The Hour Glass

[dydx]

It may be useful to note that (1) LVMH owns selective retail businesses like DFS (duty-free retail) and Sephora (multi-brand cosmetics); and (2) Berkshire Hathaway owns Borsheims Fine Jewelry & Gifts and Ben Bridge Jeweler, both sell branded watches in the U.S. market..

[money]

i am an owner of THG but i like the analysis of Big toe and Karlmax, in fact, i agree with them on the comparison with SS. Their analysis will help me manage my expectations on what to expect in terms of valuation

[Choon]

And as for the large cash balance, it is working capital to grow the business, since cash is needed to finance the inventory. This is also why the payout ratio has only been about a third over the long-term. The implication of this is that a bumper special dividend is unlikely, but if it so happens, it means that THG has decided to stop/slow its growth. Which of these is ideal? If the latter does happen the shares should trade at a higher yield.

Nevertheless, an alternative -- and probably more appropriate -- valuation tool to measure THG is its dividend yield. A payout of 3 cents a year gives a 4% yield at current prices. Given its track record of growth, this seems to be pretty fair.

For shareholders who wonder why the market is not buying up THG shares in spite of its 'good results,' perhaps a useful exercise will be for such shareholders will be to ask themselves if they are buyers of THG at current prices. And if not, why?

The point is how much cash or working capital is needed. There is already inventory on the balance sheet. Why the need to standby lot of cash to finance inventory when inventory is full? Unless one is saying that the inventory is not full or that THG has been dragging its payment of inventories beyond normal terms.

Dividend yield would not be a appropriate valuation tool (IMO). Because dividend payout is only 30% and this 30% is not due to the company being constrained by its economics (cash position or retained earnings) but instead by discretionary management decision. If next year, THG raises its dividend payout to 50%, then dividend yield valuation would produce a jump in fair value, even though the company economics and earnings have not changed. If a company dividend payout is already high (>60%), then dividend yield would be appropriate.

For me there is only one reason why I am not buying at the current price. And that is the risk of THG being taken private....at a low price (due to its illiquidity and based on its recent past trading).

[Choon]

And yet the share price barely moves...despite the good results and increase in dividend payout while its valuation is so depressed.

Not true. Based on the last done price of $0.755, this counter has advanced 19.8% from its 12-month low at $0.63 last recorded on 13Feb19. Relative to the STI, THG has out-performed the SG market by 24% in the last 12 months from 1Jun18..

https://sg.finance.yahoo.com/quote/AGS.S...1dfQ%3D%3D

But I agree with you that THG remains underpriced, as I feel for a high-quality business like THG, Mr Market should be willing to attach say at least 2 years' forward earnings or EPS in market valuation..

A lot of the share price jump from around $0.65 to around $0.75 took place recently before the announcement of 4Q results. I did not measure how much of the buying /share price surge was due to the Chairman buying. But he certainly bought significant volumes recently. Without the Chairman's volumes, would the general market have caused the recent share price surge?

[MOV]

With revenues of $720m today and record profit of $70m last year, THG has perhaps grown to a size where the Tay family has to seriously assess the future of the business, going forward next 5-10 years. I think it will be exciting....

THG owns a valuable franchise, not everyone with some money to spare can set-up shop to rival their retail franchise and close relationships with watch prinicipals and select high-net worth clients in Asia with the highest growth rate of millionaires and billionaires.

ANY offer from private equity or rival has to be well in excess of book value of 79 cents, to pay enough future earnings for the Tay family to accept.

Similarly, any offer from the Tay family to privatise also has to be in excess of today's share price - at least 30% premium, going by past offers.

  

[karlmarx]

There have been quite a few points raised. Let's try to discuss each of them.


Just how much cash/working capital does THG require? 

1) That depends on how much THG wishes to grow. We don't know the plans that management has for the future, but the requirement of working capital can still be illustrated by looking at past figures.

