Saturday, June 30, 2007

End-June 2007 Portfolio Review

The month of June came to an end rather quickly, in my opinion. Suffice to say that there were sufficient activities regarding my companies since the last half-month June 2007 review for me to post a lot of news and info. Readers would have seen that the companies involved have gone on various paths to grow their earnings (convertible bonds, share placement). Whether these measures will materialize or not will have to depend on the future. Below is a quick review of my shareholdings as at June 30, 2007:-

1) Ezra - Buy Price $1.30 (bonus adjusted), Market Price $5.80, gain 346%. There were no announcements from the company in the half-month since June 15, but JP Morgan has prepared a report on Ezra which states a target price of S$8.60 based on sum of the parts valuation. Essentially, the report values the newbuilds even before they come on-stream in FY 2009 and FY 2010, and attempts to project earnings forward all the way till FY 2009. It also makes assumptions that the 2 AHTS will go through a sale and leaseback while the new pipelay vessel will be 100% owned. They also assigned a market value to EOC and computed Ezra’s estimated 88% remaining holdings in the company after the Oslo OTC listing. This could be reduced to 50% by the end of the year should Ezra decide to dividend out shares in EOC to its shareholders.

2) Boustead - Buy Price $1.295 (average), Market Price $2.09, gain 61.4%. The only significant announcement from Boustead was the purchase of the Maxitherm combustion technology business in Australia . This will see them building up their core competencies in their 3 business units now, in order to prepare themselves to bid for more contracts. I am still waiting for news of the date of the AGM and also waiting for the Annual Report to arrive.

3) Swiber - Buy Price $1.01, Market Price $2.67, gain 164.4%. Swiber announced (on June 25, 2007) a new contract worth US$31 million going to a Malaysian customer. I did a detailed post on this. They also did a placement of 55.35 million shares at S$2.1748 per share to raise nearly S$12 million for business expansion and ordering of more vessels. This corporate move bodes well for the company as it is gearing up to take advantage of its specialization in the EPCIC niche industry. Moving forward, there is much to look forward to as the company aggressively embarks on its expansion and growth path.

4) Global Voice - Buy Price $0.1775 (average), Market Price $0.215, gain 21.1%. Much has already been written on Global Voice. If readers had kept track of my blog, they would know of the launching of Euro One by GV and how it impacts their fundamentals. What is not known is still their earnings capability and cash flow cycle. The problem with this company is that there are a lot of speculators, and include many people who may not understand or appreciate the business model. Anyhow, I am waiting for August 2007 to evaluate GV’s results and see what action is to be taken.

5) Suntec REIT - Buy Price $1.11, Market Price $1.94, gain 74.8%. A substantial shareholder, Lee Shau Kee, has just sold off a block of 75.1 million shares at a price of S$1.995 to S$2.04, thereby creating a sharp price decline amid a general loss of confidence in the company. Fundamentally, nothing much has changed for Suntec and looking forward, it is hoped that increasing office and retail rentals, coupled with organic growth within the mall, can push yields higher for unit-holders.

6) Pacific Andes - Buy Price $0.665 (rights-adjusted), Market Price $0.89, gain 33.8%. Pacific Andes is in “transition” now, with the rights being traded and unpaid for as at this point in time. Thus, my profit % is based on the ex-rights averaged price (S$0.52 + S$0.81 divided by 2) against the current market price. This may not be wholly accurate but it still gives a fair picture. % gain is now reduced but the magnitude of the gain remains somewhat similar. More news will be posted on the rights issue in July.

Overall Portfolio

My overall portfolio has increased by 115% from cost of about S$40K as at June 30, 2007. Market value of my portfolio is around S$86K. The portfolio is doing well mainly due to Boustead and Swiber, who have seen some corporate announcements being made since June 15, 2007. In the next few months, more financial results will be released and I will be reviewing each investment to see if they still generate good returns.

My next portfolio review will be on July 14th, 2007.
Investment Mistakes Part 3 – Trying to Time the Market

This mistake is, of course, a classic for most discerning investors and somehow must be made at least ONCE before a person learns his lesson. In my case, this was a very painful lesson as I lost about 5% of my capital (amounting to several hundred dollars) within a span of 3 days.

The counter in question was called Keppel Telecommunications and Transportation (Keppel Tele & Trans or KT&T). I bought in on July 22, 2005 at a price of S$1.46 and sold out at S$1.40 on July 25, 2005. At the time, I had no inkling on doing proper fundamental analysis and was simply keen on buying on rumours and tips. I got wind of chatroom gossip mentioning the KT&T will be making better profits this quarter as compared to the previous quarter. I bought in 10,000 shares without doing the requisite research on the company and also without checking on valuations. I was also confident of a good dividend which would boost the share price in the short-term. In short, I was guilty of short-termism and attempted to contra.

Ultimately, the company declared a capital distribution and flat earnings which caused the share price to tank. I was totally clueless about why the share price did not manage to hold and was hoping that it could magically go up. However, after about 3 days I realized that it was futile to keep hoping for a miracle and sold off my shares at a contra loss.

Lesson Learnt: Do not try to contra unless you are an expert at reading charts and graphs. Value investors do not try to time the market, neither do they react to price trends. What to look for is value, and valuations are what drive the company’s share price. Another mistake was trying to contra with more than available funds, which resulted in me being unable to “pick up” the shares. This forces one to contra no matter whether he has a gain or loss, and essentially creates a lot of panic and sleepless nights (which I could do without !).

Always apply proper valuation techniques if you wish to assess if a company is worth investing in, and this will be highlighted further in my research series.

Thursday, June 28, 2007

Global Voice – Launch of Euro-One Network Collaboration

Global Voice announced on June 27, 2007 that it has launched the Euro-One Network. This is a metropolitan fibre network which connects Europe’s leading fibre optic network providers to deliver infrastructure and next generation networking solutions which span countries in Eastern, Western and Central Europe and North America.

The announcement and details can be found on GV’s website located at They are collaborating with e!Net, Exatel, FIBRELAC, Geo, Hybernia Atlantic, JazzTel, Neo Telecoms, Net4Net and Retalit. Each of these companies represent a specific country or region (details within announcement) and are working together to connect fibre cables up to 85,000 km spanning over 350 different cities in Europe and North America. The benefits of this collaboration are immense as it means that EuNetworks (GV) is not limited to serving customers just in Europe alone (bound by its own fibre optic network), but can also partner with the above companies to offer “bundled” solutions to customers. The implications are as follows:-

1) GV is the initiator of this collaboration between the companies and the entire seamless linking up was a success. This would definitely increase the visibility and profile of GV as this important piece of news will be widely reported in newspapers and network publications all over Europe as well as North America. This would propel GV into the spotlight and allow it to market its solutions more effectively.

2) In terms of branding, GV has imprinted its brand name in over 350 cities as it was the initiator of the Euro One Project and the CEO has also commented on the immense value of this news 85,000 km network. This would allow them to further increase their brand equity which is an intangible asset but which will allow them to grab more contracts in future.

3) With this seamless connection, GV can also partner affiliated companies in offering more customized solutions to potential customers. With an expanded network, more customers will be receptive to using the services of Euro One as its connectivity spans 350 cities almost across half the globe.

4) The size of contracts would probably get larger and span a longer period of time as well due to the new customer mix which GV can reach out to, assuming it collaborates with its partners to offer fibre network solutions to its customers. Since the network now covers more cities than GV’s own private fibre networks, this means customers which were previously not within their radar would become potential customers to target. This could significantly scale up GV’s business in the next few years.

5) This is just a guess, but with the increased network connections over Europe and North America, GV could perhaps offer solutions which were previously not available due to the constraints of their own private fibre networks. This would mean that they can expand their scope of services offered and possibly create a new revenue stream.

The above are just some thoughts regarding the launch of Euro One and we must still wait for confirmation from the company itself on whether it can continue to offer good value to customers, and generate good returns for shareholders. At this point in time, it’s easy to get excited over GV as they have been announcing consistent contract wins. What’s uncertain is their cash flow management and ability to return to profitability. I would rather take a more neutral and cautious stance now and adopt a wait-and-see attitude first. There will be more reviews and updates on Global Voice as more news comes up in future.

