OTO Holdings (6880)

[LLI]

A short valuation on OTO!

OTO Holdings has launch a warrant during 2012, and they state that the reason it to issue it to suppliers as an incentive for them to have a stake in the company so as to promote longer-term relationship. Furthermore, they also hope that through this issue, they can improve the relationship with the suppliers so that they can get other corporate contracts from their contacts. It is yet to be seen if this strategy will work. However, they have issued the warrants at too low a price in our view. This again indicates to us that the management might lack capital allocation skills but they have relatively good operational skills. As long as they do not do over the top capital allocation decision, we should be safe with this investment.
Given the large cash holdings in the company, management has indicated to us that they have started a little share buyback, but have not gone into large-scale purchase. We do not see large scale purchase anytime soon due to the illiquid nature of the stock and large shareholding by the Yip Family, there is little advantage for share buybacks in large scale. What we feel the company should do is to increase the dividend payout, as cash should still be staying relatively high, as there is no need for the excess cash for expansion purposes. The right decision is for the management to return the cash to shareholders.

We have done a simple FCF valuation on this company for the average FCF for the past 4 years; HK$ 31million. We tried to be conservative in our calculation.
Assumption
Discount Rate = 15% due to the small capitalization and short history of the company,
Growth Rate = 3% due to slow market condition and slightly successful gain from OSIM market share

This will give us a market capitalization of HK$ 260million. However, they still have around HK$ 200million of net cash after all liability.
That will give us a total of HK$ 460million market capitalization, which is 320million shares outstanding, a price per share of HK $1.43
The current market price of the stock is HK$ 0.59, giving us a margin of safety of 58[/align]%. The company has a net cash of HK$ 0.63 currently.

[greengiraffe]

Good work but I always have this question for Osim - how to trust a company that constantly have more salesmen than customers in the shops...

I am vested in Osim but always wonder how they generate cashflow...

A short valuation on OTO!

OTO Holdings has launch a warrant during 2012, and they state that the reason it to issue it to suppliers as an incentive for them to have a stake in the company so as to promote longer-term relationship. Furthermore, they also hope that through this issue, they can improve the relationship with the suppliers so that they can get other corporate contracts from their contacts. It is yet to be seen if this strategy will work. However, they have issued the warrants at too low a price in our view. This again indicates to us that the management might lack capital allocation skills but they have relatively good operational skills. As long as they do not do over the top capital allocation decision, we should be safe with this investment.
Given the large cash holdings in the company, management has indicated to us that they have started a little share buyback, but have not gone into large-scale purchase. We do not see large scale purchase anytime soon due to the illiquid nature of the stock and large shareholding by the Yip Family, there is little advantage for share buybacks in large scale. What we feel the company should do is to increase the dividend payout, as cash should still be staying relatively high, as there is no need for the excess cash for expansion purposes. The right decision is for the management to return the cash to shareholders.

We have done a simple FCF valuation on this company for the average FCF for the past 4 years; HK$ 31million. We tried to be conservative in our calculation.
Assumption
Discount Rate = 15% due to the small capitalization and short history of the company,
Growth Rate = 3% due to slow market condition and slightly successful gain from OSIM market share

This will give us a market capitalization of HK$ 260million. However, they still have around HK$ 200million of net cash after all liability.
That will give us a total of HK$ 460million market capitalization, which is 320million shares outstanding, a price per share of HK $1.43
The current market price of the stock is HK$ 0.59, giving us a margin of safety of 58[/align]%. The company has a net cash of HK$ 0.63 currently.

[dzwm87]

Good report. Here's my 2 cents worth:

OTO is doing very bad currently and that's the reason why the market is discounting so much based on execution risks.

The main issue was that they expanded too fast in the past 2 years and they are currently being impacted by increasing rental expenses. HK rental rates are exorbitant. It increased around 32% for 2011 and probably added more in 2012. This will impact less profitable business as their marginal profits are now being eaten up by rising rental. We see this clearly in cases such as Esprit who is closing down some outlets in HK simply because their lower global profit is unable to offset the rising rentals. In contrast, more profitable companies like H&M, Forever21 are paying up to grab more market share. So we have widening gap between the profitable and less profitable retail companies. It is obvious OTO falls into which category.

Secondly, though they are the market leader for relaxation products in terms of units sold, they are actually just 2nd in terms of revenue. And the change is very drastic with OTO & Osim taking clearly opposite roles, which simply suggest that ASP for OTO's relaxation products is much lower than Osim. Osim is clearly the premium segment of massage chair and this weighs down badly on OTO's pricing power. If OTO decides to increase their ASP, I rather buy from Osim. And the other product segments won't matter much since relaxation product accounts almost 75% of their revenue.

Prima Facie, the industry may seem like a duopoly which might look all rosy for both Osim and OTO. But has the duopoly case actually started to tilt towards Osim's favor? If you look at it another way, Osim is actually twice the size of OTO! It will be interesting to do up an estimation of market share between the two over the past 5 years. Osim has been advertising aggressively with Andy Lau and many others being their ambassadors. My guess is OTO might have been losing their market share.

So in the end, we have both pricing pressure and cost pressure on OTO's business. So net cash is likely to be burned. They recently announced another profit warning for FY2013. Things won't look rosy at least for another 1 year or so.