($000)                 Revenue             Changes in working capital                                     
FY08:                   489,768              -7,334
FY09:                   441,908              -10,039
FY10:                   488,298              -22,262
FY11:                   521,834              -34,442
FY12:                   611,780              -43,827
FY13:                   607,758              -54,500
FY14:                   688,943              -6,599
FY15:                   740,804              -36,642
FY16:                   714,029              -45,480
FY17:                   703,952              1,314
FY18:                   691,645              9,802
FY19:                   727,315              -21,205

Growth in Revenue over 12 years: $237m
Total Change in Working Capital over 12 years: -$271m

As THG grew its revenue by $237m over the past 12 years, its increase working capital -- mainly inventory -- is $271m. So it looks like THG has to use an extra dollar to earn an extra dollar (and part of the reason is that it is holding inventory for longer periods than before). How much revenue growth does THG desire? Does its present cash balance represent a realistic amount of growth that THG may wish to achieve, in the near future?


2) But working capital is not all that THG requires for growth, although it constitutes the largest proportion. More retail shops means more PPE requirement. How much? I will spare readers the details and summarise the numbers.

Total Depreciation & Amortisation over 12 years:              $66m
Total Investment Cash Flow over 12 years:                      -$156
Difference over 12 years:                                               -$89m

Not all of its investment cash flow is being spent on PPE, but to save myself the trouble of digging for the numbers, the illustration here should not be too wide off the mark. Thankfully, the requirement on capital expenditure is not as high as for working capital.


3) So what does all these mean for THG? How much cash does it really need? How much cash does it really generate? In a previous discussion, I have mentioned how companies may allocate their capital into 3 broad areas: growth, financial security, and distribution. How much does THG spend on each of these?


Total Operating Cashflow before WCC:   $739m              (100%)

Total Change in WC:                            -$271m             (37%)
Total Investment Cash Flow:                 -$156m             (21%)
Total Dividends:                                   -$146m             (20%)

Remaining ‘Excess Cash’:                       $165m              (22%)


It should be clear that the bulk of the cashflow is spent on working capital and PPE; growth. And the remainder is split between distribution and financial security.

So if (prospective) shareholders are expecting to have a higher payout ratio, it has to either come at the cost of growth or cash accumulation. Certainly, the absolute amount of dividend can increase in proportion with the profits. But for THG to increase the payout ratio -- while it is certainly possible -- may signal a shift in management strategy, the effects of, which as previously mentioned, may or may not be favourable to shareholders.

Can THG distribute a bumper $50m or $100m special dividend? Sure, from its $165m 'excess cash,' which it accumulated over 12 years. Will THG do so? This is something for (prospective) shareholders to ponder over. Perhaps the real amount of 'excess cash' from management's perspective is the amount that they are holding in fixed deposits.

---

What makes it difficult for a competitor -- new to market or an existing market player -- to enter the luxury watch industry? 

Principals are concerned with being able to produce and sell a stable and growing volume of their products to dealers. So the requirement for a dealer, inter alia, is the ability to purchase inventory at a consistently high rate. This means that the dealer has to have plenty of capital and soundness of management to sustain business over the very long term.

Does THG have very close relations with its principals? Maybe. But that is only because THG has been able to fulfill its end of the purchasing deal. And this has come at an expense to THG. Why has THG's inventory turnover increased from 4 months to 6 months over the decade? They are not selling as fast as they are buying. So why don't they slow down their buying? Are they constrained by purchasing agreements with principals, or are they hoarding inventory because they believe they will further appreciate? I don't know.

As mentioned, my opinion of THG is that its business is good. But is it as awesome as the rhetoric here suggest? 

---

What are the exit option for a (prospective) shareholder?

So far, from the discussion, there are four being offered. 
1. Tay buys back all the shares.
2. A watch retailer competitor buys out Tay.
3. Private equity buys out Tay. 
4. A luxury goods retailer buys out Tay.

Let's briefly discuss each of them.

1) The first has been explored, so I will not repeat the points here.

2) The second has also been explored. If it is uneconomical for Tay to pay for a premium to buy out its competitor, then it is the same for Tay's competitor to do likewise. In other words, why will Cortina -- or whichever luxury retailer -- pay a premium for THG when it can build its own inventory and stores, without?

