HKTV (1137 HK)

10 Bagger Potential with Lion Rock Spirit

Background

HKTV is no stranger to HKers, but interestingly has nothing to do with TV anymore, despite its initial aspiration to challenge TVB, the long standing TV empire here in Hong Kong.

In 2013, HKTV’s application for a free-to-air TV license was rejected due to “a basket of factors”. Ricky Wong and his team did not live in despair and they overcame challenges. They have proven people wrong that online retail is not a viable business in Hong Kong.

Hong Kong, known for its superior population destiny, transportation infrastructure and shopping convenience, together with sky-high rental and logistics costs, has long been considered a difficult market for online retail. There are also inherent factors, e.g. 1) HK is a small market vs China so there’s no point to focus on HK, 2) HK is lack of tech talents vs Shenzhen/Silicon Valley, 3) PARKnSHOP and Wellcome (owned by Li Ka Shing and the Jardines respectively) have always dominated the market.

Ricky Wong, a legendary HK entrepreneur who made a fortune by previously challenging the incumbent IDD business monopoly Hong Kong Telecom and later the incumbent internet service monopoly PCCW, seemed to have a different idea. He reckons that the underlying core part of online retail is logistics, and HK’s high population density and world-class transportation infrastructure should result in low logistic costs. As a result, HKTVmall was established in 2015, following the cessation of the chaotic TV business amid its rejected license application. And now, HKTVmall is the market leader in the city’s online retail market, or in its own words, “largest online ecosystem in Hong Kong”.

Business

HKTV is engaged in e-commerce business in HK via its HKTVmall platform and has three revenue sources:

1. Direct Sales: HKTVmall purchases inventories and sells them via its own HKTVmall platform
2. Concessionaire Income: Commission income from 3rd parties selling products or services via HKTVmall platform
3. Advertising (minimal for now)

Delivery and logistics for both direct sales and concessionaire sales are fulfilled by HKTVmall (with some exceptions for concessionaire sales being fulfilled by 3rd parties themselves).

Gross merchandise value (GMV) was recorded at HK$2.8 billion in 2019, of which 40% were direct sales and 60% were concessionaire sales.

A GMV target of HK$3.4 billion was given for 2020 in early January, which looks highly achievable as the coronavirus outbreak has been a strong tailwind for online shopping since the beginning of the year.

Investment Thesis

• Cash flows and profit set to turn positive: HKTV’s operating cash flows (adjusted EBITDA as a proxy) and profit are likely to turn positive in 2020 and 2021 respectively, driven by improvement in business fundamentals. The reversal is likely to result in shift in investor sentiment and therefore a strong long-term re-rating story

• World-class automated logistics infrastructure, while major capex has already been spent: Fulfillment centres of 400,000 square feet with daily capacity of 35,000 orders. Major capex has been spent in previous years and has peaked out. Phase 2 robotic system was completed in 1H19 and Phase 3 is scheduled to complete by end of 2020

• Established market position for concessionaire sales partnerships: One of the top visited local sites, the go-to online partner for traditional retailers to go for the online model

HKTVmall.com as #25 Top Visited Site in HK

• Growing user base with strong customer stickiness: Fast growing user base with 566k unique customers in 1H19. 70%+ of customers (roughly estimated) are recurring

• Low online retails sales market penetration: Market size of HK retail sales was HK$485.2 billion in 2018. Only 8% of which were in the form of online sales, vs China’s 27% and US’s 14%. Online retail is likely to grow to 20% of the total market in 5 years, and that’s more than $45 billion, assuming no growth in overall market size

Online Retail Sales as a % of Total Retail Sales in 2018

• Strong management track record: Ricky Wong and his team have challenged market leaders Hong Kong Telecom and PCCW and disrupted industry dynamics in the past. They are trying to do the same now against PARKnSHOP and Wellcome, which may be too big or old-fashioned to respond. Amazon was also able to rise in its early days by being nimble

Metrics

Rising metrics across the board —

Latest metrics (as of Feb 2020):

1. GMV: HK$2.78 billion for 2019, HK$3.4 billion target for 2020 (+22% YoY)
2. Average daily order number: 32,600 (+165% YoY)
3. Average daily GMV on order intake: HK$16.6 million (+159% YoY)
4. Monthly GMV on order intake: HK$482 million (+169% YoY)
5. Average dollar value: HK$510 (-2.5% YoY)
6. Number of unique devices: 2,750,000 (+99% YoY)
7. Number of unique customers: 373,000 (+95% YoY)

Financials

HKTV is currently unprofitable, but is likely to reverse in 2021. Its adjusted EBITDA, derived by adding non-cash items to net profit and therefore a proxy to operating cash flows, may turn positive earlier in 2020.

