HongKong & Shanghai Hotels Stock: Backing A Long-Standing Hong Kong Family (HKSHF, HKSHY)

YANG WANG

The following segment was excerpted from this fund letter.

The HongKong and Shanghai Hotels Limited (OTCPK:HKSHF, OTCPK:HKSHY)

Backing a long-standing Hong Kong family – with enormous margin of safety.

“Luxury hotels are having a glorious moment. Rich travellers mean rich returns for investors” – “The Economist” 21 March 2024

When you look at the share price performance of this business, you could have fooled us.

By our reckoning, there are 58 publicly listed hotel groups around the world, ranging from Marriott International (MAR, market capitalisation US$72 billion) downwards. The companies divide into various baskets, both in respect of “comfort” to ultra-luxury, straight accommodation to resorts and (especially) casinos, but more importantly from an equity investor’s standpoint, ranging from property owners, franchisors, brand owners and managers. The economics of each are radically different, ranging from asset heavy “rental” income through to asset-lite service income with a theoretically high return on capital.

There are very few combined property owner operators only, especially owning and operating an ultra-luxury but small network. Moreover, where these do exist, they are usually in Asia, are controlled by local families but often also have complex ownership structures and are intertwined with significant and undesirable commercial property ownership.

The HongKong and Shanghai Hotels Limited (0045.HK, OTCPK:HKSHF, OTCPK:HKSHY) has been around since 1866, was one of the first companies listed on the local stock exchange and has a colourful history – given its multinational prime properties – which is scrupulously documented on its website.

However, THKSH shares have been rather less exciting than the company itself. Recent prices have seen them trading at levels last seen in 2009; indeed the current price is roughly equivalent to the level (HK$5.80 per share) in a general offer by the then 35% shareholding Kadoorie family to ward off a takeover offer from Lo Yuk Sui;³³ including various trusts in which the family has some entitlement, the “locked” shareholding was around 55% in 2007 and had crept up to 60% by end 2021. In January 2022, the Kadoorie’s agreed to purchase 12% of the company – after shareholder agreement not to force a takeover offer was obtained – at HK$12.80 per share to take their holding to 72%. Sino Holdings (1221.HK) owns 5.1% of HKSH as a “long-term investment”. These appear to be the foundation stones for a classic “value trap”. That can’t be ruled out but we see scope for a significant uptick in earnings, gradual improvement in cash flow and the potential to see a closing of the enormous gap between stated NAV and share price of these amazing trophy assets, for which Middle Eastern interests are currently ravenous.

Approaching the investment thesis

THKSH owns and operates 10 hotel properties with at least 50% ownership across four regions for a total of 2400 attributable rooms.³⁴ In addition, THKSH owns four retail arcades attached to hotels in the same proportional ownerships, two commercial office buildings in Hong Kong, two mainly residential complexes in Hong Kong and Saigon, a retail tower in Hong Kong and a mixed-use building in Paris. It also owns the Peak Tram in Hong Kong and a golf course in Carmel, California.³⁵ THKSH also owns 20% of the property and operations in Peninsula Paris and Beverly Hills.

At face value, THKSH looks extraordinarily cheap. At end March with the shares at HK$5.95 (market capitalisation HK$9,811 million), this compares to the 31 December 2023 “fair value” net assets per share of HK$24.95 – a 76% discount; if we adjust for the net debt of HK$15,033 the notional asset level discount against assets of ~HK$55.65 billion is about 55%.

