Hong Kong Television Network: A Rare Combination Of Growth And Net-Net

HKTV has a very interesting story and background. The company’s original name was “City Telecom” which was built by CEO and founder Wong Wai Kay in 1992.

Mr. Wong was born and graduated in Hong Kong, worked in IBM and later became an immigrant of Canada. In 1992, he started City Telecom, conducting long distance telephone business at the beginning. At that time, international long distance phone call was very expensive and was under monopoly by Hong Kong Telecom. Wong started his discounted phone call plan and had success in reducing the rate significantly.

Since year 2000, he started an ambitious plan to build broadband internet for local residents in Hong Kong. At the beginning, many investors thought that plan was crazy, and the company indeed had many years of large losses, but eventually he successfully built the first broadband network and covered 90% of the Hong Kong families by 2010.

After this success, he sold all the broadband network and telecom business to CVC Capital Partners, a global private equity firm, for HK$4.87 billion in 2012, and then he changed his focus to building a TV program business, the current HKTV. Since the company was then rich in cash after the sale, he issued a HK$2.5 special dividend or HK$2 billion to shareholders in 2012.

However, after 2012, a new drama began as the company was trying to apply for TV broadcasting license. Rumor says that because Wong had offended the local government, Hong Kong government rejected the license application from HKTV. Many Hong Kong residents apparently thought this was totally unfair, since between 36,000 and 80,000 protesters gathered and protested the government’s decision. Later, HKTV also filed a lawsuit against the government and actually won the lawsuit in some sense with the Hong Kong High Court ordering the Executive Council to reconsider the proposal. However, it seems that Executive Council filed another lawsuit after that and the decision is still pending with no expected date of resolution.

Since HKTV failed the application for traditional TV broadcasting, it tried to turn into digital mobile TV broadcasting, but that was again getting into trouble since the government claimed that it has to require a license too if it uses DTMB (Digital Terrestrial Multimedia Broadcast) transmission standard to do broadcasting. HKTV then filed another lawsuit to this claim but failed in court this time in late 2015. Now the company is trying to consider other transmission standards to do broadcasting, but whether it will get government approval is still highly uncertain.

Since the path to build a good TV programme business is at least temporarily blocked, Wong suspended the TV programme activities and turned his focus to building the first large scale online retail platform in Hong Kong: HKTVMall.

Online Retail In Hong Kong

Unlike mainland China and many other developed countries, online retail never got very popular in Hong Kong. The primarily reasons are:

1. Shipping cost is high.

Shipping cost from overseas such as Japan, US and Europe is too high. The shipping cost from mainland China is relatively cheaper, but it is still cross boarders and not as cheap as shipping within the mainland China.

With shipping cost high, returning a product becomes even harder and uneconomical.

2. Lack of trust in products from sellers in mainland China.

Some official report from China says only 41% of sample online purchases meet the quality standards when buying from online sellers in mainland China. It might not be a big problem for people who live in China since they might be experienced enough to know a few tricks to identify the best sellers (relying solely on reviews and ratings usually don’t work), but for Hong Kong residents, it might not be that simple. Personally, I had a few purchase experiences a couple years ago when purchasing on TaoBao, and the experience was very bad, nothing comparable to the experience in Amazon, but this might have changed in the recent years.

Also, a lot of the “trust” problems are not just with the online sellers, but also with the producers of the goods. As IP is not widely respected in China, good brand names often get copied without severe punishment, which in turn discourages any effort/investment on building a good brand.

3. Small local area.

Hong Kong is a fairly small city with a lot of retail shops. Therefore, shopping in local retail store is pretty convenient and doesn’t require much traveling at all. However, people might still need to wait in lines from time to time though.

4. Small market.

With about 8 million people, it is a small market. Therefore, it is not very attractive to big corporations such as Alibaba (NYSE:BABA).

For the reasons above, large scale online retailing was virtually non-existence in Hong Kong before HKTV tried to enter this market.

HKTVMall

Click to enlarge

HKTVMall started the online retail platform in late 2014. The platform invites product listings of many local merchants and the delivery services are also sometimes provided by these local merchants. For merchants without resource to prepare listings, the company would help them on that and the company has its own delivery team for fast and high quality delivery service.

Serious marketing campaign didn’t start until Summer 2015. Due to the large scale local campaign and promotion activities, the web site was very popular at that time.