[felixleong]

Ya, sometimes I also dont understand how OTO and OSIM makes money.
Every time walk pass their retail outlets... no customers one.. lol

[LLI]

Good work but I always have this question for Osim - how to trust a company that constantly have more salesmen than customers in the shops...

I am vested in Osim but always wonder how they generate cashflow...

A short valuation on OTO!

OTO Holdings has launch a warrant during 2012, and they state that the reason it to issue it to suppliers as an incentive for them to have a stake in the company so as to promote longer-term relationship. Furthermore, they also hope that through this issue, they can improve the relationship with the suppliers so that they can get other corporate contracts from their contacts. It is yet to be seen if this strategy will work. However, they have issued the warrants at too low a price in our view. This again indicates to us that the management might lack capital allocation skills but they have relatively good operational skills. As long as they do not do over the top capital allocation decision, we should be safe with this investment.
Given the large cash holdings in the company, management has indicated to us that they have started a little share buyback, but have not gone into large-scale purchase. We do not see large scale purchase anytime soon due to the illiquid nature of the stock and large shareholding by the Yip Family, there is little advantage for share buybacks in large scale. What we feel the company should do is to increase the dividend payout, as cash should still be staying relatively high, as there is no need for the excess cash for expansion purposes. The right decision is for the management to return the cash to shareholders.

We have done a simple FCF valuation on this company for the average FCF for the past 4 years; HK$ 31million. We tried to be conservative in our calculation.
Assumption
Discount Rate = 15% due to the small capitalization and short history of the company,
Growth Rate = 3% due to slow market condition and slightly successful gain from OSIM market share

This will give us a market capitalization of HK$ 260million. However, they still have around HK$ 200million of net cash after all liability.
That will give us a total of HK$ 460million market capitalization, which is 320million shares outstanding, a price per share of HK $1.43
The current market price of the stock is HK$ 0.59, giving us a margin of safety of 58[/align]%. The company has a net cash of HK$ 0.63 currently.

Hi,
yes, their sales is dropping. We spoke with the CFO. The issue is they do not have much Capex in order to expand a new store. Most of their sales are done in departmental stores, their flagship stores are more of a marketing icon.

So for each department stores, their only capex is the billboard and some sample products. And as they are on consignment basis, their breakeven point is extremely low, maybe 1-2 chairs sold per month they are able to break even.
So they have a huge cash, with not much capex for expansion and even if they lose money on paper this interim, their cash flow will most likely be positive due to the high margins.

So, yes it might take a while to unlock value, but the margin of safety is quite high for OTO.

[FFNow]

Good work but I always have this question for Osim - how to trust a company that constantly have more salesmen than customers in the shops...

I am vested in Osim but always wonder how they generate cashflow...

Hi greengiraffe, Osim sells premium products at premium prices and thus the volume will be low. There are two ways to make money - sell at low price, high vol or vice versa (that is what Osim is doing I believe).

[Musicwhiz]

Just off the cuff thinking (I have not gone through the DCF valuation of OTO in detail yet) - but shouldn't OTO be more comparable to OGAWA from Malaysia? To me, these are the mass market massage product sellers compared to OSIM which is more of a "premium" brand.

Comparing OTO and OSIM may seem logical but they are targeting different market segments and also have different ASPs for their somewhat similar product ranges.

Thanks.

[greengiraffe]

I miser - I exercise by going outdoors and do it tough.

Sorry OSIM is not for me - never will.

GG

[CY09]

In my view, to evaluate OSIM and OTO, we have to understand the extent of their ability to market, sell and persuade potential customers.

There are indeed "misers" (like green giraffe) who will nvr pay for such pricey products for relaxation or the promise of losing inches on their thighs or waist. But there are also many who are willing to pay high prices for such products, with the expected desire to get their "slim image or sense of relaxation"

Hence the key is to evaluate how good are OTO and OSIM in branding and marketing their products to East Asian consumers who are willing to pay a premeium for this high-priced products instead of taking the "cheap route" of going out to exercise. One has to note the factor of rising affluence of east Asia consumers as well and how much it can be translated into buying these products. It is from this step that we will be better able to evaluate the "Growth rate" that OTO and OSIM will get and hence obtain the valuation range.

I have not much knowledge of this industry and hence this is as much advice as i can give for now.

[LLI]

In my view, to evaluate OSIM and OTO, we have to understand the extent of their ability to market, sell and persuade potential customers.

There are indeed "misers" (like green giraffe) who will nvr pay for such pricey products for relaxation or the promise of losing inches on their thighs or waist. But there are also many who are willing to pay high prices for such products, with the expected desire to get their "slim image or sense of relaxation"

Hence the key is to evaluate how good are OTO and OSIM in branding and marketing their products to East Asian consumers who are willing to pay a premeium for this high-priced products instead of taking the "cheap route" of going out to exercise. One has to note the factor of rising affluence of east Asia consumers as well and how much it can be translated into buying these products. It is from this step that we will be better able to evaluate the "Growth rate" that OTO and OSIM will get and hence obtain the valuation range.

I have not much knowledge of this industry and hence this is as much advice as i can give for now.

True, I think most people will not buy these equipment for themselves. A check with people in the industry, it seems most of their sales is done during Q2 and that is because, most people buy it for their parents during papa and mama day.
If you are always busy working, hardly had time for your aging parents, OTO and OSIM seem to be a logical gifts for them during father and mother day, and that is how they generate most of their sales.