We believe the reasons behind these enormous discounts are as follows:

THKSH is a controlled entity via the Kadoorie family 72% holding; investors clearly believe, based on recent experience, that the company will continue to invest any spare cash flow in the properties themselves to keep upgrading them, rather than other initiatives (below); This is backed up by the fact that in September 2023, THKSH opened London’s most expensive new hotel in Mayfair at a cost of £1,020 million – spent over five years – upon which there is cynicism as to the likely return; The site itself cost £240 million (HK$2,472 million) in two tranches from Grosvenor Estates in mid-2013 and September 2016; The Peninsula London included 24 apartments, of which 10 are sold for proceeds of HK$2,298 million (roughly £23.25 million each); a further 8 are pre-sold and at the last update 6 remain available – the residual 14 units are carried at HK$4.38 billion – above the sale prices of those sold, which achieved an 11% margin; THKSH also built Peninsula Istanbul (50%) at the same time, stretching the balance sheet to an extent not previously seen, which inhibits a “conservative” boards willingness/ability to consider measures to retire ridiculously expensive equity; The two most experienced senior executives have recently retired leaving a potentially massive hole in management ranks: CEO Clement Kwok stepped down in October 2024 (but will remain to advise the incoming but not yet appointed CEO) and COO Peter Borer stepped down in July 2024 but is a senior adviser to the Chair (Sir Michael Kadoorie) for two years; The hit to the business directly from COVID as well as inconsistent measures in China, now seemingly settled from early 2023; The enormous 60%+ decline in profitability from the flagship Peninsula Hong Kong property since 2014;

An increased unwillingness to invest in Hong Kong or even contemplate doing so, evidenced by the 18.9% decline in the Hang Seng Index in the year to end March 2024, leaving it ~50% below the record high of January 2018, and the company has little analytical following which inhibits a more sophisticated disassembly of the businesses and capital structure.

One of the attractions of THKSH is that with geopolitical fears, the Hong Kong assets seem to have “survivability”; too many of the other discounted price to asset plays in Hong Kong depend on “valuer valuations” for Hong Kong commercial property. Whilst THKSH has two commercial towers, their total valuation is a fraction of the entire company.

There is a need to take a sanguine view on Hong Kong residential property rentals since the group owns eight towers, encompassing 484 apartments which it leases out, in two separate complexes in Repulse Bay, an expensive enclave on the Southern side of Hong Kong Island. The flip side of this – as we noted in Quarterly Report #1 (March 2023) in discussing Société des Bains de Mer – is that investors struggle to value high-end residential properties held for lease within public companies.

Whilst our methodology would horrify THKSH executives and controllers, we aim to dissect the company into its stakes in hotels and treat the other assets as “non-core”; we accept treating the residential business in that manner when it is an enormous cash flow producer seemingly makes little sense, but the key exposure we want are the ten core Peninsula Hotel operations plus two 20% associates.

Our thesis is assisted by the glorious disclosure of THKSH – we have rarely come across a trophy asset owner with such detailed and transparent disclosure³⁶ (and luxurious pictures in the annual report). THKSH report consolidated earnings from eight of the hotels, then treat the 50% owned Istanbul and Shanghai, together with Paris and Beverly Hills as associates. Since the non-hotel businesses outside Hong Kong are relatively small and don’t make significant profit, we can derive a reasonably (but not 100%) accurate picture for the profitability of the flagship Peninsula Hong Kong from the segmental accounts presented by the company.

These segmental accounts show a core reason for our interest and the approach mapped out: the hotel business ex-Hong Kong is now a more proportional contributor to EBITDA³⁷ than ever before as illustrated below:

THKSH Segmental EBITDA contributions

HK$mn	Clubs & services	Property	Hong Kong “other” A	Hong Kong Total B	Proxy Peninsula HK C=B-A	Non-Hong Kong Hotels D-C	Total Hotels D
2009	81	386	467	886	419	13	432
2010	109	425	534	995	461	143	604
2011	125	453	578	1099	503	102	605
2012	135	471	606	972	384	212	596
2013	144	484	628	1080	452	197	649
2014	130	524	654	1219	565	253	818
2015	132	555	687	1223	536	177	713
2016	121	518	639	1095	456	331	787
2017	132	558	690	1169	479	414	893
2018	158	527	685	1213	528	548	1076
2019	105	584	689	950	261	617	878
2020	-11	452	441	579	138	(582)	(444)
2021	72	327	399	460	61	129	190
2022	1	279	280	357	77	234	311
2023	115	386	501	720	219	493	712

Source: THKSH Company reports compiled by East 72 Management Pty Ltd (2009-2015 are actuals, 2016 onwards proxied)

