Korea / Special Sits, Pairs, Index Rebalancing, Clepsydra Capital

Sanghyun Park

Korea / Special Sits, Pairs, Index Rebalancing

Equity Capital Markets

HDC I-Service Co Ltd / Equity Capital Markets

Interestingly, valuation isn't the main debating topic in this HDC I-Service Co Ltd (037140 KS) IPO. What most investors are mainly asking is why they do this IPO at this interesting time. You know what I'm talking about. We are in the middle of HDC tender event. Swap price determination is scheduled for Aug 23-27 and tendering period is scheduled for Aug 30-Sep 18. And this IPO bookbuilding is scheduled for Sep 4-5. I guess this is too much of a coincidence. I mean the timing of this IPO must have been closely planned in connection with HDC tender.So, how should we approach this IPO? Here are my conclusions first:Unlike the other recent tender events here in Korea, the tendering company side needs as many the target company's shareholders as possible to participate in this tender since the major shareholder's shareholding in the target company is unusually low. This clearly means one thing. They have to make this tender as appealing as possible for the target company's shareholders. How would they do it? Well, there would be multiple ways. One is to keep a swap ratio as favorable as possible for the the target company's shareholders. So, we are expected to see a weaker price of HDC Holdings (012630 KS) relative to Hyundai Dev Co (294870 KS) until Aug 27. But once this swap price setting job is done, then we need valuation/price boosters for HDC Holdings to further incentivize the target company's shareholders to tender their shares.And guess what, this IPO may come in very handy for this specific job since HDC Holdings is the major shareholder with a 56.56% stake. That is, the management side must be extra motivated/incentivized to make this IPO a smash hit during the Sep 4-5 institutional bookbuilding so that whatever sentimental boost coming from this IPO will flow into HDC Holdings. Then, how would investors react to this? Well, of course it wouldn't be easy to change fundamental views of long-term investors. But short-term oriented speculators? The current dynamic of this IPO may be enough to make them move, and considering Korean IPOs generally attract a disproportionately high level of short-term speculative money, I feel we may see a surprisingly much stronger demand. That is, it seems highly probable that IPO price will be settled around at a level rather close to the ceiling despite the rather dull nature of the realty business.* Alright, let's talk about this in a bit more detail below.Who is HDC I-Service and what they do?HDC I-Service Co Ltd (037140 KS) is basically a property management realty company. In fact, it is Korea's largest one in this field and currently provides a wide range of property management related services.(HDC I-Service business portfolio - Source: HDC I-Service corporate brochure)The company has four core business areas: 1. property/facility management (realty), 2. landscaping (or landscape architecture), 3. interior design and 4. property repair/maintenance. Property/facility management is the biggest chunk as it accounts for 64.05% of total sales, followed by landscaping with 19%, interior design with 9.57% and property repair/maintenance with 7.37%. Profitability wise (based on 1Q18 numbers), interior design tops with a 14.70% OPM, followed by property repair/maintenance with a 7.80% OPM and landscaping with a 7.30% OPM. The biggest chunk, property/facility management, delivers only a 4.30% OPM.



Based on 1Q18 financials
Property/facility management
Landscaping
Interior design
Other (mainly CS - property repair/maintenance)


Sales
52,966
15,711
7,917
6,097


As a % of total sales
64.05%
19.00%
9.57%
7.37%


OP
2,301
1,145
1,161
479


As a % of total OP
45.24%
22.51%
22.83%
9.42%


OPM
4.30%
7.30%
14.70%
7.80%


Note: ₩ mil
Source: DART, Sanghyun Park


Below are more details about each of the four core business areas.