Wednesday, June 27, 2007

Research Series Part 1 - The Importance of Independent and Objective Research

In a new series I am introducing (I have another series on investment mistakes which is up to Part 2 so far), I will be touching on aspects of objective research and how to go about doing fundamental analysis for companies in order to ascertain fair value, and estimate intrinsic value. For those who think it is simple, let me clarify by saying that it is not rocket science, but neither is it easy as it involves a lot of hard work and long hours of reading. One thing I can assure readers is that the hard work will eventually pay off !

Part 1 will touch on the importance of getting independent and objectively verifiable research. As I have mentioned on my post about tips, rumours and hearsay, we often get information overload in our daily lives and we have to constantly filter out the important information (usually only 1% of what you hear) from the crap (the other 99% !). Doing research conscientiously means equipping yourself with the neceesary knowledge and information to enable you to make an informed decision. This is in contrast to the so-called off-the-cuff decisions made by punters and traders as they predict the market's next movement. Most of the time, information based on tips and rumours are unverifiable and it is highly risky to speculate in something in which you have no control over, and which you don't fully understand. There are obviously people who claim to understand market and human psychology but this blog is not going to touch on this aspect as this is, after all, a value investing blog.

Independent research is defined as research which is obtained from objectively verifiable sources. This would include an accredited website such as a news or editorial website, newspapers, business magazines and/or publications. This research may be of a macro or micro nature and may or may not be specific to the investment which you may be eyeing. One must be selective about what one reads because theoretically, it is impossible to read everything. Thus, one may wish to concentrate on news involving the general health of the economy, inflation rates, unemployment statistics, industry analysis, market commentaries and analyst reports. Also take note that some reports may be written from a personal point of view and may contain opinions which are not representative of the general public. It is up to the discerning reader to distinguish between slanted opinions, and bare facts. One has to put on his thinking cap as well and not just read blindly into everything. This is the essence of objective research which I will touch on in the next paragraph.

Objective research involves research into the facts and figures such as employment data, CPI, GDP growth rate for the economy, as well as profit margins, revenue growth and earnings per share data for companies. Objective information should not be tainted with subjectivity, meaning that the data obtained has to be rigorous and should be free from bias. Thus, reports obtained from government agencies such as MAS are the most accurate as they are considered reliable sources and are "untainted" by possible editing or amendments. For companies, most of the information can be obtained through SGXNet, OPERA (for prospectuses and OIS) as well as company websites. The Annual Report is a good report to start off with when researching a company, but I will touch on that in future parts.

The next thing to do is to collate all this information and READ it thoroughly. It will be useful to make notes or use bullet points to help to summarize the large volume of information available, and it also helps to channel and focus the mind in order to make clearer, unbiased decisions. Consulting a friend or relative may be useful but a word of caution here: make sure that your friend's objectives and investing philosophy are in tune with yours; otherwise there may be conflicts and vast differences in opinion on how to evaluate a piece of news or fact. Absorbing information is a key "job" for a value investor, as he has to have knowledge on many aspects which may affect his investment.

Finally, here comes the hardest part. We have to analyze and decide if the information presented would culminate into a good investment decision. This is probably the most difficult part of the research process. Don't be too disappointed if you make mistakes initially (as I did) because mistakes help you to learn and avoid similar mistakes in future.

Next in the series will be how to do industry-specific research on a company and the factors to look out for in the macro-economic environment. There is no confirmed date where I will post part 2 but just keep checking back daily. There will be other posts in the meantime to satisfy your time.
Swiber - Placement of 55,350,000 shares at S$2.1748 for Business Expansion

Swiber today announced a private placement of 55,350,000 shares (55.35 million) at S$2.1748 representing 15% of its current share capital base of 369 million shares to raise a total of S$120.38 million. The offer was managed by CIMB GK Goh and according to them, it was well-reecived with the offer being over-subscribed for. Some prominent investors include JF Asset Management. The enlarged share capital base is now 424,350,000 shares pending approval by SGX of the placement shares to be listed on the SGX.

Most shareholders will immediately recognize this move as being dilutive to existing shareholders, as the placement increased the share capital base of the company. Furthermore, some shareholders on forums have mentioned that the placement was done at a discount to market price of S$2.29 before the trading halt at 2 p.m. today.

To put things in perspective, this move may be dilutive to shareholdings but it may not necessarily be dilutive to earnings, as the company is utilizing S$77.4 million to fund the expansion of its vessel fleet. Recall that Mr. Raymond Goh (CEO of Swiber) mentioned just yesterday that the company was considering an equity fund-raising exercise to raise funds for business expansion; thus this news should not come as a big surprise as I had blogged about it just one day ago ! In fact, companies can only raise funds through either equity or debt. Equity create dilution but has no immediate impact to P&L, while debt increases interest expenses but does not impact EPS. However, one must focus more on the big picture, which is Swiber's aggressive plans to expand their fleet and conquer new markets.

With this new issue of shares, the fair value of Swiber needs to be recalculated. From my previous post, estimated net profit for FY 2007 is around S$49.57 million. Based on the new enlarged share capital, diluted EPS will be 11.68 Singapore cents per share (down from 13.4 singapore cents per share pre-dilution). Thus, applying a PER of 13 times yields a price of S$15.2 while a PER of 15x yields a price of S$1.75. On the surface, this would imply that at S$2.29, Swiber is 30% over-valued assuming a PER of 15x. However, by collating the positive factors about the company which I have discussed previously, intrinsic value is likely to be much higher than S$1.75 at this point. This is due to the following factors:-

1) The placement changes the fundamentals of the company in that it injects cash into the company to fund its expansion. Thus, in the short-term, operating cash flows may be negative as vessels are being constructed, but in the medium-term cash inflows will start to build up as the vessels are deployed to various locations to carry out their EPCIC activities. Under "Financing Activities" in the Cash Flow Statement, this large cash inflow will ensure there is a net cash inflow balance which should sustain operations and provide adequate working capital.

2) The CEO mentioned that only part of the capital was to be used for the vessel fleet expansion program. This would imply that the remainder could be used to finance other aspects of the business such as building up their networks in key countries which Swiber is targeting, and to do the ncessary due dilligence to ensure that investments are worth undertaking.

3) The intense interest in Swiber's placement (even at S$2.17, which is at about 16.2 times forward PER pre-dilution) would indicate that funds and other institutional investors have faith and confidence in the company's ability to deliver in future. Thus, they are willing to accept the risk of buying into Swiber at S$2.17 as they probably see more upside to its intrinsic value which will lower the forward PER post-dilution by increasing earnings substantially.

4) A private placement has to be done at a discount to market price in order to make it attractive to potential investors. Thus, S$2.17 can be seen as a "benchmark" price floor set by the institutional investors and they are thus valuing the entire company at about S$800 million (market capitalization) pre-dilution.

Shareholders who have confidence that the company can deliver should seize the opportunity to buy more of the company when weak holders sell down the following day.

Boustead - Acquisition of Combustion Technology Business in Australia

Boustead announced that it has acquired (for A$400,000 or S$520,000) the Maxitherm combustion technology business in Australia. The acquisition is in line with their strategy of consolidating their core competencies and beefing up their solid energy waste recovery systems expertise. The company had already acquired the intellectual property rights to the Maxitherm combustion technology through MBPL in 2003 and this move is a follow-up to ensure that the full range of activities can be provided to customers.

A new wholly owned-subsidiary, Boustead Maxitherm Boilers Pty Ltd, was set up in Australia to undertake the marketing and installation of the technology in Australia. This move by Boustead is positive as it sees the group slowly building up its capabilities in their 3 areas of waste recovery solutions, water and wastewater solutions and industrial real-estate solutions. Moving forward, Boustead will be bidding for more contracts in Vietnam which it hopes to clinch soon.

Pacific Andes - Rights Trading and Offer Information Statement (OIS)

For those who do not know, the OIS can be downloaded from the OPERA website (see my links on the sidebar) before the hard copy comes along to your household. Since I am in Vietnam, I have no choice but to read the 80-page soft copy which I am still going through ! The trading of the rights will commence tomorrow June 27th and the counter is named "Pac Andes R" representing the rights. Note that your can choose to sell your provisional allotment of nil-paid rights in the market which means that you do NOT have to pay the rights conversion price of S$0.52 per rights to convert to shares. However, this move will be dilutive to the seller as he now owns a proportionately lower amount of shares as a % of the enlarged share capital base of the company. Similarly, one can choose to buy the rights from the open market, assuming that they are priced at (Market Price of Pac Andes Mother Share - S$0.52), otherwise it would be better to purchase the mother share directly.