The table shows that 2018 might realistically be the last “normal” year for THKSH when all the businesses were firing, prior to specific issues in one market or other beyond that point. At that stage, Peninsula Hong Kong was half the global hotel EBITDA because HK was buoyant AND Peninsula Hong Kong has a far wider revenue base of adjoining shops (classed as hotel income), functions and other non-room/food & beverage profits. Hong Kong declined sharply from 2019 as a result of the protest movement and policing tactics in that year followed by COVID and the volatile measures adopted by the authorities. The table illustrates that Peninsula Hong Kong is estimated to be 60% less profitable than it was at its peak in 2014.

So, at current earnings rates, it’s not an HK hotel business you are buying – in essence, a big recovery in Peninsula Hong Kong is effectively an option because there is real growth elsewhere.

The hotel business is starting to improve sharply

We have adopted THKSH methodology for analysing the hotel properties as presented in their segmental accounts. The twelve Peninsula Hotel locations are tabulated below:

	Rooms	Owned		Attributable rooms	CY2023HK$ million total revenue (100%)	TOTAL RevPAR (HK$)³⁸	Fair value (100% basis) d HK$ million
Hong Kong	300	100%	Long term leasea	300	1,039	9,489	12,322
Beijing	230	76.6%	Short term lease	176	328	3,907	1,047
Manila	351	77.4%	Lease expiry 2026 from Ayala Land	272	224	1,748	45
Tokyo	314	100%	Long term leasea	314	741	6,465	1395
Bangkok	370	100%	Freehold	370	207	1,533	642
New York	233	100%	Long term leasea	233	766	9,007	2,129
Chicago	339	100%	Freehold	339	617	4,986	1,227
London	190	100%	Long term leasea	190	129b	6,172	8,201
TOTAL	2,327			2,194	4,051		27,008

Shanghai	235	50%	% property owned THKSH operator	118	460	5,363	2,706
Istanbul	177	50%	% property owned THKSH operator	88	191c	3,362	2,147
Beverly Hills	195	20%	% property owned THKSH operatore	39	616	8,655	2,771
Paris	200	20%	% property owned THKSH operatorf	40	714	9,781	4,600
TOTAL	807			285	1,981		12,224

(A) lease over 50 years (B) from 12 September 2023 (C) from 14 February 2023 (D) per THKSH accounts (E) 80% Katara Hospitality (QAtar) – 100% equates to €545 million (F) 80% Zarnigen brothers (California property moguls) – 100% equates to US$355 million

At the most basic level, even if THKSH wasn’t an owner/operator of upscale hotels, its earnings over the next 2-3years have significant leverage from an extreme base effect, especially in 2022 but still prevalent in 2023. In 2023, of the ~850,000 room nights³⁹ within the consolidated hotels, we estimate THKSH only had just over 760,000 available as a result of the new London open and China/HK COVID restrictions.

Whilst tourists are flocking back to Europe, Asia is a different matter, with isolated hot spots but Greater China being a more difficult “sell” at the present time. This was acknowledged by management in the 2023 earnings call that geopolitical circumstances brought about by difficult to judge fluctuations in China’s economic and political policy – not the least COVID strategies, has deterred tourism and business. Around 23% of consolidated THKSH room nights are attributable to Greater China. However, there are major bright spots, especially Tokyo, which benefitted from strong tourism back to Japan as well as more buoyant business conditions enabling a massive increase in average room rate plus greater occupancy.