Property/facility management
2015
2016
2017
1Q18


Sales
138,896
164,276
173,613
52,966


COGS
130,054
152,367
161,381
49,161


Gross income
8,842
11,909
12,232
3,805


Gross margin
6.40%
7.20%
7.00%
7.20%


SG&amp;A
6,280
5,624
5,499
1,504


OP
2,562
6,285
6,734
2,301


OPM
1.80%
3.80%
3.90%
4.30%


Note: ₩ mil
Source: DART






Landscaping
2015
2016
2017
1Q18


Sales
38,447
35,826
52,691
15,711


COGS
36,106
32,309
50,152
13,999


Gross income
2,341
3,516
2,540
1,712


Gross margin
6.10%
9.80%
4.80%
10.90%


SG&amp;A
1,683
2,335
2,155
567


OP
657
1,181
385
1,145


OPM
1.70%
3.30%
0.70%
7.30%


Note: ₩ mil
Source: DART






Interior design
2015
2016
2017
1Q18


Sales
18,411
26,895
34,534
7,917


COGS
15,053
23,833
30,044
6,185


Gross income
3,358
3,061
4,491
1,732


Gross margin
18.20%
11.40%
13.00%
21.90%


SG&amp;A
2,332
2,368
2,942
572


OP
1,025
693
1,548
1,161


OPM
5.60%
2.60%
4.50%
14.70%


Note: ₩ mil
Source: DART






Others (CS &amp; nursing home)
2015
2016
2017
1Q18


Sales
11,657
11,552
21,802
6,097


CS
9,807
9,470
19,723
5,529


Nursing home
1,850
2,082
2,079
568


COGS
10,609
10,573
20,520
5,526


Gross income
1,048
979
1,282
571


Gross margin
9.00%
8.50%
5.90%
9.40%


SG&amp;A
182
201
183
92


OP
865
778
1,099
479


OPM
7.40%
6.70%
5.00%
7.80%


Note: ₩ mil
Source: DART


Solid recent growth but a little concern over debt levelBelow are key financial numbers from 2015 to 1H18. For a realty firm, HDC I-Service has shown a remarkable growth in the recent years. Last year, sales grew 18.50% and this growth pace is just continuing in the first half of this year. Just, debt level has risen a little too fast last year, and this seems to be a main source of concern among some investors. The company explains that this was mainly due to a rapid rise in marketing expenses resulting from their aggressive sales efforts for landscaping and interior design businesses last year. Well, ahead of this IPO, they might have overdone to make their top line growth story look a little more sexy, but I don't really feel that this is near dangerous levels.



Key financials from 2015 to 1H18
2015
2016
2017
1H18


[Current Assets]
47,581
60,674
79,727
83,893


· Cash and cash equivalents
15,640
8,233
13,639
20,583


· Short-term financial instruments
5,022
9,300
13,304
14,304


· Accounts receivable
26,321
42,450
52,341
44,047


· Other receivables
116
95
58
4,085


· Other current assets
481
595
384
874


[Non-current assets]
23,818
26,312
34,637
28,589


· Long-term financial instruments
5
-
-
-


· Investment in affiliated companies
16,889
19,200
20,608
14,392


· Long-term investment securities
2,279
2,308
2,537
2,740


· Other long-term receivables
1,113
1,223
1,448
1,521


· Tangible assets
3,372
3,432
3,303
3,196


· Other intangible assets
160
148
147
147


· Investment property
-
-
6,594
6,594


Total assets
71,399
86,985
114,365
112,482


[Current liabilities]
28,543
38,330
54,780
46,612


[Non-current liabilities]
2,596
1,717
1,133
2,573


Total liabilities
31,139
40,047
55,914
49,185


[Capital]
7,070
7,070
7,070
7,070


[Capital surplus]
1,310
1,310
1,310
1,310


[Other cumulative comprehensive income]
2,283
3,111
2,405
2,742


[Retained earnings]
29,597
35,447
47,666
52,175


Equity
40,260
46,938
58,451
63,297



Sales
207,411
238,548
282,641
168,983


OP
5,110
8,938
9,765
9,493


OPM
2.46%
3.75%
3.45%
5.62%


NP
4,687
8,487
14,774
8,860


NPM
2.26%
3.56%
5.23%
5.24%



· Earnings per share (₩)

3,315
6,002
10,449
627


Note: ₩ mil
Source: DART






Key financial ratios
2015
2016
2017


Sales growth rate
10.80%
15.00%
18.50%


Total asset growth rate
3.30%
21.80%
31.50%


Pre-tax earnings growth rate
133.20%
77.20%
63.30%


Net income growth rate
138.10%
81.10%
74.10%

Source: DART

Governance structure issue can left out for nowBelow is the HDC Group's governance structure. They currently have a total 4 circular shareholding links which will have to be removed within 2 years after their holdco conversion was completed (May 1, 2018). HDC I-Service is involved in two of these 4 links. This IPO may be a preparation step to this effort. But how specifically would they do? This still remains uncertain and this IPO itself wouldn't have a direct impact on removing the links. So, I think we can leave out this aspect for now as we have more imminent and important things on our plate.
HDC Holdings→HDC I-Service→HDC I-Controls→HDC Holdings
HDC Holdings→HDC I-Service→HDC EP→HDC I-Controls→HDC Holdings
HDC Holdings→HDC I&amp;Cons→HDC I-Controls→HDC Holdings
HDC Holdings→HDC EP→HDC I-Controls→HDC Holdings

