The following write-up was previously published in The Manual of Ideas.
It does not represent a recommendation to buy or sell any security.

Nirvana investment note

Intrinsic value estimate: HKD 4

Upside: 80%

Summary of assumptions underpinning intrinsic value:

  • Nirvana can generate c$50-55mn of owner earnings.
  • The company pays half of this out to shareholders and reinvests the other half at 20-25% ROIICs (target 25% IRRs on greenfield projects, current ROIC = 30%).
  • Nirvana would then generate a total return yield on the current share price of HKD 2.2 comfortably in the high teens.

Business model/simplicity – average

  • Nirvana is the largest integrated death care services provider in Asia1. Founded in 1990 by the current CEO Dato Kong and a (passive) business partner2. Each owned 50% and developed the initial memorial parks with their own capital.
  • Since then Nirvana has, through subsidiaries3, developed or acquired 10 cemeteries, 12 columbaria and two funeral homes cross Malaysia, Singapore and Indonesia. In 1999 Nirvana began offering funeral services in addition to burial services.

Nirvana service offering
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  • Nirvana focuses on pre-need (prior to death) services, which account for 85% of revenues. As-need services are the remaining 15%.

Nirvana investment note2

  • Labour and working capital intensive business model: The main components of cost of sales are land development, niches, and tomb design and construction.

Nirvana investment note2

  • The core customer base is 40yrs+ Buddhist, Taoist and Confucian ethnic Chinese population, considering pre-planning funeral and burial services for themselves and their family.
  • The business was established to satisfy demand for higher quality death care services; public cemeteries became increasingly congested, were poorly maintained, and were unpleasant places to spend time. Nirvana Memorial Parks are serene environments:

Nirvana investment note5

  • Nirvana’s business model is to develop and re-sell land: The land on which Nirvana develops cemeteries is often zoned for agricultural use at the time of acquisition. Nirvana applies for the land to be converted for use as a cemetery before construction begins (clearing, landscaping, road paving etc.). Cemeteries are developed in phases to manage cash flow; new phases of development are only entered into once preceding phases have one or two years of inventory remaining.

Nirvana business model:

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  • The business model is capital light: distribution and penetration of new markets is through its network of independent but exclusives sales agents (typically ex-estate agents and ex-insurance agents; Nirvana has the largest sales force in Malaysia and Singapore). Commissions are matched to cash receipts from customers. However, Nirvana contracts directly with customers and agents have no autonomy over price setting.
  • The business model is working capital intensive:
    • Nirvana has no long term debt. Three quarters of $430mn of long term capital comes from equity and the remainder from deferred pre-need funeral contract revenues (due > 1 year).
    • One third of long term capital has been deployed on long term assets, mostly land, development expenditure, and amounts receivable from the sale of burial services4.
    • After funding long term assets Nirvana has $280mn of net financing resources. Working capital takes up $70mn of this (land under development and completed developments available for sale, plus amounts receivable from the sale of burial services, less advance billings from pre-need sales), leaving $214mn (28% of the market cap) of liquid funds5. Working capital is almost half of annual revenues.

Nirvana investment note3

Finances – strong

  • Funding history:
    • 1993: $50k was raised through the issuance of shares to five independent third party investors to fund Malaysian expansion. Dato Kong then acquired some of these interests in 1995 to take his share from 20% to 40%. Another investor acquired the remaining 60%.
    • 2000: Nirvana listed on the Malaysian stock market to fund expansion into Malaysia.
    • 2010: Nirvana was privatised. Nirvana was then 70% owned by Rightitan, an entity held 50/50 by Dato Kong and his son. Portwell Investments Limited held the remaining 30%, before selling its stake to Rightitan in 2012.
  • Credit risk in business operations: Customers can pay for pre-need burial services in monthly instalments of up to four years. Revenue is recognised from burial plots when the plots and niches are ready for delivery and 35% of the sales price has been collected6. The default rate on the remaining trade receivables is c.0.3%. Pre-need funeral services on the other hand are provided usually many years after they are sold. Revenue is only recognised once the pre-need service is rendered. This is a modest source of float for Nirvana (c$70-75mn per above).
  • Maintenance and sinking funds are created: These are created to cover projected site maintenance and funeral service expenses respectively. Funds are deposited in trust accounts that are attached to each cemetery; trustees use the principal and investment returns on the trust to fund the maintenance of the respective asset. Independent actuaries review the balance of the sinking fund with respect to Nirvana’s future funeral services obligations.
  • Suboptimal capital structure could imply material shareholder returns: The CFO believes that an optimal capital structure for the business would be c.30-40% debt/equity. This would imply a net debt level of c$110mn, a difference of c. $300mn (40% of the market cap) to the current net cash level of $210mn. This could be addressed via special dividends or buybacks.
  • IPO proceeds: Nirvana listed on the Hang Seng at the end of 2014. The net proceeds from the listing were $250mn. Of this c. $80mn was used for the acquisition and development of cemeteries and columbaria, and to fund working capital. The remaining net proceeds will be used as follows:
    • 25% for increasing capacity at existing cemeteries via adjacent land acquisition.
    • 40% to establish new cemeteries, columbaria and funeral homes through greenfield projects, both in existing and new markets.
    • 25% for the acquisition of existing death care service providers.
    • 10% to fund working capital (i.e. development of the existing land bank).