In our view, what has been missed by investors has been the significant lift in average room rate across the group. To some degree, these rises in room rates are to compensate for inflation, notably of wages. The graphs below map out rolling 12-month room rates across the three geographic categories THKSH disclose each quarter:

Source: THKSH quarterly company reports compiled by East 72 Management Pty Ltd

In compiling our estimates for CY2024, we are conscious that Q4 is typically the strongest room rate quarter, but it is clear from the smoothed numbers that THKSH in 2024 should experience the triple upside of full years in London (and Istanbul in associates), higher occupancy and higher room rates. On this basis, we expect revenue from the consolidated group of hotels (on a 100% basis) to increase from HK$4,174 million to around HK$4,800 million in CY2024; about HK$500 million of this comes from a full year of London, assuming a 55% occupancy rate.⁴⁰

Historic composition of consolidated hotel revenues

HK$mn	Room	F&B	Shops	Other	Total	Room %age	F&B %age
2009	1,355	987	556	282	3,180	42.6%	31.0%
2010	1,549	1,123	567	337	3,576	43.3%	31.4%
2011	1,642	1,175	597	352	3,766	43.6%	31.2%
2012	1,637	1,232	639	377	3,885	42.1%	31.7%
2013	1,768	1,218	687	371	4,044	43.7%	30.1%
2014	1,889	1,239	747	385	4,260	44.3%	29.1%
2015	1,765	1,168	761	379	4,073	43.3%	28.7%
2016	1,812	1,173	691	364	4,040	44.9%	29.0%
2017	1,912	1,246	643	388	4,189	45.6%	29.7%
2018	2,141	1,330	625	438	4,534	47.2%	29.3%
2019	2,014	1,229	618	427	4,288	47.0%	28.7%
2020	470	448	511	165	1,594	29.5%	28.1%
2021	808	683	519	253	2,263	35.7%	30.2%
2022	1,284	892	532	287	2,995	42.9%	29.8%
2023	2,063	1,215	529	367	4,174	49.4%	29.1%
AVERAGE						43.0%	29.8%

It should be noted that Peninsula Hong Kong derives significant revenue (>70%) from shopping and “other” which dulls the leverage impact of higher room rates but increases overall margin.

We expect EBITDA margins within the consolidated group to improve given a longer period of higher room rates – note the gradual acceleration of room rates during CY2023. In the past (i.e. pre-2019) EBITDA margins in the consolidated group have been as high as 20.7% (2018) and were significantly higher in the associates (see below). We expect an improvement on CY2023’s 15.1% EBITDA margin to ~17% over the course of CY2024, suggesting EBITDA from the consolidated hotels will rise by 28% from HK$633 million to HK$814 million.

The associate hotels will benefit from an extra six weeks of Istanbul, a hopeful absence of another devastating earthquake, but most obviously the Paris Olympics, where the property is sold out for the relevant period, and we can’t imagine at discount rates. Margins should be higher as a consequence. We estimate attributable revenues from the properties to aggregate to HK$646 million in CY2024 (HK$591m in 2023) with EBITDA of $103 million, up from HK$79 million in CY2023.

The fair value estimates within THKSH annual report attribute a proportional value of the hotels of HK$30,654 million. This equates to a forward EV/EBITDA multiple of 33.4x. Such multiples might be reasonable for “trophy assets” but, in our view, are way above the metrics we could reasonably attribute.

The good news is that the price of THKSH shares is not asking is to do so.

What are we paying for the twelve core hotel properties?

At a share price of HK$5.95, we are paying an enterprise value for the assets of $24,844 million. The tabulation below suggests the value is entirely covered by assets outside of the 12 core hotel properties/operations, and that we are obtaining these amazing assets for less than zero:

HK$ million	Conservative Value	Comments	Fair value per THKSH accounts for 100%
Office property:
St Johns Building	940	HK$47m revenue at 3.5% yield and 70% P/value (in line with office REITS)	1,174
Repulse Bay	1,400	HK$60m revenue at 3.0% yield and 70% P/value (in line with office REITS)	Embedded in Repulse Bay complex (say HK$2,000)
Residential:
Repulse Bay complexes	16,400	484 apartments at average HK$98k/month Implied sale price HK$38.1mn (US$4.87mn) est 3.1% yield	Embedded in Repulse Bay complex (say HK$16,424)
Other:
London apartments	3,152	Prior sales less 2% costs	4,382
Yangon development	–		122 (x 70%)
Peak Tower (retAil)	1,418	Equates to 9% revenue yield	1,418
Quail Lodge Golf	140	BV = US$36m, loss making bought 1997. Revenue HK$228m (US$29m)	282
Vacant land	–	Thailand	91
Own properties	188	Book value not fair value	403
Paris – 21 avenue Kléber	474	2013 acquisition price (€56m) – adjacent to Peninsula	674
Apartment assets	200	Shanghai (7 – none sold 2023) and Ho Chi Minh City = 50% of book	385
Other business (Peak Tram, merchandising etc)	600	HK$600 million revenue est EBITDA >$100m	–
Other assets	6,172		7,720
TOTAL NON HOTEL	24,912		>27,318