What makes more economical sense is for THG to merge with Cortina, and then try to get better purchasing terms from principals, and raise selling prices. The hurdles to these include anti-trust regulation, and personal ego. So probability of such an event is not likely to be high.

3) The third is not likely to happen because very few reasonably successful Asian businesses actually sell out to private equity. Again this is probably due to cultural and/or egoistic reasons. In any case, someone is needed to run the business, and preferably someone from within the business itself. Since THG has always been family-managed, any private equity buyer will want Tay to stay on to run the business. But why will Tay want to go from being boss to employee? Or even have his majority stake reduced to a paltry 10-20%?

A PE buy out is more likely if the price offered to Tay is very high. But this is injurious to the PE, which, will still have the problem of getting someone to run it, even if they are able to retain Tay for a few years as part of the deal.

If a PE wishes to get exposure to the luxury watch industry, perhaps it will be more economical to buy out a smaller player, and then pump it with plenty of cash to expand and compete with the likes of THG.

4) This is perhaps the most likely, since a luxury goods retailer will likely have management expertise suited to run THG. It is also one which may offer the largest premium. But family pride/ego of Tay remains a barrier.

In the foreseeable future, for reasons I have mentioned in the explanation of 1), my opinion is that Tay will continue to buy shares at below NAV, when such opportunity arise.

---

THG is quite alright as a business. And my opinion is that its share price is closer to, rather than further from, its business reality. The possibility of a huge jump in share price is always possible -- as it is for any listed company, due to a variety of events -- but shareholders need to assess the possibility of such events occurring, to have a more realistic perspective of its valuation.

[Shiyi]

There have been quite a few points raised. Let's try to discuss each of them.


Just how much cash/working capital does THG require? 

1) That depends on how much THG wishes to grow. We don't know the plans that management has for the future, but the requirement of working capital can still be illustrated by looking at past figures.

($000)                 Revenue             Changes in working capital                                     
FY08:                   489,768              -7,334
FY09:                   441,908              -10,039
FY10:                   488,298              -22,262
FY11:                   521,834              -34,442
FY12:                   611,780              -43,827
FY13:                   607,758              -54,500
FY14:                   688,943              -6,599
FY15:                   740,804              -36,642
FY16:                   714,029              -45,480
FY17:                   703,952              1,314
FY18:                   691,645              9,802
FY19:                   727,315              -21,205

Growth in Revenue over 12 years: $237m
Total Change in Working Capital over 12 years: -$271m

As THG grew its revenue by $237m over the past 12 years, its increase working capital -- mainly inventory -- is $271m. So it looks like THG has to use an extra dollar to earn an extra dollar (and part of the reason is that it is holding inventory for longer periods than before). How much revenue growth does THG desire? Does its present cash balance represent a realistic amount of growth that THG may wish to achieve, in the near future?


2) But working capital is not all that THG requires for growth, although it constitutes the largest proportion. More retail shops means more PPE requirement. How much? I will spare readers the details and summarise the numbers.

Total Depreciation & Amortisation over 12 years:              $66m
Total Investment Cash Flow over 12 years:                      -$156
Difference over 12 years:                                               -$89m

Not all of its investment cash flow is being spent on PPE, but to save myself the trouble of digging for the numbers, the illustration here should not be too wide off the mark. Thankfully, the requirement on capital expenditure is not as high as for working capital.


3) So what does all these mean for THG? How much cash does it really need? How much cash does it really generate? In a previous discussion, I have mentioned how companies may allocate their capital into 3 broad areas: growth, financial security, and distribution. How much does THG spend on each of these?


Total Operating Cashflow before WCC:   $739m              (100%)

Total Change in WC:                            -$271m             (37%)
Total Investment Cash Flow:                 -$156m             (21%)
Total Dividends:                                   -$146m             (20%)

Remaining ‘Excess Cash’:                       $165m              (22%)


It should be clear that the bulk of the cashflow is spent on working capital and PPE; growth. And the remainder is split between distribution and financial security.

