16/06/2015

Investment Case

MANDARIN ORIENTAL (TICKER : MAND SP)

Mandarin Oriental operates deluxe and first class hotels, resorts and residences around the world. Having grown from a well-respected Asian Hotel company into a global brand, the group now operates, or has under development, 44 hotels representing almost 11,000 rooms in 24 countries, with 20 hotels in Asia, 10 in The Americas and 14 in Europe, Middle East and North Africa. In addition, the group operates, or has under development, 15 Residences at Mandarin Oriental connected to its properties.

Mandarin Oriental (MO) is listed on the Singapore stock exchange, with a market cap of USD 1.9 billion. It trades approximately USD 0.5 million a day. The group’s flagship hotel, The Mandarin, was established in 1963 in Hong Kong. The hotel was the tallest building on the island when it opened. It soon built up to an enviable reputation for service excellence and instantly became the historic landmark. In 1974, The Oriental in Bangkok, which was already acknowledged as one of the world’s most legendary hotels, was partially acquired by the group, giving the company two “flagship” hotels whose names represented the very best in hospitality. As a consequence, the two famous hotels joined to create the brand Mandarin Oriental Hotel group.

Current Stock price: USD1.50 (close to a 2-year low of USD1.46).

MO’s global hotel property portfolio

MO currently operates close to 8,000 rooms in 27 hotels around the world. By including the hotels under development, the total portfolio extends to almost 11,000 rooms in 44 hotels located in 24 countries. Hence, we could expect MO’s operating scale, on a worldwide basis, to expand by 37.5% over the next 5 years. MO’s global competitors such as Four Seasons and Ritz Carlton already operate 94 and 81 hotels worldwide respectively; hence showing the potential for global luxury brands.

2 | P a g e

INVESTMENT MOTIVATION

Deep value play

How much is Mandarin Oriental worth? Averaging the various valuation methods, which includes MO’s own RNAV valuation, we derive an IV of USD2.24 – 45% price upside. Our base case includes our internal valuation of MO’s hotel properties, which include conservative assumptions of value per room of USD600k-700k, less than half of the market transactions in the last twelve months. In a bull case scenario, we value MO at USD3.25, implying 109% price upside. Our bull case pegs MO’s prime properties in Hong Kong, London, New York, Paris and Japan, at a valuation of USD2m per room, in line with recent market transactions. In addition, we assume that the management contract and branding business hits management’s target of USD100m (from the current USD77m), with an EBITDA margin of 75% in the next three years. In the bear case, we derive an IV of USD1.37, implying 12% downside. In the bear case scenario, we peg MO’s properties to the low end of market transactions at USD500K/room, and assuming that its management contract business stays stagnant with EBITDA margins of 48%. This presents a very attractive risk reward scenario in our view.

3 | P a g e

Trading at a discount to peers in the hospitality sector

Mandarin Oriental (MO) trades at 19x 2016 PE, 18% discount to peers. In terms of EV/EBITDA, MO trades on 11.6x 2016 EV/EBITDA, a 6% discount to peers. MO’s P/B of 1.7x, was at a 37% discount to peers. MO’s discounted valuation to the sector is unjustified, considering that MO’s EBIT margin (19-20%) and ROE (6-7%) are comparable to the peer average. Shangri-la Asia trades most expensive to the sector at 26x 2016 PE and 15.5x 2016 EV/EBITDA, despite having lower EBIT margin (11-15%) and lower ROE (2-3%) compared to MO.

Starwood Hotels and Minor have the highest ROE in the sector, at 42% and 19% respectively. The reason could be Starwood’s asset light strategy where 80% of revenue comprise of hotel management fees (MO derives only 11% of sales from management contracts). On the other hand, Minor is a conglomerate in Thailand which derives 40% of its earnings from F&B and retail.

For detail peer comparison, please see appendix 1 on page 12.