Even if we were extraordinarily harsh and discounted our value of these assets by 50%, at HK$5.95/share our entry price (including debt) to the hotel business would be around HK$12.4 billion, against THKSH share of fair value of HK$30.6bn⁴¹ or a 59% discount. Such an attributable value would equate to 13.5x EV/EBITDA, a reasonable value for such assets in only the second year of uplift from the devastating impact of COVID and related restrictions.

Have there been other relevant transactions?

Given the trophy asset nature of THKSH portfolio, there are always few comparative deals; the more so in 2023 given the impact of rising interest rates deterring buyers. However, there were four transactions which stand comparison with THKSH portfolio during 2023 as follows:⁴²

	rooms	brand	location	price	US$ equivalent	US$ per key	Buyer
January	172	Hoxton	Paris	combined €260 million	Combined $281mn	$993k	Schroder Capital
	111	Hoxton	Amsterdam	combined €260 million	Combined $281mn	$993k	Schroder Capital
February	428	Westin	Paris	€650 milliona	$702mn	$1,640k	Dubai Holdings
July	120	Mandarin Oriental	Barcelona	€240 million	$260mn	$2,167k	Olayan Group (Saudi Arabia)
December	1726	Rocco Forte (14)b	Various: 9 in Italy	£1.4 billion inc.£200m debta	$1,764mn	$1,022k	Public Investment (Saudi Arabia)
	2,557				$3,007mn	$1,176k
(A) attributable 100% value for purchase of stake (B) includes Browns, London, 115 rooms

THKSH holds 2,469 attributable rooms, with a fair value in its books of HK$30,654 equivalent to US$3,920 million or US$1,588k per room. This suggests the valuers are well on top of prevailing transactions, with due regard to the premium nature of THKSH portfolio.

However, at prevailing THKSH equity prices, we are acquiring the portfolio at US$1,586m or $US$642k per key if you apply a 50% discount to the values we attributed to the non-hotel assets. (Of course, if you accept those non-hotel valuations, you get the hotels for nothing!!)

Is this just a value trap presided over by an 83-year-old patriarch?

This is 83 years old Sir Michael Kadoorie’s baby, and given the family owns 35% of China Light and Power (CLP Holdings, 0002.HK) the electricity supplier to Kowloon and New Territories, a stake worth HK$55 billion (US$7bn), if the hotel business teeters, he is hardly going hungry.

But the return on assets is very low, befitting their trophy status – sub 3% at the EBITDA level, but rising. “This is a company that looks 100 years ahead” according to the patriarch⁴³ and based on the history, it’s hard to argue. So, are we stuck in a company where the patriarch will just spend the cash flow on renovating the assets to the highest possible level, when for the 28% minority shareholder base, it is inarguable looking on a long-term view that THKSH should be retiring its equity given the implied discounts to realisable value?

The company has spent an average of HK$500 million a year over the past fifteen years on capital expenditure on existing assets – including the Peak Tram – let alone the financing of new structures such as London. In fairness, this has been broadly in line with the annual depreciation and amortisation charge over the period.

Of course, the new assets and tough trading conditions mean that net debt has trebled since 2017.

We are hopeful that the debt load, the need to bed down the two new hotels, and to settle in new management, replacing multi-decade veterans, will lead to a period of less robust capital spend, with the exception of an upgrade to the New York property.