However, the real high organic growth probably didn’t start until late 2015 or early 2016. As Wong said, comparing to November 2015, the sales volume had gone up 100% by January 2016, and he planned to expand the delivery team by tripling its size by the end of 2016. He also said the growth of sales had been in double digits every month.

At the same time, the web site also got much better over time. Not only it became much prettier, it also got easier to search products. Recently, there are more and more reviews with the listed products, which can provide good information for consumers.

Since it is called HKTVMall, along with the shopping, customers can also view TV programs online or on mobile, as well as the promotional TV ads for the products on sale.

So far, HKTVMall has about 1 million active users, or about 12% of Hong Kong population.

Advantages of online retail

To better understand HKTV’s business model, it might be good to have a review on the advantages of online shopping:

1. Convenience.

For people who don’t really enjoy shopping by itself, but need to buy needed products anyways (like me), online shopping can become an almost exclusive shopping method. After all, considering all the time to drive to store, search for products in a physical store, wait in lines to check out and drive back, a few clicks on a web site or a mobile app can save a lot of time. This time saving provides a lot of intangible value to consumers.

It should be mentioned that the increasing popularity of mobile devices also helped online shopping.

Although this advantage may be less obvious for Hong Kong residents (since they live pretty close to the retail shops), it can still save them the time for waiting in line or walking over.

2. Low cost.

Online retailers can save the expense of renting a physical store. This saving can be especially significant in Hong Kong as the local rent has gone up significantly in the last few years. According to Wong, rental expense is about 25% of the retail price for those local retail stores.

So far, HKTVMall has not achieved a cost advantage over local stores yet, due to its present small scale. However, as the scale gets bigger, there is likely a cost advantage later.

3. More selection and easy to search.

One big advantage for online shopping is the vast selection of products which is very hard to achieve in a local store. It is also much easier to search products online.

4. More information transparency.

Information transparency should be considered as a new source of efficiency, since this reduces the waste on marketing, and increases competition on price and real quality of the products. Because of information transparency, consumers can easily compare prices between retailers and producers, and can get feedbacks about the product quality through ratings and reviews.

Many shoppers go online to shop because they can get these feedbacks to help them find the best product.

Of course, there are also some disadvantages in online shopping:

1. Shipping cost.

It depends on the item’s price and size, but shipping cost is generally significant for many products.

2. Time delay.

Again, it depends on the products. Some are very time sensitive, others are not.

3. Not able to see or try the products.

For a well-known brand and product, this might not be a problem, but generally this is an issue that stops online shopping for many products.

4. Difficult for returns.

This might be less of a problem in Hong Kong and China than in US, since it is my impression that it is pretty difficult to return products there in local stores too, but maybe Hong Kong is quite different from China.

Overall, some products are more suitable for online shopping, but some others are not. But in general, online shopping should be on the trend to get much more popular, even in Hong Kong, mostly it is a habitual behavior that will be gradually changed. Also, online retail has significant networking effects, so its attractiveness will increase over time too as the network gets larger.

Why It is Cheap

1. Burning cash

Since the TV programme business has failed (at least temporarily), and the new online retail platform is still being built, the business is burning cash at a fast rate.

Recently, the company’s earnings warning announcement indicated that the loss in year 2015 increased 200% relative to the 16 months in 2014. This means the second half of 2015 may have a loss of about HK$460 million, or about twice of the first half of 2015. Considering that this company only had a $1.4 billion market cap at the current price, there is no doubt that this is a very big loss that will scare many people away.

However, when we take a closer look at the announcement, we can find that the “cash loss” may be much smaller:

The increase in loss for the Year is mainly attributable to:

1) the impairment loss on certain assets resulting from the uncertainties on the media business; and

2) the increase in programme costs charged to the profit or loss over the showing period while the revenue from licensing of programme rights and net advertising income was not increased proportionally; and

3) the e-commerce business was officially launched on 2 February 2015 and is still in its early investment stage to be financially material to the Group.

As we can see, the impairment loss may be related to the HK$370 million intangible asset which includes the right of using network capacity of former subsidiary, which should be a non-cash charge. There is also HK$132 million programming cost on balance sheet as a part of current asset which should be charged off as the company suspended all TV programs. So the actual cash loss may be just HK$200 million or less in the 2nd half of 2015. However, this is just my estimate, and we will have to find out the fact in the coming annual report of 2015.