So if (prospective) shareholders are expecting to have a higher payout ratio, it has to either come at the cost of growth or cash accumulation. Certainly, the absolute amount of dividend can increase in proportion with the profits. But for THG to increase the payout ratio -- while it is certainly possible -- may signal a shift in management strategy, the effects of, which as previously mentioned, may or may not be favourable to shareholders.

Can THG distribute a bumper $50m or $100m special dividend? Sure, from its $165m 'excess cash,' which it accumulated over 12 years. Will THG do so? This is something for (prospective) shareholders to ponder over. Perhaps the real amount of 'excess cash' from management's perspective is the amount that they are holding in fixed deposits.

---

What makes it difficult for a competitor -- new to market or an existing market player -- to enter the luxury watch industry? 

Principals are concerned with being able to produce and sell a stable and growing volume of their products to dealers. So the requirement for a dealer, inter alia, is the ability to purchase inventory at a consistently high rate. This means that the dealer has to have plenty of capital and soundness of management to sustain business over the very long term.

Does THG have very close relations with its principals? Maybe. But that is only because THG has been able to fulfill its end of the purchasing deal. And this has come at an expense to THG. Why has THG's inventory turnover increased from 4 months to 6 months over the decade? They are not selling as fast as they are buying. So why don't they slow down their buying? Are they constrained by purchasing agreements with principals, or are they hoarding inventory because they believe they will further appreciate? I don't know.

As mentioned, my opinion of THG is that its business is good. But is it as awesome as the rhetoric here suggest? 

---

What are the exit option for a (prospective) shareholder?

So far, from the discussion, there are four being offered. 
1. Tay buys back all the shares.
2. A watch retailer competitor buys out Tay.
3. Private equity buys out Tay. 
4. A luxury goods retailer buys out Tay.

Let's briefly discuss each of them.

1) The first has been explored, so I will not repeat the points here.

2) The second has also been explored. If it is uneconomical for Tay to pay for a premium to buy out its competitor, then it is the same for Tay's competitor to do likewise. In other words, why will Cortina -- or whichever luxury retailer -- pay a premium for THG when it can build its own inventory and stores, without?

What makes more economical sense is for THG to merge with Cortina, and then try to get better purchasing terms from principals, and raise selling prices. The hurdles to these include anti-trust regulation, and personal ego. So probability of such an event is not likely to be high.

3) The third is not likely to happen because very few reasonably successful Asian businesses actually sell out to private equity. Again this is probably due to cultural and/or egoistic reasons. In any case, someone is needed to run the business, and preferably someone from within the business itself. Since THG has always been family-managed, any private equity buyer will want Tay to stay on to run the business. But why will Tay want to go from being boss to employee? Or even have his majority stake reduced to a paltry 10-20%?

A PE buy out is more likely if the price offered to Tay is very high. But this is injurious to the PE, which, will still have the problem of getting someone to run it, even if they are able to retain Tay for a few years as part of the deal.

If a PE wishes to get exposure to the luxury watch industry, perhaps it will be more economical to buy out a smaller player, and then pump it with plenty of cash to expand and compete with the likes of THG.

4) This is perhaps the most likely, since a luxury goods retailer will likely have management expertise suited to run THG. It is also one which may offer the largest premium. But family pride/ego of Tay remains a barrier.

In the foreseeable future, for reasons I have mentioned in the explanation of 1), my opinion is that Tay will continue to buy shares at below NAV, when such opportunity arise.

---

THG is quite alright as a business. And my opinion is that its share price is closer to, rather than further from, its business reality. The possibility of a huge jump in share price is always possible -- as it is for any listed company, due to a variety of events -- but shareholders need to assess the possibility of such events occurring, to have a more realistic perspective of its valuation.

[Shiyi]

There have been quite a few points raised. Let's try to discuss each of them.


Just how much cash/working capital does THG require? 

1) That depends on how much THG wishes to grow. We don't know the plans that management has for the future, but the requirement of working capital can still be illustrated by looking at past figures.