HDC governance structure
Chung Mong-gyu
↓ 13.36%
HDC Holdings (012630 KS)

↓ 7.03%

↓ 46.3%
↓ 56.6%
↓ 95.2%
↓ 81.5%
↓ 25.0%


Hyundai Dev Co (294870 KS)
HDC EP (089470 KS)

HDC I-Service Co Ltd (037140 KS)
* 2.0% in HDC EP
** 5.5% in IPARK Mall

HDC I&amp;Cons

IPARK Mall* 25.0% in HDC Shilla

HDC Shilla


↓ 14.8%
↓ 6.7%
↓ 6.4%


HDC I-Controls Co Ltd (039570 KS)
* 3.4% in HDC Holdings
** 3.4% in Hyundai Dev Co

Source: HDC, Sanghyun Park
Valuation wise?The banker's valuation is nonsensical. You don't need to bother it. Well, it is understandable that they do not have any legitimate valuation peer for HDC I-Service. C&amp;S Asset Management (032040 KS) may be the only legitimate local valuation peer, but it is now on the verge of de-listing. So, the banker picked three local peers, but none of them closely matches HDC I-Service's business lineup.



Peer valuation
Kukbo Design (066620 KS)
Hanmiglobal (053690 KS)
S 1 Corporation (012750 KS)


FY2017 earnings
13,341
8,953
143,327


Market cap
138,375
116,072
3,302,129


PER
10.37
12.97
23.04


Avg. PER
15.46


Note: ₩ mil
Source: DART





Valuations

Annual earnings

15,270
* 1:2 weighted average of FY2017 earnings and FY2018 annualized earnings based on 1H18 earnings



Target valuation
236,157


Total shares
19,140,000


Price per share (₩)
12,333


Note: ₩ mil
Source: DART





Indicative price band

Price per share (₩)
12,333


Discount
13.24 - 32.70%


Indicative price band (₩)
8,300 - 10,700

Source: DART

So, forget about the banker's valuation, and let's do this in a more sensical way. Apparently, local street generally agrees that this year's earnings will be at least ₩15bil. Consensus seems to be at around ₩17bil. At 10-20x PER on ₩17bil, we have a ₩170-204bil valuation. This is pretty much in line with the valuation given by the indicative price band. Basically this is like the floor is set at a 10x PER on this year's earnings and the ceiling is set at a 12x PER. So, this is now a question of where we should be on a 10-12x PER range (or even higher). Even a 10x PER would seem a little too generous given OPM still hovering at less than 6%. But we'd need to give a premium on the growth factor that the company has achieved in the past three years and even now. The company's less dependancy on intra-group deals (60% of its total sales coming from outside clients, which is very rare for a realty affiliate of Korean chaebols) should be translated into an extra valuation premium. Lastly, we have this tender event going on which is expected to lure short-term money into this IPO. So, the ceiling, a 12x PER on FY18 projected earnings of ₩17bil, doesn't seem to be a hard target to hit at this point.



PER / annual projected earnings
15
17
19
20


10.0x
150
170
190
200


12.0x
180
204
228
240


14.0x
210
238
266
280


15.0x
225
255
285
300


Note: ₩ bil
Source: Sanghyun Park




HDC I-Service IPO: Strong Demand from Short-Term Money Is Expected with HDC Tender in Progress

South Korea

C&S Asset Management Co., Ltd. provides facility equipment maintenance, commercial cleaningservices, and epidemic control operations.  The Company provides its services to governmental and industrial buildings, department stores, banks, historic sites, amusement parks, apartment complexes, military installations, and embassy housings.

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C&S Asset Management (032040 KS)

HDC I-Service IPO: Strong Demand from Short-Term Money Is Expected with HDC Tender in Progress

Interestingly, valuation isn't the main debating topic in this HDC I-Service Co Ltd (037140 KS) IPO. What most investors are mainly asking is why...

Sanghyun Park

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