K1-Ventures

I constantly find it difficult to find any stocks of interest in my local Singapore stock exchange, perhaps due to the lack of diversity. Companies listed on the SGX are commonly property names (which I do not touch simply because I do not like their business model and have no particular strong insights on property prices), ODM or OEM manufacturers, oil and gas names or commodity producers. All of those industries requires a strong understanding of their respective industries which are driven by politics or global marco-economic forces. Therefore, I rarely get the conviction to pull the trigger, even though at times the prices look cheap.

A few days ao, I chanced upon a mid-cap stock and broke my extended idea generation drought for the Singapore market. (Actually this wasn't my idea. I was just coat-tailing Benjamin Koh of Lighthouse Advisors, whom I came upon looking through the interviews at Value Conferences).

K1-Ventures is a investment holding company listed on the SGX. It is 36% held by Keppel Corp (founding sponsor), 14% held by Steven Jay Green (Chairman & CEO), 12% held by BV Investments (a private equity firm) and the remaining 38% is public. K1-Ventures attempted to take itself public June last year. The conditional cash offer fell through eventually, due to a well argued case by Lighthouse Advisors. The cash offer was at SG$0.135 but Benjamin Koh of Lighthouse Advisors argued that SG$0.277 is a closer estimate to the intrinsic value of the company. Trust fat cats not to raid the coffers when you ain't looking. If the offer goes through, Steven Green's ownership goes up to 43%, and Keppel Corp goes up to 45%. If the insiders, especially the Chairman here, wants to increase their ownership of the company significantly and is willing to bet a significantly portion of their wealth on it, I think that is a clear sign that the company is undervalued. Let's go through K1-Ventures Holdings, starting with the easy bits.


Guggenheim Capital

K1-Ventures owns a US$100-million investment in Guggenheim Capital, LLC (Guggenheim), a US-based, privately held financial services firm with more than US$100 billion in assets under management. The US$100-million investment comprised 100,000 Series A Preferred Units (Preferred Units), 250,000 Common Units, and 11,111,111 Warrants to acquire common units issued by Guggenheim. The preferred units has a 7% dividend yield and are redeemable at par with full payment of any accumulated unpaid dividend. 

This is easily valued at cost, which is US$100m. When MF Global went bankrupt in 2011, it caused a scare over financial services firms. This can be easily be seen in Jefferies Group's share price. Nonetheless, Jefferies soon recovered. In the absence of any information on Guggenheim Capital, I believe a valuation at cost is reasonable. At an exchange rate of 1.238, US$100m translate to SG$123.8m.

McMoran Exploration

McMoRan Exploration Company (MMR) is an independent publicly traded company (NYSE: MMR) engaged in the exploration, development and production of oil and natural gas in the shallow waters of the Gulf of Mexico Shelf and onshore in the Gulf Coast area of the US. The Group owns 2,309,000 shares of common stock in MMR. This is approximately 1.43% of the total outstanding common shares. On 10 December 2012, Freeport-McMoRan Copper & Gold Inc has announced an acquisition of MMR for a per-share consideration of US$14.75 in cash and a 1.15 unit of a royal trust. The trust will hold a 5% overriding royalty interest in future production from MMR's existing ultra deep exploration properties. Modelling the payout from the trust is too difficult at this stage without more information. Given that K1-Ventures only owns 1.43% of MMR, it is safe to assume here that they are able to dispose of their stake through open market sales at the current market price of US$16.35 per share. MMR's share price has remained fairly stable post the acquisition offer.

Helm

Established in 1980 and headquartered in San Francisco, Helm is one of the largest independent rail equipment leasing companies in North America. Helm uses its nationwide network of professionals to purchase, refurbish and service rail equipment for customers in North America. K1 acquired 80.1% of the issued shares in Helm in 2005 at a cash consideration of US$110.5 million along with the Helm management team acquiring 19.9% for US$27 million. The balance of the acquisition cost was funded by US$333 million in term financing.  Helm and its subsidiaries are primarily engaged in the business of:

(i) Leasing rail equipment to railroads and other end-users;

(ii) Leasing and brokering equipment for others;

(iii) Remarketing previously leased equipment; and

(iv) Buying and selling rail equipment and parts in the resale market.