($000)                 Revenue             Changes in working capital                                     
FY08:                   489,768              -7,334
FY09:                   441,908              -10,039
FY10:                   488,298              -22,262
FY11:                   521,834              -34,442
FY12:                   611,780              -43,827
FY13:                   607,758              -54,500
FY14:                   688,943              -6,599
FY15:                   740,804              -36,642
FY16:                   714,029              -45,480
FY17:                   703,952              1,314
FY18:                   691,645              9,802
FY19:                   727,315              -21,205

Growth in Revenue over 12 years: $237m
Total Change in Working Capital over 12 years: -$271m

As THG grew its revenue by $237m over the past 12 years, its increase working capital -- mainly inventory -- is $271m. So it looks like THG has to use an extra dollar to earn an extra dollar (and part of the reason is that it is holding inventory for longer periods than before). How much revenue growth does THG desire? Does its present cash balance represent a realistic amount of growth that THG may wish to achieve, in the near future?


2) But working capital is not all that THG requires for growth, although it constitutes the largest proportion. More retail shops means more PPE requirement. How much? I will spare readers the details and summarise the numbers.

Total Depreciation & Amortisation over 12 years:              $66m
Total Investment Cash Flow over 12 years:                      -$156
Difference over 12 years:                                               -$89m

Not all of its investment cash flow is being spent on PPE, but to save myself the trouble of digging for the numbers, the illustration here should not be too wide off the mark. Thankfully, the requirement on capital expenditure is not as high as for working capital.


3) So what does all these mean for THG? How much cash does it really need? How much cash does it really generate? In a previous discussion, I have mentioned how companies may allocate their capital into 3 broad areas: growth, financial security, and distribution. How much does THG spend on each of these?


Total Operating Cashflow before WCC:   $739m              (100%)

Total Change in WC:                            -$271m             (37%)
Total Investment Cash Flow:                 -$156m             (21%)
Total Dividends:                                   -$146m             (20%)

Remaining ‘Excess Cash’:                       $165m              (22%)


It should be clear that the bulk of the cashflow is spent on working capital and PPE; growth. And the remainder is split between distribution and financial security.

So if (prospective) shareholders are expecting to have a higher payout ratio, it has to either come at the cost of growth or cash accumulation. Certainly, the absolute amount of dividend can increase in proportion with the profits. But for THG to increase the payout ratio -- while it is certainly possible -- may signal a shift in management strategy, the effects of, which as previously mentioned, may or may not be favourable to shareholders.

Can THG distribute a bumper $50m or $100m special dividend? Sure, from its $165m 'excess cash,' which it accumulated over 12 years. Will THG do so? This is something for (prospective) shareholders to ponder over. Perhaps the real amount of 'excess cash' from management's perspective is the amount that they are holding in fixed deposits.

---

What makes it difficult for a competitor -- new to market or an existing market player -- to enter the luxury watch industry? 

Principals are concerned with being able to produce and sell a stable and growing volume of their products to dealers. So the requirement for a dealer, inter alia, is the ability to purchase inventory at a consistently high rate. This means that the dealer has to have plenty of capital and soundness of management to sustain business over the very long term.

Does THG have very close relations with its principals? Maybe. But that is only because THG has been able to fulfill its end of the purchasing deal. And this has come at an expense to THG. Why has THG's inventory turnover increased from 4 months to 6 months over the decade? They are not selling as fast as they are buying. So why don't they slow down their buying? Are they constrained by purchasing agreements with principals, or are they hoarding inventory because they believe they will further appreciate? I don't know.

As mentioned, my opinion of THG is that its business is good. But is it as awesome as the rhetoric here suggest? 

---

What are the exit option for a (prospective) shareholder?

So far, from the discussion, there are four being offered. 
1. Tay buys back all the shares.
2. A watch retailer competitor buys out Tay.
3. Private equity buys out Tay. 
4. A luxury goods retailer buys out Tay.

Let's briefly discuss each of them.

1) The first has been explored, so I will not repeat the points here.

2) The second has also been explored. If it is uneconomical for Tay to pay for a premium to buy out its competitor, then it is the same for Tay's competitor to do likewise. In other words, why will Cortina -- or whichever luxury retailer -- pay a premium for THG when it can build its own inventory and stores, without?