More details will be posted here once I get through the OIS, and I will be posting on how to apply for excess rights and how they will be alloted and paid for.

Monday, June 25, 2007

Swiber - Clinching of US$31 million LOI in Malaysia (An Analysis and Review)

This morning, Swiber announced that it had clinched a US$31 million LOI (Letter of Intent) with a Malaysian Group to provide offshore installation works for the Puteri Wellhead platform in Malaysia. This LOI comes at the right time as Swiber has just received delivery of 2 new barges; namely the 2,500 metric-ton Da Li Hao crane barge and the pipelay barge Swiber Conquest. These barges were immediately deployed for this LOI and the contract is expected to commence in August 2007 and be completed by October 2007. As the CEO Mr. Raymond Goh says in the press release, Swiber will strive to build the business further by investing in new technology for vessels (e.g. sheerleg barge order planned for FY 2008), expanding their fleet (another pipelay vessel and 4 AHTS planned) and to explore new markets such as Vietnam and Thailand.

With this LOI win, current order book as at June 25, 2007 stands at US$228.3 million. However, for the Brunei Shell deal, only US$70.4 million will be recognized in FY 2007. Thus, from my previous post on Swiber dated May 23, 2007, the order book for Swiber for FY 2007 will increase from US$121.1 million to US$152.1 million. Using the same net margin of 18.9% for 1Q 2007 (this is a conservative approach as Swiber has already taken charge of its own barges and we should assume a higher net margin) gives a net profit figure of US$28.7 million for FY 2007. Adding this to the 1Q 2007 profit figure of US$3.7 million gives an approximate net profit estimate of US$32.4 million. Using an exchange rate of 1US$ to S$1.53 yields a net profit of approximately S$49.57 million. Therefore, the EPS based on 369 million shares will be 13.4 Singapore cents per share. Applying a PER of 13x (conservative) yields a fair value of S$1.74 A PER of 15x would suggest a fair value of S$2.01.

The fair value for Swiber, however, is different from its intrinsic value. Intrinsic value would take into account the following factors:-

1) MOU signed with Emirates Investment Group (EIG) to explore contracts and EPCIC jobs in the Middle East. An MOU is not a definitive contract, but it helps to build up Swiber's network and paves the way for them to form a 50:50 joint venture to explore business opportunities in the Pakistan, the Gulf region and the Middle East.

2) In an interview with AFX-Asia on June 25, 2007 (today) at 10.00 a.m., Mr. Raymond Goh mentioned that this JV will be bidding aggressively for projects in the third and fourth quarter of FY 2007 (July to Dec) and that he expects the JV to be earnings accretive in FY 2008. Thus, this is a prelude to more probable contract wins in the Middle East for FY 2008.

3) Plans are underway to expand Swiber's fleet in order to allow it to service more customers and expand its client base. Mr. Goh said that the company will probably look to fund its next wave of vessel expansion with a share placement to raise funds from the market. Currently, they have already entered into a sale-and-leaseback arrangement for 5 vessels. More such arrangements can be expected in order for the company to remain asset-light.

4) Margins are set to improve from 18.9% (as I had mentioned, a conservative estimate) as the company takes control of more and more vessels which have completed construction in FY 2007. Thus, as the year passes, more and more of Swiber's own vessels will be deployed for use, thus reducing reliance on third-party vessels and reducing margin erosion.

5) Mr. Goh is also bullish on the long-term outlook for the oil industry as he said 40% of the world's crude oil production comes from the Asia Pacific and the Middle East. Thus, there will still be continual demand for EPCIC services in the region. The Middle East consists of mostly shallow waters in which Swiber excels in.

Witht he above 5 points, the intrinsic value of Swiber is probably much higher than the S$1.73 to S$2.01 estimate I have computed. The market is pricing in expectations of Swiber performing well in future by pricing the shares at S$2.36 at today's closing. However, this is still a little lofty for I feel that the company has yet to demonstrate a sustainable increase in margins. 2Q 2007 results should show if the company has managed to improve margins, and I will adjust my valuations from there.

However, moving forward, there are several concerns which I would like to point out:-

a) The recent LOI won by Swiber only lasts for 3 months from Aug 2007 till Oct 2007. While this means that revenues (and hence profits) will be recognized quickly, it also implies that this LOI will noe sustain earnings into FY 2008 as it is short-term in nature. Swiber would do well to capture contracts of longer duration in order to ensure earnings can be sustained into future periods.

b) The LOI was announced for Malaysia, while the previous one was announced for Indonesia (US$21.3 million). These are markets in which Swiber is already well-established and in terms of market reach, it does not present anything new or ground-breaking. It is hoped that Swiber will be able to clinch contracts/LOI in areas they are currently targeting. Such areas will include (but are not limited to) Thailand, Vietnam, Pakistan, the Middle East, Bangladesh, the Gulf region, Myanmar and China. Seeing that the company is targeting so many regions, I hope that they are not over-stretching themselves at the same time.

c) The company also has to watch out for its cash flow as 1Q 2007 showed a negative operating cash flow. Swiber is undergoing an aggressive expansion cmapaign and it is possible that they may either over-leverage to fund their vessel expansion, or be short of cash for day-to-day operations. I hope this concern will be address when I see their cash flow statements for 2Q 2007.

d) The move to deep-water exploration will be gradual and by FY 2009, it is expected that 10% of exploration will be in deeper waters. Swiber has to gear up to adapt to this change; otherwise it may not remain competitive enough to ensure that it can clinch further contracts/LOI.

The above represent risk factors for Swiber, and the prudent investor should always do a SWOT analysis of the company concerned to review its competitive position as well as its prospects.

I will continue to provide in depth and (hopefully) useful analysis for my companies and also tools for value investing on this blog. But please note that for June 26 to 30th (afternoon) I shall be on business trip in Vietnam and thus may not be able to blog daily.

Short Update - Swiber Terminates Loan Agreements

Just a short update for Swiber before I fly off for my business trip. Swiber has announced that loan agreements amounting to US$7.3 million entered into between 2 and 23 March 2007 have, on 25 June 2007, been repaid fully with US$7.8 million.This would imply that the interest expenses to be charged to the Profit and Loss Account amounts to US$0.5 million, which represents an interest of about 6.8% for 3 months !

The announcement however, states that the interest rate on the loans are 9%. I would think that the company had paid off a sum of money as part of termination clauses inherent within the loan agreements in order to terminate them so swiftly.

One can only hope that the money was well-utilized for Swiber's operations before it was returned. I did mention in my evening post that I am concerned about Swiber's use of cash for operating activities. Let's see how this pans out in the 1H 2007 financial statement announcement.

Sunday, June 24, 2007

Diversification or Di"worse"ification ?

It's been quite some time since I mentioned the topic of diversification as compared to focused (value) investing. I've been reading news articls in the papers which mention the benefits of diversification, and the standard dogma for professionals in brokerage and investment banking firms is that diversification reduces your risk and helps to achieve an average return on your investments.

True, I have to agree with the pundits that being diversified does help to mitigate risks which may be company-specific or industry-specific. But in any case, an investor has to do appropriate and detailed research first in order to sniff out potential trouble before investing. Cases like Malaysia's Transmile scandal and Singapore's China Aviation Oil are striking examples of frauds in large, established companies with big names involved (Robert Kuok in the former and Temasek for the latter). These examples seek to highlight the fact that one should not dump everything into one company as it may be extremely risky to do so.

Coming from another angle though, is Mr. Warren Buffett and Mr. Peter Lynch. Mr. Lynch is the famed investor for the Fidelity Fund, which has achieved consistently good returns over a period of 20+ years. He described diversification as "diworsification" in that you start getting your fingers into too many pies; thus one cannot discern the true taste of each individual pie. Diversification also tends to lower your total portofolio returns as a 100% gain in one company spread over 10 stocks only increases your portfolio gain by 10%. Mr. Buffett mentions that diversification is for people who do not know what they are doing, and it is a perfectly sound strategy for people who do not know how to value companies.