Strong balance sheet

MO has by far the lowest leverage among peers, at 7%. Adjusted for the market value of the group’s freehold and leasehold interests which are carried in the consolidated balance sheet at amortised cost, MO’s net gearing was a mere 3%.

4 | P a g e

Potential dividend yield of 4.5% MO has paid dividends every year since 2005. Dividends paid were maintained at historical high in the last three years despite the global economic slowdown. We expect the dividend yield to be sustainable, considering MO’s cash generative business.

Good profitability track record

MO is in a cyclical business and earnings are affected by economic cycles. However, over time, the group had

delivered a sales CAGR of 5.8% over 2005-2014 and recurring profit CAGR of 11% over the same period. Sales

has grown 1.7x and profit grew 2.5x over the last 5 years. EBITDA margin improved over time from 22.6% in

2015 to 25.7% in 2014, despite volatility in between years. We believe EBITDA will continue to improve as the

scale of the group expands. Meanwhile margin volatility, largely due to renovations and upgrading of hotels, is

instrumental to sustain long term growth. As a rule of thumb every hotel needs to be refurbished every 10

years.

5 | P a g e

6 | P a g e

Positive RevPAR (Revenue Per Average Room) trend in a difficult operating environment in 2014 The group recorded a RevPAR growth of 2% YoY in USD terms in 2014, led by a RevPAR growth of 4% in Europe, 5% in America and -2% in Asia.

In 2014, Asia recorded the weakest RevPar growth of -2% in USD terms. Strong performance in Tokyo (RevPar +7%), was offset by weakness at The Excelsior (RevPar-4%) due to political demonstrations in the last quarter. Asia’s performance was further dragged down by MO’s Bangkok’s 14% decline in RevPar in local currency terms as a result of political uncertainty in Thailand.

7 | P a g e

In Europe, the group’s hotels were successful in maintaining their positions at the top end of their markets, and most continued to benefit from resilient demand in the leisure sector. Across the region, RevPar increased by 3% in local currency terms compared to 2013, with the best performance from Geneva where RevPar grew 14% in local currency terms. The hotel was singled out as ‘Switzerland’s Leading Business Hotel’ in the World Travel Awards 2014, as well as being voted one of the top 10 City Hotels in Switzerland in the well regarded Swiss business publication, Bilanz.

In the United States, the trading environment continued to strengthen in 2014, leading to an increased demand for most of the group’s hotels in the region with an overall RevPar increase of 5% on a like-for-like basis over the previous year. Apart from Washington which recorded a -5% in RevPar over the prior year due to drop in overall visitor arrivals to the city, the rest of the group’s hotel in the US recorded an improvement. The strongest RevPar growth in the US in 2014, came from Mandarin Oriental, Boston(+7%), hotels in Atlanta (+14%) and Las Vegas (+15%). All three hotels were recognized with the Forbes ‘Five Star” rating in 2015 for

8 | P a g e

hotel and spa, with hotel in Las Vegas being awarded a further ‘Five Star’ rating for its restaurant Twist, operated by Pierre Gagnaire.

s

Cautious outlook in the short term, vast potential in the long term Management’s guidance remained cautious, stating that performance is reliant on the overall economy. Additionally, MO’s hotels in Hong Kong face weakness in its leisure demand, while corporate demand recovered. While MO is expanding its managed room pipeline, the completion dates for some of its hotels have been delayed. MOH is also renovating its hotel in London, which would result in half of the rooms being renovated at any point in time between early 2016 and mid-2017. More importantly, we believe the attractive valuation of Mandarin is backed by the underlying value of its strategic assets globally. The beauty is that MO owns 100% of most of its prime assets, which presents a strong barrier of entry to competitors and increases MO’s appeal as an asset owner and operator in the long run. Besides, MO’s execution is not bad at all, considering that it was able to outperform expectations in a difficult year in 2014 (recurring earnings down 4% YoY/dividends maintained), led by a lackluster global economy.

