My Report: Straco buys Singapore Flyer

Straco Corporation is a stock that I owned for some time, one that taught me some invaluable investment lessons. For some time, they been updating shareholders that they are looking for potential greenfield projects to deploy their capital. They finally found one.

Mainboard-listed Straco Corporation, 63 per cent-owned by his family, is buying the 165-metre-high Singapore Flyer attraction by the Marina Promenade for S$140 million. Straco will fund the purchase with part of its S$100 million cash pile. The company will also be taking on debt.

Dubbed the highest observation wheel in the world, the Flyer is a prominent feature of the Singapore skyline.

Some details of the deal

The Singapore Flyer have been in the news for some years now, all for the wrong reasons. It is seen more as an amusement to put Singapore on the world map but it went into receivership in May 2013 by Singapore Flyer Pte Limited.

Straco basically swoop in for a distressed asset. Merlin Entertainments, listed in London, second biggest in the world that runs entertainment themes behind Disney and the ones that run the London Flyer, Legoland and Madam Tussauds were in contention but pulled out of it.

• Straco will hold 90% stake with the other 10% held by WTS Leisure
• WTS Leisure is a subsidiary of Woodlands Transport Service, which was established in Singapore in 1981 and owns and operates one of the largest private transport fleets here
• Initial Cost of Flyer: S$240 mil
• Annual Capacity: 7.3 m visitors
• Officially open in 2008
• Record no of visitors: 1.9 m
• 40% of tourist are local
• Adult Ticket prices $33
• Last Year No of Visitors: 1.3 m
• In 2008, the initial goal was to attract 2.5 mil visitors per year
• In 2008, Adult ticket prices was S$30
• Concession lease left is 19 years with an option to extend a further 15 years (in 2003 when announced it was to lease to Singapore Flyer for 30 years with option of 15 years)
• 28 Air Condition Capsules each able to take 28 passengers for around 30-40 minutes each round.
• Under the assets is also a 3 storey terminal with retail shops

Wheels cost a lot to build, not so much to maintain

One of the problems for these Ferris wheels is that due to the size they cost a bloody lot to build. They cost 100 to 200 mil dollars in 2008 to build. And it is likely if you want to build one today it is going to cost a whole lot. As a reference the London Eye cost 70 mil pounds to build in 2000. The S$240 mil cost to build the Flyer is equivalent to 90 mil pounds.

In this case, they are like much large infrastructure, which needs to be finance by large amount of debts. Just like toll roads, you need a minimum amount of people or cars to generate enough cash flow to pay for debt payments.

What usually killed large projects was unrealistic costs and hidden fees. This is prevalent especially when you deal with bankers, who will keep inserting fees and more fees.

The end result is what you see in a lot of these toll roads, and public infrastructure: The cash flow generated are unrealistic to ever pay off the infrastructure, let alone be profitable.

From the case study of the London Eye, capital expenditure in terms of maintenance does not seem to be an issue. The London Eye cost 4% of revenue, but that is due to higher number of visitors. There are some maintenance costs that are likely to be rather fix. Since the ridership is 50% less than the Eye, and that there is a floor to cost. We would expect maintenance cost to be in the region of 7-8% of revenue.

The important part is to keep the number of visitors consistent and growing, and that may need other forms of capex. Straco might need to do what Tussauds Group did, spending big to gem up the Flyer.

Once that is done there is really minimal costs. The wheel is cash flow generating.

The London Eye Case Study

Another theme attraction that is rather similar to The Flyer is the Ferris wheel in London.In fact, Singapore government seem to like to be a big copycat. Build in 2000, it has a 13 year operating history. Merlin Entertainments own it. News articles provides some information.

• Build in 2000 at 70 mil pounds
• 3.5 mil visitors visited in 2009
• The ticket prices then was 10 and 29 pounds
• The Eye was the number 1 attraction in London
• Revenue was 56 mil pounds and Profit was 29 mil pounds. The profits was up 18 percent from the previous year
• That provides a profit margin of 51%
• In 2001, number of visitors was 3.5 mil. The loss was 8 mil pounds. Revenue was 25 mil pounds. Operating profit was estimated at 6.5 mil pounds. The debt then was 76 mil pounds.  The ticket prices then was 4.95 and 7.95
• In 2005, it was sold by British Airways to Tussauds Group for 95 mil pounds. British Airways was owed 48 mil pounds so they are forgoing that as well. This was a distressed purchase by Tussauds Group 
• In 2004, number of visitors was 3.75 mil. Revenue was 38 mil pounds a 11% CAGR since 2000. The loss was 24 mil pounds. The interest payment was 34 mil. British Airways was charging the Eye 25% interest on 48 mil pounds loan for the original construction cost they advanced. The % of revenues to run the Eye was 4% or 1.52 mil.
• The capex when Tussuads purchased in 2005 over 5 years promised was 50 mil pounds

Ticket prices have changed a fair bit but it is an interesting exercise of what such a tourist attraction can grow to. London Eye back in 2009 was a very popular attraction and that, despite in 2009 there is 2 years to sink in from the economic depression.