2. Unproven business model

Although HKTVMall has achieved fast growth recently, the business model is still not fully proven and there is still a lot of uncertainties associated with it.

The same can be said about the movie and mobile TV businesses. As Mr. Wong invests into these two new businesses, there are a lot of uncertainties ahead.

3. Small market cap.

The current market cap is about HK$1.415 billion, which is less than $200 million. This small market cap will not bring much interest from many professional large investors.

Protection From Downside

The stock is currently trading at a discount to its liquidation value, but it might not be obvious if someone uses a screener. This is because a large part of the asset is in the long-term financial asset (which is counted as non-current asset).

According to the semi-annual report, the company currently has HK$1.66 billion financial assets. Most of that asset is in debt securities. Since it is level 2 asset valued at market quoted prices, it is likely to be some relatively illiquid corporate debt. $1.28 billion of this is long term (more than 1 year maturity date), so it is classified as non-current asset, and won’t be showing in the net current asset in a screener. However, it should certainly be considered as liquid asset in the consideration for liquidation value.

Below is a summary and classification of all assets on the balance sheet:

Since the programming cost should be charged off over time, it shouldn’t be a part of the liquidation value. The value of investment properties is calculated from 20 times of rental income listed in the annual report. If we assume half of the real estate value for liquidation purpose, the net liquidation value should be the following:

1106 – 132 – 450 + 1285 + (230 + 450)/2 – 477 = HK$1672 million.

Here we excluded HK$450 million from current asset as the contracted cost to build the 31,777 square meter media center, which is expected to finish by October, 2016.

Notice that this is based on the figures on 6/30/2015. As shown above, the recent earnings announcement may indicate another HK$200 million cash loss in the second half of 2015, if we count this in, the actual liquidation value may be $1472 million, just a little above the current market cap ($1415 million).

The net cash is 1106 – 132 – 450 + 1285 – 477 – 200 = HK$1132 million. Here, I have included the HK$200 million cash loss in 2nd half 2015, and treated the debt securities as “cash” asset since it can be liquidated or used as collateral to borrow bank loans.

Enter the Movie Industry

Since the company failed to acquire mobile TV license, the decision to continue the suspended construction of the large media center seemed to be surprising to many. The CEO said the following in the semi-annual report:

I remain my belief that Hong Kong needs its own creativity, as well as local dramas and movies. Therefore, we would consider to invest and participate in movie production, contributing to the movie industry of Hong Kong.

Given the fact that existing TV programs were generally welcome by the local residents and considered as high quality programs, it is hopeful that the new movie production and/or mobile TV production can also be promising. However, in any case, there will likely be significant cash drains at least at the beginning of those developments.

Checking the details in 10k, I found that if HKTV doesn’t finish the construction by February 2017, it will have to give up the construction completely and lose the existing investment of HK$150M on it. So maybe Wong didn’t really want to enter movie industry any time soon, but need to finish the construction by the deadline and prepare for the future needs.

Recently, there is also more news about the TV license front. The company expected to get another final decision from the government 1-2 months later. The CEO also mentioned his intention on continuing TV program development in the future.

Competitions

As I mentioned above, online retail is likely to get more popular in Hong Kong since online shopping has many advantages. However, it doesn’t mean competitors can’t get popular later or squeeze the margin of HKTVMall to make its success less attractive.

Still, I believe there are several advantages of HKTVMall over the potential competitors:

1. Scale advantage.

Although its scale can’t be compared with online retail giants like Alibaba, at least in the local area, it can achieve a large scale, which can allow it to beat other local online retailers, and achieve a low-cost advantage in the local area.

Again, there is significant networking effects and first-mover advantage here.

2. Local delivery of grocery products.

Many online retailers in US and China have been trying to get into the grocery business such as vegetables and meat, but without much success. Looking at the recent HKTVMall activity, it seems that a lot of the sales were actually on frozen meat and seafood. This can work maybe because local stores have more significant rental expense, or because the city has high density, or both. If it can actually work in a larger scale, it will be a significant barrier for outside competitors.

3. Focus on quality, service and trust.

Recently, the company had an official announcement that all merchants who sell on its platform have to use authorized suppliers. This is to assure the quality and genuineness of the products. This could be an attempt to differentiate from TaoBao. Although it might affect the chance of getting super-cheap supplies, I consider this as a positive move, since differentiation is important here.

