Tsui Wah Holdings
Tsui Wah is a broken restaurant IPO that is starting to show signs of a turnaround. Its new CEO Peter Pang (with a “g”) has chosen to slow down the company’s rapid expansion on the mainland and to put a higher focus on profitability over sales growth. The current market capitalisation implies an Enterprise Value/Sales of just 0.75x – by far the lowest in the industry. A takeover offer was in the cards earlier in 2016 but rebuffed by the largest shareholders – indicating that they deemed the offer too low. It is in their interest to turn around the business in anticipation of a potential sale.
What went wrong?
The company started in 1968 and was acquired by its current 5 major shareholders in 1998, including then-CEO Lee Yuen Hong. The menu is typical Hong Kong fare, inspired by southern Chinese cuisine. Typical dishes include Hainanese Chicken Rice, Chaozhou fish ball noodles and Malaysian Beef Brisket curry. The niche is: “high quality Hong Kong food at a reasonable price” and food is priced somewhat higher than their fast-food peers Café de Coral and Fairwood.
The company expanded steadily during the 2000s from just a few restaurants to 21 restaurants by the time of its IPO in 2012. The IPO was unusual in the sense that controlling shareholders did not sell down their stakes. Instead, shares were issued to raise capital for an expansion into China. And the controlling shareholders still haven’t sold out: they only reduced their stake from 59% to 55% over these years. They still have significant “skin in the game”.
Since 2012, the company accelerated its expansion, with a special focus on building new restaurants in China. The IPO proceeds of HK$794 million were to be used for the following purposes:
The number of restaurants rose from 21 at the time of the IPO to 61 by fiscal year end 2016:
At the present time, roughly 70% of revenues came from Tsui Wah’s Hong Kong operations:
Despite the rapid expansion, revenue per restaurant in Hong Kong actually held up reasonably well. China is another story – revenue/restaurant fell from roughly HK$35 million to just above HK$20 million:
What happened? One explanation for the weaker Hong Kong revenue since 2014 is weaker tourism flows from China. The Occupy Central demonstrations in 2014 caused the Chinese government to tighten up visa and group travel approvals. But overall, Tsui Wah’s Hong Kong restaurants are doing pretty well.
The biggest change in the business concerned the business in mainland China. They were hit by the new government policy on dining out in 2013, but that wasn’t the only reason for the weaker numbers. As important may have been Tsui Wah’s failure to build popular restaurants in this new regional environment. Considering that the company’s Chinese restaurants are significantly bigger than those in Hong Kong – 7,000-10,000sqft with 65-84 tables compared with just 3,000sqft with 30-67 tables in Hong Kong – the performance was very bad indeed.
The reason is obvious: Tsui Wah’s Hong Kong restaurants are packed with people while the mainland restaurants are not. Their average table turn numbers is just 4-6x in China vs 22-26x in Hong Kong.
I have gone through a significant number of reviews for Tsui Wah’s mainland restaurants – they are generally very positive. They just aren’t as profitable as in Hong Kong. One contributing factor may be their positioning – or the Job-To-Be-Done, as Clayton Christensen would call it. In Hong Kong, Tsui Wah offers a fast-paced, busy Cha Canting environment. In China, Tsui Wah offers customers luxury Hong Kong-style dining for a somewhat higher price. The average ticket size for Tsui Wah’s Chinese restaurants are around HK$180 per table compared with just HK$90 in Hong Kong – twice as high. Customers staying longer at each table. But menu prices are also higher. Rice dishes, for example, tend to cost around HK$55 in the mainland restaurants and closer to HK$40 in Hong Kong.
I personally believe that customers like crowded environments – it’s exciting and offers something different from staying at home and ordering food from Sherpa or Deliveroo. Here is a case in point: a fancy-looking but somewhat empty Tsui Wah restaurant in Xuhui, Shanghai:
Compare this environment with the Tsui Wah restaurant in Mong Kok, Hong Kong:
Instead of copying its Cha Canting concept in its entirety, Tsui Wah has gone upscale and tried to compete directly with popular Hong Kong style restaurants such as “Bifengtang” and “Xinwang”.
Tsui Wah may also have made mistakes in choosing locations for their new restaurants in China. Xizang Lu – built in 2012 – is in the middle of the center of Shanghai, but Baoshan, Handan Lu and one of its Pudong restaurants are definitely on the outskirts of town. Not everyone can afford CNY 100 lunches.