For those who take the time, effort and patience to analyze individual businesses, they will realize that focused investing can reap huge rewards. As Mr. Buffett says, it is better to have a lot of a few (companies), rather than a few of a lot. Most people's portfolio (as posted in forums) consist of at least 15-20 companies. How in the world is one going to track the progress, financials and growth of each company when one has 15-20 to contend with ? To be frank, I have problems keeping up with the dynamics of my 5 companies (REIT not included), let alone 10 or more. Of course, in this case we are referring to companies which are reasonably active in growing their businesses, and not "dormant" companies whose Management hardly tries to achieve consistent growth over the years. Owning a lot of a few means buying large quantities of shares in a company in which one has researched thoroughly and which offers a decent margin of safety.

Diversifcation is for those who do not wish to "sweat" too much in their search for hidden gems (i.e. undervalued companies with good cash management and strong earnings prospects). It will enable you to achieve average returns because that's what mutual funds (unit trusts) are doing as well. The joke is that most mutual funds (up to 90% at one point in time) either under-perform the market or just manage to perform on par with market indices. One must take into account the fact that not only are funds well-diversified (in fact, some are OVER-diversified), but the constant buying/selling activity also creates frictional costs which erode value for the unit trust holder. Add Management and Performance fees in and you can see why I acoid unit trusts !

That said, Mr. Buffett does recommend index-linked funds for those who wish to achieve a market level of return (the "lazy investor"). These are funds which are tied to a particular stock index (e.g. Straits Times Index or S&P 500) and ETFs (Exchange-Traded Funds) are one type of index fund. Unfortunately, ETFs are still not widely accepted in Singapore and are relatively illiquid and under-appreciated. Most of the talk now is on risky warrants (more on this in future posts) and quick money; but most people fail to appreciate the fact that sometimes, "slow" money can be better in the long run than the promise of quick money as "slow" money can compound over time. I will blog more on ETFs if I get the chance to research more into it.

What I do personally believe in however, is to diversify across different investment classes. For example, I do have money parked in equities as well as an insurance savings plan. Equities are natually viewed as volatile and are subject to up and down swings of market sentiment, plus I take a long-term approach; thus they are not suitable for liquidation at short notice. A regular savings plan guarantees me a 3.5% interest rate per annum (compounded if I leave the money inside) as well as dividends on my savings after the 3rd year. In addition, I also keep sufficient cash in my bank to tide over emergencies and to ensure I have funds for buying shares cheaply should a market crash occur. This covers the aspect of money management which I will also attempt to dedicate a post to in the near future.

Saturday, June 23, 2007

Tips, Rumours and Hearsay

Somehow, during a bull market, people have the amazing tendency to throw all caution to the wind and pump in ever-increasing amounts of money into equities. Most of this is due to misplaced over-confidence and a general feeling of euphoria. The title is apt in that bull markets generally involve all sorts of "stories" of companies doing this and that, and people seize on any little bit of news to pile into a counter and push it sky-high. In essence, these are the characteristics of a raging bull market !

Tips are so-called hand-me-downs by individuals who think they know more than they do, to people who wish to know more than they should ! Call it the blind leading the blind, but most of the time the provider of these tips himself got the tip from someone else, and so on. It's sort of like a chain email; no one knows where or how it originated but it is propagated anyway and somehow manages to spread like wildfire. Tips would include the next big thing (like alternative fuels, casinos, construction) to company-specific events like mergers/acquisitions and the like. The reason why people love tips is due to human psychology. We can't resist knowing something that someone else does not, and it gives us an inflated ego and a feeling of superiority that we have "beaten the crowd". In actuality, most tips are like hot vapour - they dissipate without leaving much trace.

Rumours are somehow even more insidious than tips, as most tips have some form of basis (however nebulous) to back them up. Rumours swirl in dark, dank drains and rise up like phantoms to conquer greedy and weak minds, forcing people to believe incredible things and react in unsettling ways. I have heard rumours of shares soaring to high heavens and impossible company turn-arounds. Such rumours are usually (90% of the time) unfounded and those who chase up their pipe dream may end up much poorer. The problem with rumours and tips is that it gets infectious if one initially makes money; this causes them to listen out (to their so-called "reliable source") for more tips in order to generate more money. Thus, the hole gets deeper and deeper and the poor person simply sinks in more and more into the quicksand.

Rampant speculation and impossible valuations characterise the current market, and to me personally, this is worrying and a major cause for concern. Looking at a market volume of 3 billion shares valued at around 1.5 billion dollars simply means that on average, people are churning shares worth $0.50 ! I've seen cases where historical PER has reached 1,200, yet people are still calling "buy" and stating higher target prices. Most of the pennies are in play and even the BT calls it "rotational plays", meaning stories float from one industry/company to another to trigger either panic buying or panic selling.

Whatever the case, one thing's for sure. The market now is more emotion-driven than I have ever seen, and this is also reflected in the forums I have been browsing through. More and more people comment on how easy it is to make money, boast about their supernormal gains and pat each other on the back for profiting on a hot tip. It's herd mentality and is a perfect example of "the madness of crowds" (see my previous post on this).

In such markets, value investors do the best thing they can do in such circumstances. They wait. If the market does not produce prices which are below intrinsic value, value investors will wait patiently till the right opportunity comes along. Fervent activity is not akin to intelligence if you do not know what you are doing, and taking a slothful approach may actually be better in such a rising market.

I did ask a friend recently who gave me a hot tip about Unionmet. When asked where the tip came from, she was unable to say except that her broker had recommended it. When further quizzed if Unionmet was a good buy based on objective research, she concluded that no research or reading had even been done. This practise is common but becomes more and more frequent as the market climbs higher and higher. Those who don't want to miss the rally quickly take fresh positions, not knowing that with each successive price rise, they are only increasing their risk and their potential losses; while limiting their gains.

Thursday, June 21, 2007

Investment Mistakes Part 2 - Buying a company with limited growth prospects at high valuations

To continue with the series on personal investment mistakes, I will now candidly give my account of my investment in Yellow Pages. As most Singaporeans know, Yellow Pages is a company which deals with the printing and circulation of....Yellow Pages booklet (yes that phone book which usually collects dust in the drawer until it is needed, which is like quite seldom unless you are in the tele-marketing industry !). Yellow Pages (YP) also has the Internet Yellow Pages which allows users to surf and search for various locations and their respective phone numbers.

I had bought into the company on May 4, 2005 at a price of S$1.71 and sold out at a substantial loss of 15.8% of my capital at S$1.46 on May 27, 2005. Thus, it only took about 3 weeks for me to lose 15% of my capital, and this was my first experience with a stock that "crashed". The crash in market price was due to Yellow Pages announcing disappointing earnings and the fact that the outlook and prospects for the YP distribution was not bright. My mistake was in buying YP on the basis that it had surpassed S$2.00 before, thus it probably could happen again. That was my first HARD lesson that past price trends do not influence future price movements, as the market price of the company is based on earnings and the earnings were decreasing. Note: YP has NEVER surpassed S$2.00 since the time I sold, the lowest point was below $1.00 and YP is now involved in a boardroom tussle as this post is written.

On hindsight and after much analysis, I concluded that I had not conducted enough research into the company before buying. In fact, I had only about 6 months of investment experience then and I coolly thought that a "stable" company such as YP (I thought it was comparable to SingPost) would generate a decent return as well as dividend. Most readers who read my mistake number 1 on MCL Land will know not to buy a company purely for dividend, as this may indicate limited growth prospects.

In YP's case, the business model was not scalable and there were limited opportunities for it to grow its earnings organically. One option was to acquire but even then, there were no complementary businesses for it to acquire which would generate synergies and enable economies of scale (unlike vertically integrated companies like Olam and Pacific Andes). It was also in a "sunset" industry in that Yellow Pages was a printed booklet and most people were relying more and more on online help to locate buildings/phone numbers. In this day and age, bluetooth, blackberry devices and WAP-enabled phones which are able to access the Internet are commonplace and these are the leading edge which has taken the rug from YP's feet.