This is because the heavy upfront capex spent in previous years is now depreciated as non-cash expense, so its cash flows will turn positive before net profit, so were peers’ cases like Amazon and JD.com.

Cash flows turning positive is arguably more important than net profit turning positive, as the company can grow and reinvest relying on its own resources, resulting in a virtuous cycle.

Key assumptions:

1. GMV: HK$4.2b and HK$5.2b in 2020 and 2021 (vs HK$2.8b in 2019), derived by average order value of HK$490 and HK$505 in 2020 and 2021 (vs HK$509 in 2018), and average # of daily order of 23,500 and 28,000 in 2020 and 2021(vs 15,108 in 2018)
2. Direct sales/concessionaire sales proportion: 38%/62% and 35%/65% in 2020 and 2021 (vs 39%/61% in 2018)
3. Margin of direct sales: 28.0% and 31.0% in 2020 and 2021 (vs 24.9% in 1H19)
4. Margin of concessionaire sales: 23.0% and 24.5% in 2020 and 2021 (vs 18.7% in 1H19)

Key Assumptions

P&L

On the cost side, there are a number of components:

1. Fulfillment costs: Logistics costs to fulfill shipment, including collection from suppliers, storage and delivery
2. Marketing and promotional costs: New customer acquisition, advertising, marketing campaign to drive buying frequency and basket size, O2O shops expansion
3. E-commerce operation and supporting functions: Merchant relations and acquisition, customer service, IT and other supporting functions
4. Non-cash items: Depreciation, amortization and share option expenses

Key assumptions (as a % of GMV):

1. Fulfillment costs: 13.5% and 13.2% in 2020 and 2021 (vs 15.9% in 1H19), reduced as a result of completion of phase 3 logistics facilities by 2020 and also economies of scale
2. Marketing and promotional costs: 5.0% and 5.0% in 2020 and 2021 (vs 6.1% in 1H19), stable absolute amount growth due to stabilized new customer acquisition cost
3. E-commerce operation and supporting functions: 6.5% and 5.7% in 2020 and 2021, stable absolute amount growth as a result of increase in headcounts and salary of supporting team
4. Non-cash items: Depreciation, amortization and share option expenses: 2.8% and 2.5% in 2020 and 2021. Mainly growth in depreciation expense arising from upfront capex spent in previous years

Opex Breakdown

Valuation

It’s important to distinguish between two business models, asset-heavy and asset-light, as they are very different in terms of valuation.

Asset-heavy model: A model in which the company purchases goods from suppliers, keeps them as its inventories, and delivers them using its own infrastructure upon customer orders on its platform. As this model entails inventory risks, higher variable costs, lower margin and weaker scalability, the valuation is lower. Example: JD.com.

Asset-light model: A model in which the company derives commission income, usually a fixed % of fee from 3rd parties, as 3rd parties sell goods to customers on its platform. The company does not purchase goods from supplier nor keep inventory, but it fulfills the delivery and logistics of customer orders. As this model entails no inventory risks, lower variable costs, higher margin and stronger scalability, the valuation is higher. Examples: Pinduoduo, Alibaba, eBay.

HKTV is different from most of its competitors. It has a mixed model, in which 40% of the total GMV are direct sales while 60% are concessionaire sales. In other words, 40% of sales are from its own inventory while 60% are from 3rd parties. This is very similar to Amazon’s e-commerce business. However, Amazon’s valuation multiple is not a good reference for HKTV, because Amazon’s AWS is significant at about 20% of its total revenue, which is highly profitable and very different from its e-commerce business.

HKTV’s Comparables

Key assumptions for HKTV’s 1-year valuation:

1. GMV at HK$4.2 billion in 2020: HKTV has seen surge in user traffic and business amid the outbreak of coronavirus. People have been quickly switching from traditional shopping to online shopping as they stay home
2. Margins of direct sales and concessionaire sales at 26.5% (1H19: 24.9%) and 19.5% (1H19: 18.7%) respectively: HKTV has strengthened its bargaining power against partners. On the other hand, fewer customer discounts were offered as of late
3. Price-to-sales (P/S) ratio being used: as HKTV is not profitable therefore has no P/E, whereas DCF is tricky here as it entails many subjective assumptions. Reference is made to JD.com, Pinduoduo, Alibaba and Meituan due to similar business model and growth outlook

To value HKTV’s direct sales part, reference is made to JD.com which has a P/S ratio of 0.7x. Given JD.com has a higher gross margin at 27% (vs HKTV’s 25%) and has a more mature logistic infrastructure, a discount of 10% is applied to HKTV. The valuation of this part is HK$960 million.