Also, comparing to TaoBao, customers buying from HKTVMall may enjoy the convenience of returns for some returnable products which is nearly impossible when buying from TaoBao, due to the shipping cost and logistics.

4. Familiarity to local culture.

Hong Kong has its own local culture due to its unique history, language and territory. This can help many of its marketing efforts. Local residents may also be more acceptive to local merchants.

5. Support from local residents.

There is evident support to the company from local residents in Hong Kong. Many people have expressed their supports in comments and reviews, along with sympathy to the CEO regarding the denial of TV license.

Why I Like It

1. Good management.

The most attractive part here is the CEO’s ability and ambition. On one hand, he might be brave and takes more risks than usual; on the other hand, he may also bring a lot of upside potential to the investment.

The CEO also has the track record of achieving something others would think very hard or even unbelievable. For example, a local online retail platform looked very hard to many and nobody was even thinking about trying, at least not on a big scale. So as I was following the company since 2014, I was surprised by the fact that Mr. Wong could actually pull it off and achieve today’s success.

Since the CEO owns 44% of the stock (the top two insiders own 50%), this is also a typical owner-operator stock, with the management’s interest aligned with shareholders. The CEO also has a track record of returning value to shareholders through large special dividend, not like some other family businesses which often hoard on cash.

The CEO also has a focus on customer experience. Using his words, he doesn’t like to outsource the customer support to 3rd parties because he wants to control what could affect customer experience.

2. Good business model.

The track record of the CEO shows that the businesses he created brought a win-win situation to all parties, including shareholders, customers and employees. This is exactly the kind of entrepreneur our society needs. The long distance calling plan reduced cost for consumers. The broadband internet brought high speed internet to local residents.

The recent business plan on HKTVMall may also bring a brand new way for local shopping, therefore bring a lot of value to Hong Kong residents.

As mentioned above, online retail platform tends to have significant networking effect and scale advantage, therefore can potentially create a barrier for new entrants.

Online retail platform also has high ROIC since it has much less fixed cost comparing to the traditional retailers (almost no working capital needs, and no operating leases for store rentals).

3. Downside protection.

Since it is a net-net stock, there is some downside protection. However, given the significant cash burn, this protection is not as strong as the other net-nets.

4. Huge growth potential.

Given today’s small market cap, if the online retail business or the TV/Movie business can be successful, the upside is very big. Looking out for 3-5 years, the upside could well be 3-10 times of the current price. In some sense, this is the main benefit of investing in small-cap growth opportunities.

5. Active stock.

Although it is a small-cap stock, it is pretty active too, especially when there is news about it. This is because the company has good visibility and support from local residents. An active stock is generally a good thing for value investors.

6. Support from local residents.

As mentioned, many local residents have shown their support to the company and the CEO. This could be a strong plus in terms of marketing and attracting talents.

7. Clean accounting.

Due to the background of the CEO and announced cash transaction for the sale of City Telecom business, the balance sheet should be clean and trustable. This may be less of a problem when investing in US, but I think this added assurance can be more important when investing overseas.

8. Relatively cheap stock market in Hong Kong.

In general, due to gloomy outlook of Hong Kong economy and mainland China’s economy, the Hong Kong stock market has many more cheap stocks than US. This makes selecting good value stocks much easier and much less risky in the Hong Kong market.

Risks

The main risk is the uncertainties associated with the new businesses in online retailing and movie/mobile TV. If these fail, the cash burn may reduce the liquidation value pretty fast, so the downside protection may be not that good. In other words, the current net cash may only last 3 years. With each year passing, the liquidation value will be reduced.

Another risk comes from the fact that this is a Hong Kong stock in retail and media businesses. Many of the shareholders are likely more familiar with the business, and therefore may have an information advantage over overseas investors like me.

Conclusion

HKTV is a unique opportunity as it presents significant growth potential, but also has some downside protection from liquidation value.

Although the downside risk is still large because of the cash burn and still immature business model, I believe the growth potential is much bigger than the downside risk, and therefore, it should be attractive to growth investors and quality-value investors.

Although this is an OTC stock, the liquidity is not too bad, since it was once listed in major exchanges. Investors who have access to Hong Kong stock market may also consider purchase in Hong Kong market too (Symbol 1137).

Disclosure: I am/we are long HKTVY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.