Lesson Learnt: Always do sufficient research on a company's industry and its business model to see if it can deliver sustainable growth in the next few years. Also, analyze its competitive edge and see if this can be sustained in the long-term. Now, I use a basic Porter's 5-Forces Model (to be elaborated in a future post on competitive advantage) to assess the company's industry and competitive landscape. This can help eliminate most companies as one can see the erosion of margins and competitive edge which will lead to eventual decrease in earnings. Also, one should stick within one's circle of competence, meaning only invest in companies in which you understand (e.g. an IT professional will understand the computer industry better, while an analyst at Shell may understand the oil and gas sector better). If the business model is too complex or hard to fathom, then it is better to avoid and adopt a wait and see attitude. A lot of new-age industries such as alternative fuels, nanotechnology and solar-energy cells are grabbing headlines now, but the question is will the earnings be sustainable 2-3 years from now ? Ask yourself that before sinking your money into the company.

Business Trip - June 26th to June 30th, 2007

I will be away to Vietnam on business during the above-stated dates. Thus, I will most likely not be able to blog on a daily basis unless I can really find time. Internet connections are not a problem to find in Vietnam but the issue is speed of connection, and frequency of disconnection. I will be back in time to do a June 2007 month-end portfolio review and companies' review.

Research on companies to invest in will only take place from August 2007 onwards, as I am re-organizing my finances after my honeymoon to assess my financial position. In the interim, I will only be taking up a new position in Pacific Andes through the rights issue. More details to be posted once the OIS is released on OPERA and mailed to myself.

Wednesday, June 20, 2007

Pacific Andes Holdings - Rights Issue Details and Comments

Today was the day that PAH went Ex-Rights (XR), and the price has adjusted according to the formula (Market Price + Rights Price)/2. In this case, the previous day's close was $1.41, thus theoretically, the XR price should be $0.965 based on the formula. PAH closed at $1.04 today, thus there was a 7.5 cent premium to the theoretical XR price. Computed backwards, the pre-rights price would have been about $1.55, which is an all-time high.

This phenomenon can be explained by the fact that PAH and CFG are rapidly growing their business, and from a business analyst perspective (as all value investors should be), this means that over time, the intrinsic value of the business and company can only increase. Without taking into account EPS growth, we are still likely to see positive results as ROE increases and net margin improves due to economies of scale in having more fishing vessels. Thus, the rights issue has achieved its objective of raising funds to grow the business, and Mr. Market has correctly factored in PAH's growth potential.

With the XR, it is perhaps prudent to explain the relevant important key dates and their interpretations for all PAH shareholders and other interested parties.

Ex-Rights Date (20 June, 2007) - This represents the date at which buying the shares in PAH no longer entitles you to the 1:1 rights to buy the share at $0.52. Dates before this date are considered the Cum-Rights (CR) period.

Record Date (22 June, 2007) - This is the books closure and record date for determining shareholders' entitlements to the rights issue. This will be T+3 from the last CR date.

Rights Trading Period (27 June, 2007 to 05 July, 2007) - This is the period whereby the rights are traded on SGX. Shareholders who were entitled to receive rights during CR period are able to sell their rights or buy more during this period. The rights are called nil-paid rights during this interim period as they have not been converted into shares yet. If rights are purchased, the buyer must still fork out $0.52 per right to convert it to one PAH share.

Rights Closing Date (11 July, 2007) - This is the final day for the rights, after which each right will be converted to one share in PAH at a price of $0.52 per right share.

As far as I know, there are no admin or brokerage charges which are applicable to the subscription for rights (could someone correct me on this if I am wrong ?). Thus, all it takes is x number of shares X $0.52 to get the amount to be paid. PAH is supposed to send an Offer Information Statement (OIS) to all shareholders to formally announce the rights issue and to inform about the indicative timetable of events.

The price of the rights in the market has to be such that a person buying the rights is no better off than buying the mother share (i.e. PAH). Thus, at the closing price of $1.04 today, and with a rights conversion price of $0.52 per right share, the theoretical market price for the rights should be at least $0.52. If it exceeds this, then it is more logical to buy the mother share directly rather than the rights. Thus, the rights' market price should keep pace with the market price of the mother share, to the tune of the formula Rights Market Price = PAH Market Price minus Rights Conversion Price.

If the fundamentals of the business remain strong, the temporary EPS dilution will not be an issue as the earnings will eventually catch up with the larger share float. If margins improve and economies of scale are achieved, EPS dilution may be minimal and intrinsic value can be maintained or even improved.

For the avoidance of doubt, PAH is only CR and not CD yet, even though the dividend of S$0.54 cents per share (post-rights) has been announced. This is because the dividend has not been approved at the AGM yet. Thus, shareholders who buy during the XR period will still be eligible to get the dividend as the CD period has not begun yet.

Boustead - Purchase of Remaining 10% of Boustead International Heaters

Boustead announced today that it was buying up the remaining 10% in Boustead International Heaters, which is the heater and waste recovery business unit in Boustead. The purchase will be done over 4 instalments (you can read more about it on SGXNet) and the total puchase consideration is about S$6.7 million.

Boustead is continuing to buy up minority stakes in their subsidiary companies in order to enhance shareholder value as the earnings from these units can then be fully recognized. This is in line with their strategy of selling off non-core units and focusing on their core competency, which includes Salcon (water and wastewater treatement) and Boustead Projects (Industrial real-estate solutions). More will be written on Boustead closer to the AGM.

Tuesday, June 19, 2007

The difficulty in valuing Global Voice

Global Voice is a technology company which is extremely difficult to value, in terms of intrinsic value. It rose from the ashes of Horizon through a reverse take-over, and has only recently sold off its unprofitable legacy businesses in order to focus on its core competency: Private Fibre Networks. Because it was loss-making for FY 2006, PER isn't an appropriate measure. In addition, the following factors about GV make it all the harder to value:-

1) Contract values are not stated in their announcements of deals signed due to confidentiality requirements. Apparently, this is common within the IT industry where other competitors may use such information to benchmark their pricing. Thus, most press releases only contain details of the customer and the services being provided, as well as a short commentary by the CEO or another executive.

2) Gross margins and net margins are not known for each contract. For that matter, we don't even know the number of staff to be deployed for each customer and how costs are shared. Also, there is the matter of "purchases" in the Profit and Loss (for FY 2006). Just what does this relate to ? Technically, GV has all the assets it needs, it just needs to deploy them and allocate manpower. Thus, I can understand staff costs and contracting costs, but what constitutes "purchases" ?

3) Contract durations are only occasionally mentioned, also probably because of confidentiality requirements. Without an inkling of how long a contract lasts, it will be impossible to determine the recurrence of revenue for a particular contract/customer. A helpful point here is that GV did mention most contracts are of the 3-5 year duration type, thus we can safely conclude that most of the contracts captured and announced in late FY 2006 and FY 2007 will be recurrent in nature.

4) The re-branding of GV a.k.a EuNetworks has led to a significant increase in sales force as well as marketing personnel. The exact payroll cost increase is difficult to ascertain as some of the sales staff may be on fixed wages, while others may be incentivized through commissions. Furthermore, part of the costs may include outsourced personnel to handle the data storage solutions which GV is implementing.

5) Since late FY 2006 and for FY 2007, GV has embarked on promotional activities to raise its profile and also incurred A&P for its extensive re-branding exercise. It is difficult to estimate the extent of A&P expenses incurred so far as most of these are held in countries such as Holland and Germany of which most locals are unfamiliar with. Also, GV has sponsored several events in order to speak about the company's capabilities, and thus necessarily incurs costs which may or may not result in greater brand awareness and subsequent contract wins.

6) Cash flows are uncertain as well. In order to estimate intrinsic value, some value investors employ DCF methods which estimate a stream of cash inflows and outflows to the present. The only certain cash outflow is the interest expense of the convertible bonds of EUR 40 million. The coupon rate is 3% paid semi-annually which means an interest expense of about EUR 0.6 million every half-yearly (19 April and 19 October). Most of the deals mentioned are silent over the cash flow stream, meaning that the reader will not know the mode of payment arrangement between GV and the customer. This fuels further uncertainty.

