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Monday 8 July 2013

Tai Ping Carpets, Trophy Assets and A Dose of Reality for Value Investors

Tai Ping Carpets is a distinguished manufacturer of high-end carpets since 1956 and has been publicly traded since 1973.  The carpets grace the rooms of luxury residential homes, high-end commercial properties, air planes and yachts throughout the world. 

I have been following Tai Ping carpets for a number of months.  Having first came across the company in late 2012 when the stock was selling at a range of between HK$1.80-HK$1.90.  Financial results for the year ended 31 December 2012 were not out yet, but what caught my eye was the stock was trading a 60% below book value.  The business had a disastrous 2011 when one of their main factory located in Thailand was flooded in October 2011 resulting in a significant loss of HK$178 million for the financial year ended 31 December 2011.  But the business is resilient and by 2012, the company bounced back to a profit of HK$179 million.  However the PE remained at single digit, 3.2 to be precise.

About a dozen years ago, I had seen similar businesses such as Tai Ping selling excellent craftsmanship but at seemingly low valuations.  Companies such as Aga Rangemaster and Smallbone of Devizes that have showrooms in Bond Street, in Mayfair and Chelsea and Kensington where the well heeled go to kit out their fancy homes. 

These companies were typically small, run by long serving employees who have been promoted through the ranks, tightly held by founding family, highly localized patrons and very old brand names.  They charge ridiculously high prices for their custom made products.  And work therefore tended to be routinely feast and famine.  The result is lumpy and unpredictable financial results.  Something ordinary investors don't like.  The reason for these companies to go public was essentially to create a transparent market price for the passing of shares from one generation to the next or selling down.  So it was not so much to benefit the public but for the founders to cash out and employee participation.  However, it is also a fertile ground for large corporates looking to diversify their revenue streams by capturing the premium end of their markets.  Mondelez International, a food giant, buying artisan chocolatier Green & Blacks for example.

These businesses were essentially survivors as it had the patronage of the rich of one generation to the next.  It will never grow big conversely there will never going to be fireworks. 

However, things changed going into the 21st century, I remember in the early 2000s after the dotcom bust and the start of the housing boom, flushed with cheap funding (thanks to Greenspan) smaller Private Equity firms went out hunting for these businesses.  The strategic rational behind it was simply this: Sleepy brands that needed to be revitalized to expand into fast growing global markets and go mass-affluent

Made in Britain was a phrase that invoked strong association with quality, good taste and a distinguished lineage for the nouveau riche.

It was not so much about financial returns but an ego trip in the hunt for trophy assets.  It is similar to hunting lions that serves no purpose other that for the quick adrenaline rush and to pacify the ego. 

It is with this lens that I turn to Tai Ping Carpets.  The issue that keeps gnawing at me is this:  How can a company with a quality product and a rich history be selling at such low a multiple?

Going back from 2012 to 2003, the company made losses in 3 (2004, 2010 and 2011) of those 10 years.  Net margins averaged at around 5.3% and return on equity averaged 6.6%.  No fireworks.  Its book value grew steadily from HK$3.00 to HK$4.40 but throughout the whole decade, it traded at an average 60% discount to book value.   

The share price is a bit more upbeat producing a compound annual rate of return of 6%.  Cumulatively, the company paid out in total HK$61cents in dividends, giving an absolute return of 138%.  This return is considered poor when one considers the costs of living have skyrocketed in the last decade.

Tai Ping Carpets is a trophy asset, its designs often grace magazines such as Elle Décor, Elle Decoration, Maison Francaise but as an investment it, pardon the language, sucks.  Its operational costs are high.  Its showrooms are located in exclusive streets in major cities such as LA, NY, San Francisco, London, Paris, Hamburg, Hong Kong etc. where real estate rents are high.  It has to pony up for increasingly scare and higher material costs.  It employs expensive designers to keep product line exclusive and fresh.  Experienced employees are required to manufacture these carpets and so keeping long term employees on the payroll is not cheap.

Well you might say hang on a minute, what about LVMH? Prada?  Are they not similar to Tai Ping Carpets?  Three differences, firstly these companies no longer manufacture, infact their core competence are brand management.  Secondly, these are 'wearable' consumer brands; a whole industry is set up to encourage purchase by creating 'this season's style'.  Thirdly these brands have been able to transverse into global players, their price has become affordable luxury appealing to the aspirations of the mass affluent. 

There is still not many that can afford a US$1m home that can - just about - fit an Aga Rangemaster, a Smallbone kitchen or a Tai Ping carpet.  The story of Aga, which attempted to mass produce, bears out in its share price, it traded as high as GBP 16, but now trades at less than GBP 1.  Smallbone have gone into administration and is now in the private hands of a very wealthy individual.  It is run more out of a passion to keep the heritage alive than on cold hard investment principles.

And for the average Joe, there are better pursuits than trophy assets.

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