Key risks - poor liquidity – Average daily turnover of only USD 0.5m per day - global economic slowdown - currency risks

RECENT DEVELOPMENTS

Renovation of London Hotel

The group announced that it will invest GPB85m (USD130m) to renovate the London Hotel. The project, which will commence in 2016 and take approximately 18 months to complete, will comprise a full renovation of the existing guestrooms, restaurants ,bars, meeting facilities and lobby. In addition, two new penthouse suites overlooking Hyde Park will be created as well as an expansion of the spa facilities and improvements to core building services. The hotel will remain open during the renovation period with reduced facilities and room inventory. MO is also looking to expand its Munich hotel at a cost of USD140m.

9 | P a g e

Acquisition of Madrid hotel

On the 22nd of May 2015 MO acquired the Ritz hotel in Madrid in a JV with Saudi-Arabian investor Olayan. MO will own 50% of the hotel and its share of the investment and renovation will be USD 126m. The renovation will take place in 2017. Rights issue

On the 5th of March 2015, the group announced its plan to raise USD316m through a 1 for 4 rights issue of new ordinary shares priced at 1.29 USD. Proceeds will be used to pay off the debt from the Paris hotel acquisition and finance the London and Munich hotel renovation. The rights issue is expected to dilute 2015/2016 EPS by 20%, which we have factored into our projections. It might seem strange that MO chose to raise equity at such a steep discount but this should be seen in light of the prudent financial guidance of its main shareholder Jardine Strategic.

STRATEGIC ASSETS AND STRONG BRANDING – KEY BARRIER TO ENTRY

10 | P a g e

MAJOR SHAREHOLDER

The CEO owns 10 million shares and the CFO owns 216.857 shares. Furthermore MO has a Senior Executive Share Incentive Scheme in place, which provides selected executives with options to purchase ordinary shares in the company. Below is a summary of share options issuance in the last 6 years. The current share price of USD1.50, was below the exercise price of the share options granted in the last 3 years, and close to the average exercise price of the employee share options in the last 6 years.

11 | P a g e

Jardine Strategic owns approximately 74% stake in the stock and recently took up its share of the placement in the company. Having Jardine as a majority creates stability and long term focus but also means the group is unlikely to do large scale M&A or leverage up the balance sheet as some of its peers have.

SUMMARY

We recommend to invest in Mandarin Oriental in view of 1) its grossly undervalued property portfolio which

are strategically located in each of its key markets, 2) superb brand image and 3) good execution track record.

We derive an Intrinsic value of USD2.24, which offers a 45% price upside. Under our scenario analysis

illustrated earlier – MO’s share price could more than double to USD3.25, if valuing its prime properties at

the current market transactional price of USD2m/room. In the bear case, where we pegged each room to the

low end of the market transactional price of USD500,000/room, we estimate a potential downside of 12% to

the current share price. MO’s share price is at its 2 year low and offers an attractive dividend yield of 4.5%.

There is no dividend tax in Singapore, hence the dividend is only taxed once in Europe (Belgium 25%).

Mandarin Oriental also scores well on our internal quality Index with a score of 69%.

Catalysts include: monetisation of its hotel assets

Key risks: economic crisis, poor daily trading liquidity, currency risks

© VALUE SQUARE ASSET MANAGEMENT Warning This document may provide analyses of companies, market information or financial information but cannot be considered as specific or personal investment advice. You can contact your relationship manager for personal advice. This information is not drafted in conformity with the rules for enhancement of the independence of investment research. Recommendations are therefore not submitted to the prohibition to trade before the diffusion of the research. This information only reflects the analysis of the Asset Management of Value Square at the moment of publication. The accuracy, completeness and timeliness of such information is not guaranteed. The information can be modified at any time. Historic returns are no guarantee for future performance. Copyright You can only print or save this information on an electronic medium for your personal use. You may not modify or partly delete the information, disclaimer and copyright stipulation inclusive. Each public or commercial use needs the prior written approval of Value Square.

12 | P a g e

APPENDIX: PEER COMPARISION TABLE