VTech (303 HK)

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VTech (303 HK) is a Hong Kong toy and electronics manufacturer run by an energetic entrepreneur called Allan Wong.

The company was founded in 1976 as a manufacturer of video games, mostly for third parties such as Radioshack. Later on, Vtech branched out into toys, computers, cordless phones and a variety of other electronic products.

Today, three segments remain:

1. Toys (“Electronic learning products”) (43% of revenues) for the North American and European markets. These products are sold under the VTech and LeapFrog brand names. This business is more or less stable.
2. Contract manufacturing (40% of revenues) for third parties across audio equipment, earbuds, IoT products and the medical health industry. This segment has grown significantly over the past decade, more than tripling in revenue.
3. Telecom products (17% of revenues), under their own VTech / Snom brand names and for third parties. These products include cordless phones for residential and business use, conference phones and baby cameras. The residential sub-segment is in decline, whereas the commercial & other telecom sub-segment is holding up well.

Electronics manufacturing is a competitive industry. But VTech is unique among its Hong Kong and Chinese peers in that it owns several valuable brand names such as LeapFrog, VTech and Snom.

It’s also an exceptionally well-run business. Allan Wong has made a conscious decision to enter businesses that require little PP&E and working capital, resulting in a high return on capital. He’s also been laser-focused on costs. For example, he’s been laying off employees quickly in the troubled residential telecom segment.

The capital allocation is among the best I’ve seen in Asia. VTech typically pays out 100% of its earnings as dividends. It also engages in M&A opportunistically when prices are low. The major acquisitions of the past few years have taken place at EV/Sales multiples of just 0.2-0.4x, and the acquisition targets have often had underutilised assets. More recently, VTech announced a share buyback of up to 10% of shares outstanding.

There are several reasons why VTech’s share price has fallen. The company was hit by US tariffs on Chinese goods in 2018 and 2019. It’s also seen margin pressure from higher resin prices, freight costs and semiconductor shortages.

These problems are going to be resolved. And the weaker RMB should be a tailwind. VTech’s guidance is cautious, but gross margins will most likely recover in the next year or two.

Consensus for 2023e has VTech trading at 7.4x P/E and 13.2% dividend yield, despite a ~30% return on equity. While the business is not a fast grower, growth in the contract manufacturing is likely to counteract weakness in the telecom segment. And free cash flows of US$200 million per year are high compared to a market cap ex-cash of US$1.2 billion.

The key risks are customer concentration (top 5 customers are 44% of revenues), minimum wage pressure in China and the potential impact of e-commerce on VTech’s toy segment.

Also, check out Macklowe’s excellent write-up on VTech on Value Investors Club, available here if you have access to the website.