Cash flow volatility – strong

  • Slow moving, predictable industry.
  • Pre need services focus creates revenue visibility.
  • Sales agency model vs. fixed cost sales staff lowers operating leverage.
  • Strong balance sheet.

Competitive positioning – strong

  • Supernormal profit generation: Nirvana generates adjusted returns on capital of c30%.
  • Death care services satisfy an essential human need. It is especially important to the Chinese population whom Nirvana targets. It is an industry that is extremely slow moving and difficult to disrupt.
  • Fragmented as-need market: The market comprises predominantly small scale, non-integrated undertakers and independent and public/not for profit cemetery operators. Nirvana’s overall market share in its two key markets of Malaysia and Singapore is 31% and 35%. Its pre-need market share in these two markets is 56% and 79%. In Indonesia Nirvana has just a 1% overall market share, but a 36% share of pre-need services. In Singapore, the National Environment Agency provides public death care services. Private sector provision is made by not for profit Buddhist temples. Nirvana is the only commercial columbarium. Scarcity of land has restricted burials to under 10% of all deaths. This has also led to high prices for niches and ancestral tablets at columbaria in Singapore ($500 for a public columbarium niche, $7,000 for a temple niche, and $17,000 for a niche in Nirvana’s facilities). Due to space constraints in temples cremated remains have increasingly been stored in columbaria.
  • Pricing power: Pricing is set with reference to competitive landscape, disposable income and cost of services. Pre-need services are offered at discounts to as-need services. Nirvana targets the premium segment in each of its locations. Nirvana’s quality, premium offering are reflected in significant price differentials vs. competitors: Nirvana charges 30x government providers, 3x not for profit and 2x private competitors.
  • Dominant pre-need pioneer. Nirvana’s pre-need revenue market share is 60% in Malaysia and 80% in Singapore7 (no other operator has >7%).
    • There are several benefits of pre-need to the operator:
      • The addressable market for pre-need is much larger than as-need (40 years +).
        • Pre-need offers the potential to develop longer lasting and deeper relationships with customers, enabling Nirvana to introduce its brand to its customers at an earlier stage vs. competitors.
    • The benefits of pre-need for the consumer are as follows:
      • Ability to spread payments over up to four years.
      • Locking in pricing and avoiding inflation.
      • Time to plan bespoke funeral arrangements.
      • Avoidance of ‘burdening’ relatives with costs (as-need services are usually booked and paid for by a family member).

Sources of competitive advantage:

  • Switching costs are high: many customers like to be buried close to ancestors. Therefore the existing customer base of Nirvana, as the market leader, is a barrier to entry.
  • Intangible assets:
    • Nirvana has the most recognised death care services brand in Malaysia according to Nielsen8. This is important for both pre-need (the consumer will look for a long track record and brand reputation to ensure the operator will fulfil its obligation potentially many years after the consumer has handed over cash), and as-need (where the need is more immediate, and consumers do not have the time or inclination to conduct due diligence or compare operators, and will likely go for a provider with a solid reputation).
    • A permit is required to transform land into cemeteries. Burial services (92% of Nirvana’s revenues) therefore have higher barriers to entry than funeral services.
  • Exit barriers: land cannot be used for another purpose once it is used as a cemetery.
  • Integrated service offering:
    • Consumers do not wish to coordinate different aspects of the burial and funeral process9 themselves; they are therefore inclined to use one service provider. This may facilitate industry consolidation; there are only five integrated providers in Malaysia vs. c700 non-integrated undertakers, cemeteries and columbaria.
    • Nirvana is the exclusive provider of tomb design and construction services for pre-need burial plot customers. This means that burial plot sales will automatically generate follow on revenues from tomb design and construction.
  • Economies of scale: As the largest integrated death care service provider in Asia, Nirvana can leverage its scale with suppliers of construction, landscaping, maintenance and tomb design services.
  • Power over suppliers: There are numerous suppliers of inventory such as tombstones, caskets, urns; as such Nirvana keeps low levels of this inventory, and contracts with suppliers will be for a maximum duration of one year. Despite this Nirvana has maintained 20 year relationships with its suppliers of tomb design and construction, grave excavation and landscaping services.