Income Statement (US$m)	2007	2008	2009	2010	2011	2012
Revenue	160.8	233.5	96.1	65.5	67.8	57.1
EBITDA	118.5	141.2	71.7	48.3	42.9	37.9
EBITDA Margin	73.7%	60.5%	74.6%	73.7%	63.3%	66.4%
Fixed Asset Impairment Loss	0.0	0.0	0.0	(36.7)	(3.5)	(18.3)
Goodwill Impairment	0.0	0.0	0.0	0.0	0.0	(43.5)
Other intangible Impairment Loss	0.0	0.0	0.0	0.0	0.0	(11.9)
Operating Loss	62.7	86.3	5.5	(49.0)	(2.7)	(74.9)
Finance Expenses	(42.6)	(25.5)	(13.6)	(8.8)	(7.8)	(11.2)
Share of results of associated company and JV	7.4	7.2	12.5	10.4	9.3	9.2
Loss before tax	27.5	68.0	4.4	(47.4)	(1.1)	(77.0)

At first glance, their operations at Helm has clearly deteriorated since its peak at 2008. However, I suspect the actual situation is not as grim as the numbers suggest. Helms generates decent operating profits which the management has used to pay down debt from US$333m at acquisition to the current US$118m. As Lighthouse Advisors rightly pointed out, three of Helm's larger listed competitors (GATX, Trinity Industries and The Andersons) all showed improving operating metrics over the last few years. This includes improving utilisation rates, leasing pricing, lease renewal and operating margins. This is simply driven by the recovering US economy. The accounting earnings here are not a true representation of the earnings capacity of Helm.

Valuation (US$m)	Base Case	Bear Case	Bull Case	US$m	GATX	Trinity Industries	The Andersons	Average
EV/EBITDA Multiple	6.0	4.0	8.0	Revenue	1243.2	3811.9	5272.0
EV	227.4	151.6	303.2	EBITDA	393.2	768.5	191.3
Net Debt	104.9	105.9	106.9	EBITDA Margin	31.6%	20.2%	3.6%
Equity Value	122.5	45.7	196.3	Operating Profit	143.8	574.8	142.3
Operating profit of JV and Associates	9.2	9.2	9.2	Debt	3567.9	3055.0	466.5
EBIT Multiple	8.0	6.0	10.0	Cash	234.2	573.0	138.0
Value of JV and Associates	73.6	55.2	92.0	Market Value	2440.0	3590.0	955.5
Helm's ownership at 80.1%	196.1	100.9	288.3	EV/EBITDA	14.7	7.9	6.7	9.8

I used an EV/EBITDA ratio of 6x as a based case compared to an average of 9.8x for peers so as to discount for the small size of Helm's operations. In the absence of more information on JVs and associates, the operating profits are valued at 8x EBIT multiple.


China Grand Auto

K1 has invested a total of approximately US$12.4 million in China Auto I Co- Investors LLC, a private investment vehicle formed to co-invest indirectly in Guanghui Automobile (China Grand Auto). Headquartered in Shanghai, China, China Grand Auto is the largest auto dealership group in China operating a network of nearly 400 stores across China. In 2011, China Grand Auto sold more than 400,000 automobiles and was ranked as the top automobile dealer in China by revenues. China Grand Auto has filed for an initial public offering to list on the Shanghai Stock Exchange. K1 has a 1.6% stake in the company.

Very little public information is available on the company except that it earned a revenue of Rmb 64bn in 2011, available from their website. Quite a number of chinese automobile dealers are listed on the HK stock exchange, allowing for relative valuation.

