition price, signed year-end valuation report, explanations relating to the difference between the year-end valuation and the acquisition price, and other documents in respect of the acquisition.

6. Site visit and interview with an OEM Supplier.’’


On April 29, 2016, Miko International appointed Hodgson Impey Cheng Limited (HLB).  HLB has been involved with signing off of financial statements of other frauds such as China Solar Energy Holdings.

The resignation of KPMG, the less credible auditor, CFO resignations, director resignations, and share issuance with a significant cash balance all point to Miko being a fraud.  We will be selling all shares at the time of resumption of trading.