On the cost side, a common size income statement makes it clear what the problem is:
Gross profit margins have essentially stayed flat, as have labour costs as a % of revenue. But depreciation charges and rental expenses went through the roof from 2013 onwards. Other operating expenses have also impacted margins negatively to the tune of four percentage points. The 1.5 percentage point of “other expenses” is a HK$27 million non-cash impairment charge.
Depreciation charges and rental expenses have gone up substantially, due to the much larger restaurants that they built. A lot of capex went into the restaurants, explaining the much lower asset turnover than in Hong Kong:
Depreciation charges and rental expenses per restaurant have gone up continuously. They may have peaked in 2015, when the company decided to decrease the size of its new restaurants:
Another factor might have been a bubble in the Hong Kong retail property market. It got crazy in 2013/2014 when rents went through the roof and cap rates dropped well below 2% in some cases. Even though many shops in high-foot-traffic-areas such as Causeway Bay were loss-making, tenants were willing to pay for losses as a way to advertise their brands to Chinese tourists. The fact that Milan Station has unable to turn a profit since
According to Tsui Wah’s 2012 IPO prospectus, “other operating expenses” include the following:
- Repairs and maintenance expenses for our restaurants
- Cleaning expenses for our restaurants
- Office expenses
- Consultancy fees for third party consultants
- Staff uniform and meal expenses
- Insurance expenses
- Legal and professional fees
- Transportation expenses
- Card charges relating to credit card and smart card purchases
- Other rental expenses
- Other miscellaneous expenses
Judging from Tsui Wah’s expansion plan, much of the higher “other operating expenses” concerned repairs and maintenance as well as office expenses. In 2013, Tsui Wah opened a “Central Kitchen” to improve the quality and consistency for its Shanghai restaurants – similar to the strategy that Yum! Brands have employed for their KFC and PizzaHut brands. In 2015 Tsui Wah also relocated its Central Kitchen in Hong Kong to a new facility with 3x its old capacity. It also opened a new Shanghai head office. If the company continues to expand, utilisation rates should drive margins higher.
Overall operating margins fell substantially since the IPO, from 15% in 2010 to 4% in 2016 – well below those of competitors Café de Coral and Fairwood Holdings:
Cash flow margins paint a similar picture. They used to be higher than peers, but were impacted negatively by the company’s China expansion:
To be fair to Tsui Wah, Café de Coral and Fairwood have also had issues in China. The operating margins of their China businesses were just 8.2% and 6.4% in 2015.
Bears have made noise about rental fees paid to related parties – companies owned by the controlling 5 shareholders. But these related party transactions are very modest by Hong Kong standards. As a percentage of revenue they have actually come down since the IPO in 2012.
Of course, mainland China is a big black legal hole – if controlling shareholders want to steal from minorities by selling or buying assets with mainland entities, they can. But so far, there has been no sign of funny business. The organisational structure is very simple with no parent company and full direct ownership of practically all restaurants in both Hong Kong and mainland China.
What will happen?
Great franchises can usually be identified by strong customer engagement. In the restaurant industry – that means a high revenue/restaurant or a high return on capital. And Tsui Wah’s sales/restaurant in Hong Kong is well above those of peers: HK$40 million compared to just HK$10-28 million. The US restaurant chain with the highest sales/restaurant is Chick-A-Fil at US$2.6 million. That translates into HK$18 million – far below Tsui Wah’s number. Tsui Wah’s return on equity was 40% before the, without using any debt whatsoever. That is a spectacular number. In my view, this means that the concept has potential. If not in China, then perhaps elsewhere.
There doesn’t seem to be anything fundamentally wrong with the business in Hong Kong. Keyword searches for 翠華餐廳on Google’s Hong Kong site have been rising slowly over time:
Reviews are generally good, perhaps somewhat above other chains at around 4.0/5.0 on Open Rice in Hong Kong and 3.2/5.0 at Xiaomishu in Shanghai. It may sound low but those numbers are actually respectable. Tsui Wah’s prices are higher than at Fairwood and Café de Coral, but the quality may also be somewhat better.