The above factors serve to highlight the difficulty in assigning an intrinsic value to GV. Currently, the market price is hovering between 19 and 20 cents and this is the only indication of the "value" of GV, though I have alwqays reiterated that price seldom equals value. For those who are astutely wondering why the price is stagnant even though so many deals have been announced, the above 6 reasons should serve as a good guide.

Simply put, the market simpy DOES NOT KNOW what to expect from GV, and how to value such a company as there is no close equivalent of GV within the SGX. I have not done any research to find out if there are similar companies listed in Europe which can be used to benchmark against GV, but the uniqueness of their business model should be taken into account as well. Thus, there may not be any close comparables at all. Contributions are welcome if they are pertinent (just type it into the "comments" column, I will always read and reply).

The best thing to do now will be to wait for the HY 2007 results to be released in late August 2007. This will give an idea of GV's revenue growth as well as profit margins (assuming they are profitable). Hopefully too, the CEO and Chairman can shed more light on the uncertainties which I had highlighted and give some guidance on the future of the company in the next 3 years or so.

Monday, June 18, 2007

Ezra Holdings Limited - An Update and Commentary

Ezra Holdings (Ezra) recently announced that it had been awarded a contract by oil giant ConocoPhillips for its heavy-lift accommodation pipelaying vessel Lewek Champion. This event in itself is significant in that it symbolically represents a shift towards deep-water exploration, with this vessel (slated to be delivered before the end of FY 2007) being the first designed for deep-water. Although the press release did not mention the contract value, it stated that the charter contract would "contribute positively" to earnings in Fy 2008.

A little note here for the reader - I have emailed to the Management of Ezra and accordingly received a reply regarding how the chartering system works. Apparently, Ezra projects vessel usage up to 3 years in advance and now the expected shift seems to be towards deep-water capable vessels; hence the recent order of a 2nd pipe-laying vessel and 2 ultra-large 30,000 bhp Rolls Royce AHTS. Ezra will identify the charter party before any any vessel orders are placed, and the charter contract can only be signed close to the vessel completion date as there may be damages incurred if the contract is signed too early, but the vessel is delayed in the shipyard. It is therefore safe to conclude that by ordering these new vessels for FY 2009, Ezra's Management has already identified potential charter parties who have expressed interest in chartering the new vessels once they come on board.

Thus far, Ezra has only ordered 3 vessels for FY 2009 to fuel its expansion. This is a tiny number when compared to the 10+ vessels coming on board in FY 2007, and my expectation is that the company will identify more charter parties in order to place more orders to increase their fleet size. Another option is stated below which I will elaborate on later. Suffice to say that net gearing has remained at about 0.6x (based on Feb 28, 2007 balance sheet) and the company does not have the habit of doing share placements which will dilute existing shareholder's interests. Thus, it will probably embark on yet another round of sale and leaseback in order to remain asset-light.

Nylect Technologies

The 21.83% acquisition of Nylect Technologies also raises questions on whether this associated company can contribute positively to earnings, considering they only managed to turn around in Fy 2006 with a small profit of S$274,000. The speculation surrounding Nylect has been nothing short of spectacular, as the company is now trading at about S$1.21, effectively valuing the company at an astounding and mind-bloggling historical PER of 1,090 !! The share price rise has been nothing short of speculative as the company needs to increase earnings by 72.6 times just to get the PER down to 15. That means the company needs to have profits of S$19.8 million to justify the current share price. It is known that EOC is contracting with Nylect to provide services, but it remains to be seen if Nylect can achieve this kind of astounding growth of7,200%.

Reuters Interview - June 7, 2007

On a different note, Reuters had an interview with the MD of Ezra Mr. Lionel Lee and the essence of the interview can be found at this link. The interview is interesting in that it presents, for the first time, information on how Ezra plans to expand into the Western hemisphere. The MD talks about an acquisitive strategy which involves buying firms with a foothold in the Gulf of Mexico, Brazil, North Sea and West Africa. These firms should be entrenched players who already have their own fleet of vessels which can complement Ezra's capabilities. Also, he talks about using debt as a form of financing which means the net gearing for Ezra is likely to rise. If notes or bonds are issued, this would mean higher interest costs in the near-term which may also impact profitability. Thus, the important issue is how much Ezra pays for the acquisition(s), and whether they are earnings-accretive enough to justify the price offered. Other qualitative factors to look at would be the reputation of the company, its fleet, its network, customer base and if it has any competitive advantages. I trust that Ezra's Management would carefully consider these factors before making a purchase, and I remain optimistic that they would be able to grow the company in this way.

The rest of the interview is pretty self-explanatory, but it is worth noting that Mr. Lee said that there are 3 years of visible strong demand for deep-water vessels. Thus, the company would be projecting for such growth up to 3 years in advance. Ezra is gearing itself to become a global player and for this to happen, Ezra must expand its asset base significantly and also clinch more FPSO contracts, in order to put in at least slightly on par with global giants such as Prosafe and Haliburton. Although that may still be a long way to go, it is achievable if the company has a strategic vision moving forward into the next 5 years.

In the meantime, there is still the issue of the bonus; of which the company is preparing a circular to send to its shareholders. The EGM will be held in due course once the circular is despatched.

Sunday, June 17, 2007

Mid-June 2007 Portfolio Review

Dear readers, I am back from my honeymoon in Europe ! Was jetlagged the entire Sunday and slept from noon till about 8 p.m. (I feel like someone hit me in the head !). Now, my body clock is still that of Amsterdam and I think it will persist for a few days to come.....sianz.

Anyhow, imagine my surprise when I discovered that so much had happened to my companies while I was gone (and it's only been about 13 days !). I will now proceed with my review, more details for each company will be mentioned in future posts regarding the new events.

1) Ezra - Buy Price $1.30 (bonus adjusted), Market Price $5.65, gain 334%. On June 11, 2007, the company announced that it had been awarded a contract by ConocoPhillips for its deepwater heavy-lift accommodation pipelay vessel Lewek Champion. The vessel is expected to be delivered before end FY 2007 and the charter will commence in 1HFY 2008. An email to Ezra's Managment has confirmed that most charter contracts will be signed close to the date at which the vessel is slated for completion. I will discuss more of this and my email to the Management in a later post (there was also an interview done by MD Mr. Lionel Lee to Reuters on June 7, 2007).

2) Boustead - Buy Price $1.295 (average), Market Price $2.03, gain 56.8%. No new updates for Boustead. I am mainly waiting for the Annual Report and AGM to arrive.

3) Swiber - Buy Price $1.01, Market Price $2.33, gain 130.7%. Swiber has recently announced (on June 11) that it had signed an MOU with a Middle-Eastern company called Emirates Investment Group L.L.C. (EIG) to form a 50:50 joint venture in order to explore EPCIC activities within the Middle East. What's significant about this MOU is that the business contacts and market understanding which EIG has, and how it will act as a foothold for Swiber to explore lucrative opportunities in the Middle Eastern countries, including Pakistan. DBS has joined in the fray to upgrade this company with a TP of $2.76, while Westcomb has derived a TP of $3.00. For the life of me, I wonder how they come up with such TP when the company has not even signed a contract within Middle East ! Their projections for intrinsic value seem to come from the air, and I am not inclined to believe any prices set (I just read the reports for the facts). Intrinsic value remains relatively unchanged for now, except to factor in a slight premium for the company for its strategic tie-up. More to be said in a separate posting in future too.

4) Global Voice - Buy Price $0.1775 (average), Market Price $0.195, gain 9.9%. On June 6, 2007, GV concluded another agreement with a Dutch company called Illian Networks B.V. On June 13, 2007, they announced the appointment of a new Vice-President of Network Operations, Mr. Charles Cernicky. The announcement details can be found on the company's website. An email sent to the Management was met with no reply so far, so I question the so-called "efficiency" of their investor relations department.

5) Suntec REIT - Buy Price $1.11, Market Price $2.05, gain 84.7%. No significant updates for this REIT, which is well and good since there's so much updating to do for my other companies hehe.