To value HKTV’s concessionaire sales part, reference is made to Pinduoduo, Alibaba and Meituan, which have an average P/S ratio of 11.9x. eBay is excluded here as it recorded minimal growth in the past few years. Given HKTV has a much lower scale effect vs these peers, a discount of 30% is applied to HKTV. The valuation of this part is HK$3,924 million.

Combining the valuation of the two parts, HKTV’s 1-year valuation is estimated at HK$4,884 million (or HK$5.36 per share).

HKTV’s 1-year Valuation

Unattractive as it seems, a 5-year or longer time span will tell a different story, using a top-down approach.

Key assumptions for HKTV’s 5-year valuation, i.e. in 2025:

1. No change in HK’s retail sales market size at HK$485.2 billion in 2018
2. Online retail penetration in HK will reach 20% (vs 8% in 2018), compared to China’s 27% and US’s 14% in 2018
3. HKTV’s market share will reach 20% (vs 7% now)
4. Mix of direct sales/concessionaire sales will reach 30%/70% (vs 40%/60% now)
5. Margins of direct sales and concessionaire sales will reach 35% (1H19: 24.9%) and 26% (1H19: 18.7%) respectively, compared to Amazon’s 40% and 30% respectively
6. Price-to-sales (P/S) ratio used with reference to multiples of JD.com, Pinduoduo, Alibaba and Meituan due to similar business model and growth outlook (same as above)
7. 10% premium to peer’s direct sales multiple, due to higher customer stickiness
8. 0% premium/discount to peers’ concessionaire sales multiple, as all are established local market leaders

Combining the valuation of the two parts, HKTV’s 5-year valuation is estimated at HK$46,609 million (or HK$51.18 per share).

HKTV’s 5-year Valuation

To validate this estimation, a cross-check is done using the bottom-up approach.

Key assumptions for cross-checking HKTV’s 5-year valuation:

1. Fulfillment cost as a % of revenue at 12.0% (1H19: 15.9%), compared to Amazon’s 12.3% in 2018, this is achievable as HKTV only focuses on one single city in Hong Kong which has a higher population density and better transportation infrastructure compared with Amazon’s major regions
2. Marketing cost as a % of revenue at 5.0% (1H19: 6.1%), lower ad spend as a % of revenue is needed to acquire new customers
3. E-commerce operation and functions at 2.5% (1H19: 9.6%), stable supporting team with mild growth in headcounts and salary
4. Non-cash items at 0.8% (vs 1H19: 4.1%), depreciation as a % of GMV will drop as GMV scales quickly
5. Tax is omitted here for simplicity

HKTV’s 5-year Valuation Bottom-up Cross-check

As such, profit before tax of HK$1,616 million (margin 8.3%) and adjusted EBITDA of HK$1,766 million (margin 9.1%) are estimated in 5 years, which represent 28.8x and 26.4x P/E and P/EBITDA respectively vs the HK$46,609 million estimated valuation. Not cheap but reasonable.

Note: Income from advertising and other services is omitted here.

Conclusion

This is a potential 10 bagger. But to make a buy-and-hold decision you should believe in three things:

1. Online retail is a viable business in Hong Kong
2. HKTV will keep strengthening its market leading position over time
3. Ricky Wong and his team’s lion rock spirit will enable them to overcome challenges once again and create another miracle

“人生本來就有太多事情不在我們的估計和控制範圍之內，由出生的一刻起，所有事情都充滿了不確定性。意外就是意料之外，無法預知，無法控制。我們來到這個世上，就是要在種種的不確定性下勇敢前行。” — 王維基

Epilogue: The author has sold all his shares in HKTV in light of poor integrity of management team. In 2021, the company has purchased a yacht at about US$1 million for “employee benefits” and also an apartment for “CEO Ricky Wong’s personal use” at HK$118 million. These are shameful acts and are against interests of minority shareholders. What makes this more shameful was the fact that the company placed new shares to raise HK$453 million just a year ago for its e-commerce business expansion.