The catalyst for change may be the new CEO Kwing Ho “Peter” Pang, appointed in June 2016. Two of the company’s five founding members stepped down from executive directors to non-executive directors over the last two years, implying internal disputes. Peter Pang was then hired as a CEO to bring about change. Pang was previously a Managing Director for one of Tsui Wah’s Hong Kong subsidiaries and has had some success in this role. He is known as “the Father of SOHO East” thanks to celebrity restaurant Chit-Chat. Peter Pang already let go of previous CFO Ms On Nei Hong, and moved the Head of China operations Yang Dong to the company CFO role. Establishing much smaller restaurants. The company will target a payback period of 1-2 years for capital expenditures
The post-IPO spending spree is now over:
The focus now will be on profitability – or, at least that is what the company says. Peter Pang’s mandate is to fix Tsui Wah, and he has put in place the following strategy to do so:
- While the long-term target is for the restaurant chain to have 80 restaurants, Tsui Wah only opened four restaurants fiscal year 2017 to date, a slower pace than previously
- Reduce the size of new restaurants
- Adjusting logo and café interior designs to be more vibrant and sleek
- Increase the proportion of food coming from its central kitchens, in order to improve the consistency of food quality
- Delivery services connected to all of its restaurant on the mainland and in Hong Kong
- Pang aims to grow business by providing wedding banquet outdoor services
The company has started to close restaurants, one in Hong Kong so far and apparently another one in Shanghai. It is positive that Peter Pang will reduce the size of new restaurants, though it may not be feasible short-term to relocate existing mainland restaurants to smaller premises.
We don’t know if Hong Kong tourism is permanently impaired – I would guess not, but either way the tightening of visas and HK tour groups does not reflect poorly on the company itself. It is simply a one-off that should not be extrapolated into eternity. Another impact on FY2016 revenue was the refurbishment of its Central restaurant that led to a loss of revenue of HK$9.8 million and cost HK$10m. There was also a HK$10 million forex loss in FY2016 due to the fall in the Renminbi/ Hong Kong Dollar exchange rate.
Earlier this year, Tsui Wah repurchased 2.6 million shares around HK$1.40/share – higher than the current price of HK$1.31/share. In my experience, controlling shareholders rarely buy back stock if they plan to screw over minority shareholders – so this is a very positive sign.
The repurchases may have been done in anticipation of a takeover. An unknown party made a bid for the controlling stake in Tsui Wah, but was ultimately turned down – probably because the offer was too low. Tsui Wah trades at a relatively inexpensive multiple of 0.75x EV/Sales and 7.1x EBITDA.
M&A transaction multiples in the global restaurant industry are currently around 12x forward EV/EBITDA in the fast casual category and 8x for the casual dining category according to advisory firm TM Capital:
In terms of forecasting, one can divide the business into its Hong Kong operations, and its China/Macau operations. A Hong Kong business with operating margins around 14% – judging from its historical levels – with an operating profit of HK$157m. And then a China/Macau business that is loss-making to the tune of HK$30 million in FY2016. The HK$27 million non-cash impairment charge in FY2016 is a one-off, as is the HK$10 million loss in revenue from the refurbishment of Tsui Wah Central. The HK$10 million FX loss may continue as long as the renminbi continues to depreciate more than the Hong Kong Dollar. If Peter Pang is clever enough to sell the Chinese/Macau operations – assuming that FX losses one day go to zero and a 50% mark-down on non-current asset values – then Tsui Wah would have HK$750 million in cash and an operating profit close to HK$160 million. Tsui Wah would trade at an EV/EBIT multiple of 6.8x and an EV/EBITDA multiple of 3.9x. Any reasonable transaction multiple in the event of a takeover would give Tsui Wah a value/share well in excess of HK$2.0.
While Peter Pang may not succeed in his task to turn around the Chinese operations, it offers potential upside. We don’t know what the probability is, but what we do know is that option values are always positive. If the new CEO proves to be a “catalyst” for value realisation, then the upside could be substantial. The downside is limited by the 0.75x EV/sales multiple and a solid net cash position. Peter Pang was essentially hired to bring about change for the company, and he has openly acknowledged that a part of the problem is that newly opened restaurants are too big for their local markets. I believe in Tsui Wah as a restaurant concept, and I am willing to bet that the new CEO will take steps in the right direction.