What makes more economical sense is for THG to merge with Cortina, and then try to get better purchasing terms from principals, and raise selling prices. The hurdles to these include anti-trust regulation, and personal ego. So probability of such an event is not likely to be high.

3) The third is not likely to happen because very few reasonably successful Asian businesses actually sell out to private equity. Again this is probably due to cultural and/or egoistic reasons. In any case, someone is needed to run the business, and preferably someone from within the business itself. Since THG has always been family-managed, any private equity buyer will want Tay to stay on to run the business. But why will Tay want to go from being boss to employee? Or even have his majority stake reduced to a paltry 10-20%?

A PE buy out is more likely if the price offered to Tay is very high. But this is injurious to the PE, which, will still have the problem of getting someone to run it, even if they are able to retain Tay for a few years as part of the deal.

If a PE wishes to get exposure to the luxury watch industry, perhaps it will be more economical to buy out a smaller player, and then pump it with plenty of cash to expand and compete with the likes of THG.

4) This is perhaps the most likely, since a luxury goods retailer will likely have management expertise suited to run THG. It is also one which may offer the largest premium. But family pride/ego of Tay remains a barrier.

In the foreseeable future, for reasons I have mentioned in the explanation of 1), my opinion is that Tay will continue to buy shares at below NAV, when such opportunity arise.

---

THG is quite alright as a business. And my opinion is that its share price is closer to, rather than further from, its business reality. The possibility of a huge jump in share price is always possible -- as it is for any listed company, due to a variety of events -- but shareholders need to assess the possibility of such events occurring, to have a more realistic perspective of its valuation.

Thank you for the detailed analysis.
Based on your analysis, the watch business is asset heavy in the form of inventory. I wonder then why THG buy into Cortina?
Secondly, Tay's family squabble is well known. Will that be a major motivation for Tay senior to privatize the company as a defensive move?

[brattzz]

For many decades, retailers does not have much bargaining power over producers, until Amazon biz model, which sort of tilt the scale a bit towards retailers...abit online retailers platforms at the moment

However, for top luxury goods segment, it is niche and an viable biz model is always to be entrenched at each/all level of the luxury value chain...luxury+luxury=luxury2!

Of cos if Lvhm comes in and offer to bring in THG into the entire luxury value chain, it’s quite an attractive proposition!

I see Boss Tay and Son, focusing on consolidating on property play (assets n cost), while keep powder dry and plenty for an eye on the next opportunity, you are buying into the future growth of another Asian based luxury retailer, not just for watches, more for the retailer’s exposure and accessibility via their stores assets, in brick and motars, plus a bit of online presences...

Boss Tay is very patient and conservative, will be a medium to Long term holdings, 💪👍

[Big Toe]

To add on to Karlmarx excellent analysis.

Why is Hour Glass holding so much inventory?
Dealers/distributors typically would try hold as little inventory as possible, so why, i can only guess.

1. An agreement is already set in stone for X number of years on the purchasing volume.
2. If volume is not met, there maybe detrimental consequences, like the brand owner/principal expanding the dealer network
3. There is a minimum amount of display space/stock to be available at all times as set by the principal/brand owner.
4. They maybe making a bet on certain limited models appreciating in value.
5.  They maybe hoarding inventory in case a brand owner/principal decides to drop them or sell direct. This allows them time to react in such a situation.  
6. Obsolete or dead stock(stuff that are not moving) are still being held at cost.

As for who will buy out THG.

Karlmarx pretty much sums it up but certain PE funds are known to buy out very specialized firms(i.e. medical) which they totally dont understand or have the expertise to run. THG is actually not a difficult business to understand in relative terms. Depending on the type of PE funds, some just buy it to re-package it and re-sell/re-list it at a good profit soonest possible with no intention of running it. Then again the chances are low here because there isnt a lot THG can offer here both to the PE fund as well as to a luxury firm.Then there are chinese firms looking to expand internationally, this would be more probable as they are easy buyers flushed with cash and eager to expand. Then again the china central government clampdown recently on overseas purchases made this less likely. We'll see what happens, maybe it will happen? Because surely this would be a less stressful buy than say....hyflux?