The company is well versed in working with partners and one Middle Eastern majority property owner (Paris, Qatar) already.⁴⁴ Is it beyond the realms of possibility for an investor from that part of the world to spot the opportunity and work up a transaction on a friendly basis, to take a significant stake at a discount to overall value but a premium to prevailing prices whilst leaving the Kadoorie’s to do their stuff? Or that one of the properties is realised, providing greater flexibility and some of the funds applied to a share buy back?

We can see a myriad of opportunity, a huge margin of safety, and despite the ostentatious nature of the assets, have some level of confidence that some of the cash generated will find its way back to shareholders through a significant upswing in earnings over the next 2-3 years. If China moves back into favour, such an upturn may be especially sharp.

Footnotes

³³Mr Lo controls Century City International Holdings Limited (333.HK), the controlling shareholder of Regal Hotels Limited (0078.HK)

³⁴For example, Peninsula Beijing has 230 rooms, is 76.6% owned and so has 176 “attributable” rooms.

³⁵Former mayor 1986 -1988 was a Mr. Harry Callahan using his real name.

³⁶This piece took longer to write than usual such was the available detail and new “rabbit hole” to investigate

³⁷Yes, we are embarrassed to use EBITDA but that is THKSH segmentation metric but are VERY cognisant of the total nonsense EBITDA represents in hotels, but discuss capex later

³⁸This is total revenues not just room revenues; we estimate room revenues for CY2023 were $2,063 million and room+food/beverage were $3,278 million being 81% of the total.

³⁹2327 x 365=849,355

⁴⁰We would be delighted to underestimate this given the room rates in the hotel and the gradual wind-down of opening “offers”

⁴¹Proportionalised page 107 Annual Report 2023

⁴²Co-Star/Hotel News Now reworked by East 72 Management Pty Limited

⁴³Financial Times interview (with brilliant pictures) “The Kingdom of Sir Michael Kadoorie” 21 March 2023

⁴⁴The 80% owners of the Beverly Hills property, the Zarnigen family, have some commonality with the Kadoories, theirparents being Jewish emigrés from the Middle East, in their case Iran, rather than Iraq.

Copyright and Disclaimer

© Other than material being the property of its respective owners, this presentation is copyright 2024 East 72 Management Pty Ltd. All Rights Reserved. You may not reproduce parts of this work without permission, which can be sought by email, but you are free to distribute the work on each security (D’Ieteren Group, Fairfax India Holdings and The HongKong and Shanghai Hotels Limited) in its entirety with full attribution.

This communication has been prepared by Andrew Brown and East 72 Management Pty Limited ( E72M) (ACN 663980541); E72M is Corporate Authorised Representative 001300340 of Westferry Operations Pty Limited (AFSL 302802) of which Andrew Brown is a Responsible Manager.

While E72M believes the information contained in this communication is based on reliable information, no warranty is given as to its accuracy and persons relying on this information do so at their own risk. E72M and its related companies, their officers, employees, representatives and agents expressly advise that they shall not be liable in any way whatsoever for loss or damage, whether direct, indirect, consequential or otherwise arising out of or in connection with the contents of an/or any omissions from this report except where a liability is made non-excludable by legislation.

Any projections contained in this communication are estimates only. Such projections are subject to market influences and contingent upon matters outside the control of E72M and therefore may not be realised in the future.

This update is for general information purposes; it does not purport to provide recommendations or advice or opinions in relation to specific investments or securities. It has been prepared without taking account of any person’s objectives, financial situation or needs and because of that, any person should take relevant advice before acting on the commentary. The update is being supplied for information purposes only and not for any other purpose. The update and information contained in it do not constitute a prospectus and do not form part of any offer of, or invitation to apply for securities in any jurisdiction.

The information contained in this update is current as at 31 March 2024 or such other dates which are stipulated herein. All statements are based on E72’s best information as at 31 March 2024. This presentation may include officers and reflect their current views with respect to future events. These views are subject to various risks, uncertainties and assumptions which may or may not eventuate. E72M makes no representation nor gives any assurance that these statements will prove to be accurate as future circumstances or events may differ from those which have been anticipated by the Company.

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