The number of visitors more than doubled that of the Flyer, and that perhaps make the difference. The profit margins look good, in part because the attraction have build up the critical mass that makes it a very good cash flow generating machine (the variable revenue over cost factor)

Bond like nature

The most interesting thing is that the Eye, being the number 1 attraction in London, can attract a consistent 3.5 mil visitors for 13 years. The ticket prices goes up with inflation, cost is a fraction.

Without the debt its a really good asset.

Difficulty in increasing visitors

The consistent number of visitors seem to tell me that it will take rather extreme levels of innovation to bring up the visitor numbers for Straco. The guys at Tussauds Group and now Merlin cannot be idiots.

If the London Eye have a capacity of 6.4 mil or so, why can’t they boost the number of visitors to 4 mil per year? And it is suppose to be the number 1 attraction in London.

Perhaps we should tamper our expectations on how much visitors they can boost. They were originally expecting 2.5 mil visitors per year in 2008. They hit 1.9 mil and have not reach close since.

God knows how 2.5 mil visitors come about. I got a feeling its some estimation done so that bankers can justify the cost of financing.

If the Flyer is truly mismanaged in synergistic opportunities, then lets see if Straco can take it up a little bit.

How revenues are increased

So we know that visitor numbers are rather consistent from 2013 and back to 2000. The revenue grew from 25 mil to 38 mil in 2004 (11% CAGR) to 56 mil in 2009 (10% CAGR).

The ticket prices averages 6.5 pounds in 2000 and now 20 pounds in 2009.  That is a 13% growth. Most of the earnings perhaps comes directly attributable to maintaining visitors and ticket prices growth.

Its interesting how they can grow prices and maintain visitors. That is skilful.

This would mean that Straco need to find the opportunity to raise prices. As of now, I don’t think its possible. They would have to offer discount more like it.

Different Heritage and Identity

The London Eye was not without its critics in the early stage:

However, despite some people being more than enthusiastic about the date rolling over from 1999 to 2000, some others were having a bout of pre-millennial cynicism. Did London really need a new structure among its sprawling urban wasteland and defunct dockyards? Did anyone really care enough about the Millennium to want to go to yet another tourist attraction in the Capital? And more importantly, were the ideas just too ‘modern’ for the judges to cope with? – Link

In many things, the initial phase will usually be met with doubts. The London Eye is no exception but they do have an old Ferris wheel so this looks like a revamp of that.

To Singaporeans, they seem to identify this more with the incumbent government hell bent on fabricating some levels of identity and much feel rather repeal by this.

This does present an opportunity because identity are not forge through physical construction, but by the stories that it is associated with. And it is up to Singapore Tourism Board as well as the owners to create meaningful stories tied to the wheel. People become proud, see it as something they really own, tourist would want to come and find out why they are so proud of it.

Ways to boost profits

I am not a retail savvy person. So I am not going to pretend to be one. If we dare to put money into Straco, it is the belief that they are better managers than us in this area.

Still we have to do our common sense checks to see if there are ways to boost this at all, rather than buy everything that the management say.

Develop more synergy

London Eye was able to maintain and boost visitors by :

• Ticket reductions through online platform
• Establish e-partnerships with museums, restaurants, theatres
• Set up partnerships and tear down partnerships
• Link up with other attractions to create complementary packages

Reduce Operating Costs

I do question how come the operating costs seems much higher than the London eye. It could be the cost of running it in Singapore. Then again, London isn’t cheap either.

Should there be no overestimation in costs, the owners of Straco may be able to improve upon it

Bring in more visitors.

The collaboration with WTS Travels will be interesting. Mr Wu here likely tapped into his Chinese Chamber of Commerce relationship to set this up. Who knows how many commerce relationship he will tap this time around.

WTS have 60 luxurious buses. Assume that half of them (30) ferries 30 people as part of the tie up daily to the Flyer. In one year that is 300k more people per year.

At current ticket prices that is perhaps a 6.3 mil revenue

Renting out 50% unoccupied terminal space

There are rumor swirling around that Zouk may be looking for new premises. Based on the $7 psf/m rent. This could add a long term recurring operating cash flow stream

Profits and Cash flow for Flyer

We really do not have much information to work with at this stage but kudos to CIMB analysts who came up with this estimation. The one thing I don’t get is how can it be possible the operating cost  of 26 mil is almost similar to the revenue of 27 mil. Even the London flyer in 2000 made an operating profit of 6.5 mil pounds on 25 mil pounds in revenue. Even if you half the revenue of the Eye due to them receiving more visitors, it shouldn’t be this close.

The market is not very happy because they expected it to be cash flow generating. It is. It’s just that with depreciation and interest cost it was making a loss. Taking out the depreciation and the cash flow is positive.