Valuation	Base Case	Bear Case	Bull Case	(Rmb M)	Sparkle Roll	Zhong Sheng	ZhengTong	Yongda	Baoxin
P/S Ratio	0.456	0.291	0.683	Revenue	3,592	50,048	27,649	20,340	18,093
Valuation (Rmb M at 1.6%)	467	298	700	Operating Margin	5.30%	4.36%	4.70%	4.48%	6.85%
Exchange Ratio Rmb:SGD	0.197			Price (HKD)	0.75	9.40	5.07	8.02	6.02
Valuation at SG$	91.9	58.6	137.5	P/S Ratio	0.505	0.291	0.329	0.474	0.683
				Average P/S Ratio	0.456

Knowledge Universe Holdings
This is the most tricky of K1's holdings to value. The Group owns a 12.2% equity interest in Knowledge Universe Holdings, LLC (KUH), which is a holding company that has various interests in education-related ventures including an approximate 65% interest in Knowledge Universe Education. LP (KUE), the Group’s global education platform. The Group’s equity interest in KUH, was acquired at a cost of approximately US$57 million. At 30 June 2012, KUE indirectly owned 4,665,083 million common shares and 2,750,000 convertible Series A non-voting shares of K12, Inc (NYSE: LRN). Upon conversion of the Series A shares, KUE will indirectly own approximately 7.4 million common shares of K12, Inc., which represents approximately 20% of the outstanding shares.

I am unable to find any numbers on KUH. Here, I have to rely on the numbers provided by Lighthouse Advisors.

Revenue in 2010: US$1.6bn
Current EBITDA: US$42.6m
Cash at end 2011: US$54m
Current Debt: US$260m

Valuation (US$m)	Base Case	Bear Case	Bull Case	(US$m)	Bridgepoint	Apollo Group	Grand Canyon Education	Raffles Education
EV/EBITDA Multiple	5.5	1.2	8.0	Revenue	968.1	4,733.0	141.2	105.9
Valuation of KUH (12.2%)	2.1	(20.3)	15.1	EBITDA	226.9	1120.2	135.6	26.4
Value of K12 (20% ownership)	178.9			Market Cap	552	1,960	1,130	303
Total Valuation	181.0	158.6	194.0	Debt	16.6	598.9	100.5	38.3
				Cash	255.9	1571.6	105.1	34.0
				EV/EBITDA	1.38	0.88	8.30	11.65
				Average EV/EBITDA		5.55

The EV/EBITDA ratio for listed peers are very different depending on the country of listing and the geographical range of operations. Share prices of US based private education operators such as Bridgepoint and Apollo Group has suffered in recent months due to high unemployment as well as regulation reviews - claiming that for profit education companies were wasting tax-payers money due to a large proportion of their revenue generated from government subsidies. This explains the rock bottom valuations for both companies at <2X EV/EBITDA. Thankfully, at a EBITDA of US$42.6m for KUH, the valuation of K1's 12.2% holdings in it is small (only US$2.1m). The group's 20% holding in K12 (a listed technology based education company) is a much more valuable asset, valued at US$178.9m based on a closing price of US$24.11.

Sum of Parts

Valuation (SG$)	Base Case	Bear Case	Bull Case
Guggenheim Capital	123.8	123.8	123.8
McMoran Exploration	46.6	46.6	46.6
Helm	212.6	113.7	308.6
China Grand Auto	91.9	58.6	137.5
Knowledge Universe Holdings	224.0	196.4	240.1
Total	698.8	539.0	856.5
No. of shares (m)	2166
Intrinsic Value per Share (SG$)	0.323	0.249	0.395
Current Price	0.160
Discount to Intrinsic Value	50.4%	35.7%	59.5%

Summing up, I estimate a fair value for K1 to be about SG$0.32. This is a 100% upside from the current trading price of SG$0.16. Even in the bear case scenario of SG$0.25, this stil represents a upside of over 50%. The base case estimate is a lot higher than that of Lighthouse Advisors for the simple reason that market price of many of the underlying has rallied.

Normally I don't do holding company arbitrages. The discount that a holding company trades at against its holdings can persist for a long time without a clearly defined catalyst. That in itself affects your IRR since you have no control over realisation of the discount. I try to aim for an annualised target return of 15% and investing in companies trading at >30% discount to an intrinsic value which I can reasonably estimate with some degree of confidence. K1-Ventures here has a clearly defined catalyst in that the management has resolved to liquidate the company to realise the value of its holding, although there is still some uncertainly over the time frame.



For more information on the case put forth by Lighthouse-Advisors please refer to their website. Benjamin Koh has put together an excellant powerpoint detailing his thesis.