6) Pacific Andes - Buy Price $0.81, Market Price $1.44, gain 77.8%. The China Fishery Group has purchased another 5 purse seine vessels on June 11, 2007, bringing their total number of vessels to 34 with a fish hold capacity of 9,395 square metres. CFG have been very aggressively acquiring vessels and assets since the issue of their senior notes due 2013. It is good to know that the Management is very pro-active in securing a foothold in Peru through these acquisitions, and it is hoped too that they are earnings-accretive acquisitions. At this point, it is rather difficult to assess the intrinsic value of PAH and Mr. Market has decided that he wishes to offer a better price for PAH recently, thus the spike up to $1.50. Patience rewards the rational investor, and I hope to see more good news flowing from CFG and PAH in time to come to benefit shareholders.

Overall Portfolio
My overall portfolio has increased by 106.7% from cost to date. I attribute this partly to bullish sentiments as the STI had a record close of 3,581.16 on June 15, 2007. The important thing is for my companies to keep being pro-active in order to grow earnings and the business, and even on my trip (during long journeys in the coach), I was thinking about my companies' business models, their competitive advantages and their customers and how it all gelled together. I will be talking about competitive advantages and a little about Porter's 5-forces model of analysis for companies soon, so stay tuned for that !

My next portfolio review will be on June 29th (last trading day for June 2007). I have missed curry chicken, chai tow kway and char kway teow !! All I get for breakfast in Europe is.........bacon, eggs, ham, beans, bread.....rinse and repeat. Almost drove me nuts.....cup noodles all exhausted liao. I was wishing Pac Andes could donate some nice fish fingers and fishmeal to spice up my meals haha ! Kidding !

P.S. - I did not visit any European bourses though I did pass through the financial district of Belgium and Holland. What I did notice though, was the prevalence of banks such as ABN Amro, Citibank, CIC and Fortis. I also noticed the amazing amount of chocolate in my lap, which I was busy finishing up. Keke.

Tuesday, June 05, 2007

China Fishery - Acquisition of Panamanian Companies in Peru

Yesterday, China Fishery announced another strategic acquisition in Peru. They have acquired 2 Peruvian fishmeal producers with assets which include fishing vessels, fishmeal plants, canning plant and a dock. The total consideration is US$26 million, which is a US$5 million discount to the appraised market value of the assets at US$31 million done by an independent valuer.

With this acquisition, China Fishery (and thus Pacific Andes which is going to recognize 63.9% of the profits from CFG) has increased its fishmeal combined processing capabilities to 442 tonnes per hour, and it now has 29 purse seine vessels (up from the preious 26 in my last posting). The vessels total capacity is 8,419 cubic metres and represent 5% of the total fishmeal processing capability of Peru currently.

This acquisition is notably different from the previous ones in that the assets acquired are more diversified (rather than just supertrawlers or purse seine vessels). The canning facility is of note as it will allow for CFG to produce Peruvian anchovies as canned sardines for sale to consumers. As this specie is highly regenerative, there is no immediate danger of extinction for the species and this represents a highly lucrative income source for CFG and PAH. CFG also plans to start harvesting more of the under-utilized fish species in order to broaden their product range and offerings.

Peru will act as CFG's logistical base in South America and allow CFG and PAH to get a foothold in the Exclusive Economic Zone, where the government has already halted the issue of new licences for fishing. Thus, licences can only be obtained by purchase from existing Peruvian companies, hence PAH/CFG's strategy. They are simply continuing their vertical integration strategy by acquiring more control over the production/catch aspect, in order to boost the capacity in their fishmeal plants. Thus, it is an entire SCM system whereby catch increases, processing facilities increase (for fishmeal) and new product lines are also introduced.

So far for FY 2007 (for CFG), they have been embarking on an aggressive expansion plan to set up base in the South Pacific and to increase their processing and catch volume. Below are a list of the announcements made so far for FY 2007:-

1) December 27, 2006 - CFG acquires 2 fishing vessels to bring their purse seine vessel fleet to 18.

2) January 4, 2007 - Third VOA signed to add 3 supertrawlers to their fleet, boosting their number to 17. Total harvest will be no less than 210,000 tonnes of fish.

3) January 24, 2007 - Fourth VOA signed with Perun Limited, adding another 7 supertrawlers to their fleet and bringing the total number to 24. Total harvest has increased to become no less than 270,000 tonnes of fish.

4) March 15, 2007 - Acquires 4 more purse seine vessels bringing total fishing fleet to 23. Fish hold capacity increases to 6,671 cubic metres.

5) May 22, 2007 - Acquires 3 more purse seine vessels bringing total fleet to 26. Fish hold capacity increases to 7,363 cubic metres.

6) June 4, 2007 - Acquires 3 more purse seine vessels, total fleet now 29. Fish hold capacity increases to 8,419 cubic metres. Also acquires fishmeal processing plants (from 4 to 6 currently), one canning plant, a 200-metre dock and related fishing permits.

These 6 announcements show CFG's aggressive growth strategy to increase their fishing fleet which includes supertrawlers (VOA-related) and purse seine vessles (fishmeal related). I project that there will be more acquisitions to come in order to boost their fleet and to entrench themselves as one of the dominant players in the market. PAH can only stand to benefit from this as CFG's earnings will grow strongly. Currently, the terms of the 4th VOA are also being restructured. Once that is successful, margins are expected to increase. I am hoping for a net margin of 10% for PAH eventually.

Honeymoon from 6 June to 17 June, 2007 - Hiatus from the Stock Market

As readers may already know, my honeymoon starts from 6 June (midnight) till 17 June (early morning). I will be travelling to several parts of Europe, in an effort to study the various bourses and stock markets throughout Europe including the Amsterdam Exchange, FTSE and Parisian Exchange.

Gotcha ! No way, I was just kidding ! haha anyhow I will NOT be posting for these 2 weeks. Any announcements from my companies will have to be put on hold till I am back before I can analyze them; and my mid-June review of my portfolio will have to wait till 17 or 18th June.

Wishing myself a pleasant flight ! Hehe.

Sunday, June 03, 2007

Projecting Growth - Not as easy as it seems

True be told, I didn't really know how to title this post, so I just left is as "not as easy as it seems" ! The main crux of this post is to explain how growth works for a company and how many people may over or under-estimate the growth of a company's revenues (top-line) and earnings (profits or bottom-line).

First, the basics. Growth of a company is what drives its top and bottom line to better performance every quarter/half-yearly, and this in turn drives up its share price as share prices are correlated to the valuation of a company (based either on DCF, PER or Sum of parts analysis). When we say "growth", it's not just growth based on recycling cash or capital, but also to grow owner's earnings based on actual increases in sales or through yield-accretive acquisitions. This is where it gets murky....some companies claim superlative growth over a period of 2-3 years but sometimes this is at the expense of shareholders. Some companies over-leverage and cause their debt to mushroom using growth as an excuse, while others do endless placements and/or rights to increase their equity base and further dilute existing shareholders. Thus, there is "growth" but this does not add to shareholder's value.

Strictly speaking, growth consists of 2 types: organic and through acquisitions. Organic growth works for most companies, in which they expand their customer base, get more sales and make more money ! While it may sound deceptively simple, growth does not come easily as most of the time, expanding customers and entering new territories incurs higher costs and there may be significant barriers to entry. From a marketing perspective, entering new markets or expanding existing product lines always carries a certain risk: that of lower sales and higher costs. Thus, be very careful of companies which claim to increase their production capacity, because this may not always mean higher sales and higher profits. In fact, increase of production should come with increased demand and the manufacturer should have a certain level of pricing power. Otherwise, as the market for the product matures, more entrants come in and drive down prices through competition. The result is that the capacity increase will come at a high cost: that of declining margins. Frequently, I have seen companies in "commodity" industries such as chips and PCB boards suffer from declining profits even as their sales grew. This is due to the margin erosion effect which cannot be effectively eliminated through economies of scale.