Track record – average

  • Historic contracted sales have grown at a low to mid-teens CAGR over the last five years. In FY15 contract sales declined 4% in USD but increased 14% in RM, EBITDA increased 13% in local currency and adjusted PAT increased 21%.
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  • Nirvana has successfully replicated its pre-need business model from Malaysia to Singapore. Indonesia, despite being launched earlier than Singapore, has taken longer to gain traction.
  • Recent reported financials have been weak due to the strength of the USD (reporting currency), which appreciated 20% vs. the Malaysian Ringgit (main transaction currency) in 2015; 85% of revenues were generated in Malaysia.

Growth opportunity at acceptable ROI – strong

  • Growth drivers: There are three areas in which Nirvana reinvests capital:
    • Roll-up strategy: acquiring smaller operators, consolidating a fragmented industry and pushing additional revenues through the existing sales agency network.
    • Developing the existing land bank. This is likely to be a modestly returns-accretive activity as the land has already been acquired. However, note above that the majority of cost of sales is the development of that land.
    • Acquiring land in and outside of existing geographies.
      • Existing geographies: Nirvana intends to acquire land adjacent to existing cemeteries. Nirvana’s first cemetery, Smenyih in Selangor, Malaysia, was 200k sq m when it was opened in 1990; it is now 2.6mn sq m. It also intends to invest in greenfield projects in existing market as well as new geographies. Key criteria for the selection of new locations is high visibility (e.g. along highways) and close proximity to major cities. Nirvana targets a 25% IRR on greenfield projects; the company has achieved this on average without leverage over the last 15 years.
      • New geographies: Nirvana has adequate land bank and financial resources to fund geographic expansion. In addition to strengthening market leadership in home markets, Nirvana is pursuing expansion opportunities in China, Vietnam, Thailand and Indonesia. These will typically initially involve partnerships with local operators rather than land acquisition. China’s increasing disposable income and demand for premium death care services makes it an attractive potential market. But pre-need burial services are not currently permitted in China. New locations are selected on the basis of return on capital hurdles, which are assessed as a function of demographic composition, the regulatory and competitive environment, and availability of land. It is generally expected that new sites will be profitable within a couple of years.
  • Pre-need services industry growth drivers: As-need growth is limited by mortality rates. Pre-need services has a much larger growth potential due to the following:
    • Ageing population: the 40+ segment is growing c4% pa. in Malaysia and Singapore. The proportion of 40+ has been increasing:

nirv14

    • Pre-need penetration growth. Nirvana has been promoting pre-need services since 1990 and now dominates the pre-need market. Pre-need has been gaining acceptance: ethnic Chinese in Malaysia have been open to pre-planning death services since 1990, when Nirvana started marketing. The Chinese population in Singapore and Indonesia have been accepting the pre-need concept more recently. The penetration of pre-need is still low at 6% in Malaysia, 2% in Singapore and 1% in Indonesia. Singapore in particular is an advanced economy with an increasingly affluent Chinese population but an underdeveloped death care services market. As pre-need will generally cannibalise as-need, this is really a market share opportunity for Nirvana and an opportunity to increase average unit pricing as pre-need affords larger scope to cross-sell services, and is therefore well suited for the integrated operator. Nirvana typically has c30k burial plots sold without tomb design arrangements.