Some how i have a hunch operating profit is much higher.

• The CIMB projected cash flow is 7 mil not inclusive of taxes
• The other interesting thing is that 50% of the terminal is still available for rental. If they are rent out to a big player for long lease (say Zouk), they could probably get another S$7 mil
• If WTS managed to bring in 300k more people per year, and since fixed costs don’t increase while variable cost is  low, this could bring in S$6.3 mil in revenue or S$ 5 mil in cash flow after cost

That adds up to 19 mil in operating cash flow or 11.5 mil in PBT. That is a 8.2% ROA. Not astounding. But better than the 3.88% earned on cash now.

On the basis on current Straco 2013 FCF of 34 mil, that is a significant boost.

At this stage it’s not going to be a good investment, in fact, it may leech more capex. Much will depend on what the management of Straco can do about this.

The UWX case study

The only other purchase of significance carried out by Straco was in 2007 when they bought over UWX from the 3 Tan brothers. That acquisition cost $12 mil. The first year, the aquarium generated $2 mil in profit or 16% ROA.

In 2013, the net profit was $12 mil. That’s as much as the purchase price. It was a shrewd deal in hindsight. Would this flyer deal be the same?

Owner Deploying $120 mil of cash

Straco is vomiting cash really. The historical cost of the assets is S$58 mil and they are throwing out S$34 mil last year. Mr Wu owns roughly 55% of Straco.

Given the choice, he can choose not to do this deal. He waited for sometime before he purchase UWX and have been waiting since.

By deploying $120 mil of the cash, he is forgoing the 3-4 mil in interest income (around 3.88%)  for a higher risk adjusted return.

If this deal turns out bad, he could stand to wash a large part of this $120 mil down the drain.

$120 mil is a huge investment for him, consider the current assets were bought $58 mil at cost.He will not only incur losses but also lose out on the interest income.

At 60++ years old, he can take the safe route. If this is a bad deal, he doesn’t have to bite it. Pay out a special dividend and pocket $65 mil.

We won’t know if he chooses now to fail, but it is likely the decision to purchase is evaluated thoroughly that he can improve upon it.

The existing business

The market seem to be discounting the Flyer deal. They seem to like to underestimate Straco just like how I used to underestimate it.

The flyer deal can be seen as deploying cash to generate a higher rate of return than 4%.

It does not affect its main business which is doing rather well.

The main business have reach a stage where a $1 increase in revenue per visitor does not increase the cost by the same proportionate amount. Since majority of the cost is fixed cost, then as visitor grows,the revenue flows to operating profits.

The past years growth in visitors in the busiest 3rd quarter:

• 2007: 414k
• 2008: 658k
• 2009: 650k
• 2010: 1073k (World Expo)
• 2011: 869k
• 2012: 947k
• 2013: 1260k

When I first look at it, my domain competency in this business is really bad. I have no idea that the growth can be so crazy. If you are afraid that they are going to hit max capacity, the maximum capacity per day provided by management was SOA 20,000/day and UWX 16,000/ day. That’s nearly 5.8 mil.

Valuation

At S$0.78, the PE is 18 times or an earnings yield of 5.5%. That looks rather rich to a lot of people. But for me is the growth rate and the speed of growth that matters. If Straco grows at 3% per annum from here on out, then of course this is an expensive proposition with little margin of safety.

If it grows 25% for the next 3 years,  based on current purchase price, your forward PE becomes 8.71 times. That looks kind of a bargain.

Great companies are even better in that they tend to grow at above average growth rates.

But if you are valuing it to purchase, it is better to use conservative estimate. Anything surprisingly good is a bonus.

We know that even Straco’s current assets is based on concession and the Flyer ends at 2033 while the rest of the assets concession ends at 2037.

Based on my cash flow project estimate, it is whether you believe a 19 mil supplementation to current cash flow is possible. Remember that existing assets are still growing.

I felt that its not far fetch to see earnings rise from 34 mil to 34 + 8 mil (current assets at 8% growth) + 19 mil = 61 mil (EPS 7.2 cents). The forward PE then would be  10.8 times.

If we use DCF with 34 mil as current year cash flow to 2033, growing at 22% for the first 3 years follow by a stable 5% for the rest of the years. We use a 10% discount rate.

We arrive at $0.75. The summary actions that accompany this valuation is a good business that doesn’t collapse, existing business growing at 8% for the first 3 years, 50% of Flyer unoccupied space rented out, WTC brings in 6.5 mil in additional revenue.

It looks like to have enough meat to purchase Straco, we need to be pleasantly surprise more. Pleasantly surprise that 5% growth is too conservative that this model is just too good. Pleasantly surprise that Straco can turn around the Flyer in better ways then we conservatively think.

References

• Case Study: The London Eye
• BA ends bumpy ride on London Eye
• The Bigger Ferris Wheels Get, the more Cash Flows

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