The other option is for a company to grow through acquisitions. One immediate example is Olam International Limited, an SGX listed company which deals with the SCM business of distributing foodstuffs ike peanuts and coffee beans. They are vertically integrated and cover the entire supply chain of production, distribution and selling. Recently, Olam was involved in a tussle with Louis Dreyfuss to buy over Queensland Cotton, with the bids getting increasingly higher at A$5.80 per share. The outcome is as yet unknown but one must ask: what price does Olam have to offer to make the deal unattractive ? The problem with growing through acquisitions is that a "fit" needs to be obtained. Frequently, acquisitions or mergers involve staff from different companies with different cultures, which may result in problems. Take the example of Daimler-Chrysler in which the Chysler unit was never profitable after the merger (it was eventually sold off just recently). Other notable Singaporean examples include Osim's acquisition of Brookstone which has dragged down the company due to the high debt financing the company had to undertake, coupled with losses incurred in the USA-based unit. Growth through acquisitions is therefore fraught with risks and uncertainties and I do not understand why shareholders get so amazingly excited when an acquisition is announced, as the merits of the acquisition have to be reviewed objectively before one can conclude if it is indeed "great news" for the existing shareholders.

Growth which is too swift also tends to fizzle out after a while. A lot of companies can report superb earnings growth for 1 year, maybe 2; but how many can consistently grow their earnings over a period of say 5-10 years ? The volatile nature of business these days means that shareholders are stepping on a minefield when it comes to expecting growth every quarter. Take UTAC for example, after 14 consecutive quarters of growth, it suffered its first quarterly decline in revenue of 2.4%. This is due in part to the uncertainty and cyclical nature of the industry. A shareholder thus has to sit back and think about the business: will it be able to sustain a consistent growth track record over a long period of time ? If not, then value investing dictates that this may not be a good long-term investment. The ability of a company to weather the storms depends on the nature of its business, its Management as well as the competitive advantage it commands.

For myself, I go for companies with consistent growth rather than superlative short-term growth. Examples I can think of are Pacific Andes and Boustead. Pacific Andes has steadily increased their revenues and profits through a series of acquisitions, as well as organic growth (though at the expense of higher gearing). Boustead has a 5-year track record of increased revenues and earnings ever since CEO F.F.Wong turned the company around in FY 2002 by selling off unprofitable units and steering and focusing on the company core competencies. His strategic vision has also, in part, contributed to the strong and steady growth of the company. These are companies which I feel comfortable investing in for 3-5 years, and which are more likely to survive a recession should one come along.

Saturday, June 02, 2007

The value of analysts' reports

For those of you who rely heavily on analysts' reports in order to buy or sell shares in companies, let me pose this question: how much can you rely on these reports, and are they really serving the interests of the shareholder ?

First, let's analyze the analyst himself (I use a male to denote the analyst, but I know many female analysts myself, this is just for convenience sake !). The analyst has got himself a job at a brokerage house doing research and reports in order to earn a fixed income. His profession allows him to get up close and personal with company's management as well as visit the location and premises of their factories and offices (if overseas) to get a better feel of the company and their potential. Armed with this knowledge, he will proceed to write a report (usually glowing) on the company, analyze the financial figures (usually consists of forecasts) and come up with a target price.

So how is the analyst connected to the shareholders of the report for the company in which he reports on ? The answer is: NONE ! The fact is that analysts are salaried employees whose job is to understand Management and operations in the company he is researching in order to produce a meaningful report. Granted, the report is for clients who may or may not be shareholders of the company, but usually the report is not specifically prepared only for shareholders, but also for interested investors. However, a problem arises here in that the analyst becomes detached from the interests of the shareholders because he is reviewing the company from the point of view of the "outsider". Some may argue that this enhances objectivity and rationality when it comes to financial and management evaluation; but it's a double-edged sword as it also means that the analyst may not bother being "detailed" enough as this is just one of the many companies he has been tasked to research.

Let's use a simple example: Ezra Holdings Limited. I have been a shareholder of the company since October 2005 and in the process, have read up everything I can about the company, browsed through 2 years of annual reports and even spoken to key management personnel on their strategies. I do remember reading reseach reports from CLSA written by a certain Jason Wee who used to initiate coverage on Ezra. Recently, to my surprise, the analyst in charge of Ezra has been replaced by a Caroline Maes. There have been cases too when I noticed that certain companies report having a change of analyst covering it.

An immediate problem arises in such situations. 2 different analysts covering the same company will surely have different views and ways of analyzing the company. Thus, there may not be much continuity in the coverage given by the analyst on the same company (in this case, Ezra) considering that there was a change in analyst. The shareholder (i.e. me) however, will always have a consistent vested interest in the company and will continue to research on the company's prospects and progress by taking a value investing approach. Therefore, is it fair to assume that fully involved shareholders can probably understand and write a more comprehensive report on the company than any analyst ? This is my argument and I know there is no right or wrong; it's just that I am merely trying to tell readers that analysts may not always be the best people to turn to when analyzing a company; sometimes there are others who know even more than analysts, and they are the value investors who have stayed with a company through thick and thin.

Another issue I have with analysts is that they can be wildly incorrect or spot on in their analysis, but they will always get paid the same. Furthermore, can someone name me an analyst who got severely reprimanded or fired because he issued a report with a totally inaccurate target price ? Apparently, readers have to realize that a lot of the analysis and conclusions are based on (sometimes) flimsy, overly optimistic forecasts of future performance. This can decouple the reader from the reality and cause an expectation gap ! I have observed analysts being 180 degrees wrong in their analysis of a company, but I did not observe any major repercussions. In the end, the losers are the ones who faithfully lap up every single analyst report without doing some independent, logical thinking of their own. Who else can you blame if you buy without a margin of safety or based on pure hope ?

Warren Buffett has continually emphasized independent thinking, which means thinking clearly and objectively and based on facts and rational reasoning. As human beings, we are swamped with tons of information everyday from all sources, including analyst reports, friends' recommendations and pundits pushing certain industries or companies. The right thing to do is to filter out all the noise (usually about 95% of what you hear) and focus on what's important (the remaining 5%). Once you have the clarity of mind to think through an issue or to analyze a company, then analysts reports will become just that: analyst reports ! Good for bedtime reading and to give you some ideas, but not good enough to base your investment decision solely on.

The next time you come across an analyst report, read through the entire report word by word and think about what the analyst is saying. The section below describes my reaction to reading a report by DBS Vickers on Pacific Andes, one of my investments.

Pacific Andes Analyst Report - DBS Vickers

I would assume everyone has a copy of this report as it is freely available on the website (see my links on the right), thus I will not "copy and paste" the contents of the report. Rather, I would like to add my comments and opinion on what the analyst has already said, as I am coming from the point of view of a shareholder who has observed the business for more than a year.

Generally, the report is well-written and accurate in describing the company's current state of affairs, as well as the SGM coming up and the impending acquisition of 63.9% of CFG and the 1:1 rights issue. The report also attempts to come up with a target price (I call it intrinsic value) for PAH ex-rights, after taking in 63.9% of the profits from CFG. The analyst had a target of $1.24 pre-rights and $1.04 post-rights, assuming the company went ex-rights at a market price of $1.16 (PAH closed at $1.20 today).

The sensitivity analysis is quite well done, except that it misses a crucial aspect: the future earnings potential and vertical integration enjoyed by PAH, PAIH and CFG. Most analysts' reports are pretty accurate with the numbers (hey they are trained in that !) and can use DCF, sum of the parts and PER to value a company. However, as I mentioned, the fact that they use the term "target price" shows that they are only evaluating the numerical and financial aspects of the company. What is intangible is the company's competitive advantage, exclusive fishing licences from the Peru acquisition, scaling up of operations downstream as they move into fish SCM and fishmeal processing, economies of scale in managing a larger fleet of purse seine vessels as well as cost reductions on negotiation of the 4th VOA. All these factors alone will command a premium when viewed objectively, thus the intrinsic value of PAH will definitely be higher than just $1.04 ex-rights (using 10x FY 2008 PER). The analyst had also failed to project for the earnings growth of PAH, and thus the numbers used are purely from FY 2007's profit, which is historical and rather useless for predicting the future intrinsic value of the company.

Thus, from this example, one can see that analyst reports may not account for everything; and the discerning shareholder should seek to learn more about the company in which he has a stake, in order to form a more well-rounded opinion on the prospects of a company. A long-term approach also helps as one can think of the business as evolving, without a singlewell-defined intrinsic value but more like a rolling, increasing value. The target prices set by a brokerage firm are merely static targets which are probably outdated in about a month's time. This is the dynamic nature of investing and understanding businesses, which is why value investing is almost a full-time job !