Malaysia death care market size:
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  • Long runway for growth on existing land bank: Nirvana has 3mn sq m of land which is either developed and available for sale or available for future development10. The average selling price per sq m of burial plots is $585. This is c$1.8bn of potential contracted revenues that could be generated on the existing land bank; this is 9x the contracted sales of $200mn generated in 2015. This does not include further upside from tomb design and construction ($524 ASP per sq m)11, niches ($6,200 ASP) and funeral services ($5,000 ASP). The total extractable contracted revenues from the existing unsold land bank of 3mn sq m is therefore significantly higher than 9x current contracted revenues.

Stewardship and corporate governance – strong

  • Founder Dato Kong owns 42% of the equity. Nirvana is his only business. 31% of the equity is owned by two private equity funds Orchid Asia and Transpacific Ventures.
  • Independent but exclusive sales agents are appropriately incentivised. Nirvana does not pay agents base salaries. Agents are paid commissions based on cash receipts from customers. This (1) increases staff retention; payment can be made over up to four years, and (2) encourages agents to consider customer creditworthiness and follow up on payment. The number of sales agents and the contracted sales per agent have increased.
  • Agents are also encouraged to train junior sales staff as they will receive commissions based on the success of their trainees.

Valuation

  • Penalised for HK listing? Nirvana derives the vast majority of its earnings and assets from Malaysia. Yet it is listed in Hong Kong (Hang Seng P/E = 10x) rather than Malaysia (Bursa Malaysia P/E = 18x).
  • Strong long term prospects, near term headwinds: Long term growth opportunity seems intact despite recent FX headwinds.
  • Low cash-adjusted multiples of normal earnings: The current enterprise value of Nirvana is $560mn and the market cap is $760mn. The FY15 reported adjusted EBITDA was $61mn (excluding the FX drag this would have been $72mn). Adjusted PAT in FY15 was $45mn (excluding the FX drag this would have been $55mn). Based on these ranges the stock trades at c. 8-10x EV/EBITDA, a very modest multiple for a high quality, capital light business, and 11-13x cash-adjusted P/E.
  • Cheap vs. peers: Despite being the largest death care services provider in Asia by land bank, contract sales and revenues, Nirvana’s enterprise value is smaller than some peers:

Nirvana investment note4

  • Owner earnings estimate: In FY15 Nirvana generated $54mn of operating profits, of which it reinvested $44mn in working capital, generating $8mn in cash from operations. Capex was $2mn, leaving $6mn in FCF to the firm. This is a 1% yield to Nirvana’s enterprise value. If the current assets in the business were run for cash and operating profits were not reinvested for growth, the business could generate c$50-55mn of owner earnings, a c9-10% yield to the current enterprise value. In 2015 Nirvana paid dividends of $27mn. If we assume that the business can generate $50mn of owner earnings and pays half of this out to shareholders and reinvests the other half at 20-25% ROIICs (target 25% IRRs on greenfield projects, current ROIC = 30%), then Nirvana would generate a total return yield on the current share price of HKD 2.2 comfortably in the high teens12:
    Nirvana investment note4

Risks

  • Land expropriation: Under the Land Acquisition Act 1960 the Malaysian State Authority can acquire any land which is required for public purpose; compensation, however, must be made at fair market value.
  • Fraud: Risks are mitigated by:
    • Tangible, verifiable, assets, a high number of customers and relatively low ticket items.
    • 90% of customer receipts are received via card payments, cheque or wire transfer. Cash payments must be made in branches and cannot be handled by sales agents.
    • Nirvana is audited by Deloitte and each subsidiary is audited by international accounting firms BDO and Grant Thornton.
    • Calls with management confirm a sound understanding of the role of capital markets and appreciation of capital allocation choices as a mechanism to create value.

Appendix

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1In terms of revenues, contracted sales and landbank
2Business partner exited in 1995.
3See Appendix
4Customers can settle two to 48 months after purchase.
5Cash plus short term investments minus short term debt
6At this point management has determined that collectability of the remaining contract sum is reasonably assured
7Entered Singapore in 2009
891% of survey respondents aware of the brand name
9Nirvana services cover embalming and funeral services in funeral homes, cremation services in crematoria and niches, burial plots, ancestral tablets and tomb design and construction in its cemeteries and columbaria.
10This is total saleable land, i.e. it does not include land for communal walkways and buildings etc. that cannot be resold and is therefore not part of working capital.
11Nirvana offers single, double and family burial plots ranging from six sq m to 1,500 sq m.
12This ignores the possibility of repurchasing undervalued shares funded by gearing up the capital structure.