Monday, August 20, 2007

Global Voice – 1H 2007 Results Review

Well, to start off, let me reiterate again my fears for the IT industry and how I was “cautiously optimistic” and even “slightly pessimistic” before the 1H 2007 results were released. Suffice to say that my worst “fears” have come true, as my estimate of the competitiveness and cost-efficiency of companies in the IT industry was more or less right. Looking at the sorry state of companies such as Mediaring and Trek 2000, I sometimes wonder what the future will be like for these companies. They are in an intense industry which is changing every 6 months, and which sees prices being slashed by 70-80% due to shorter and shorter product life cycles. It is with a heavy heart and a tinge of regret that I bring you this analytical review:-

Income Statement

The income statement for 1H 2006 is apparently “misleading”, as a bulk of revenues came from “non-recurring infrastructure sales and sales from discontinued operations”. Notwithstanding this fact, recurring revenues only rose a miserable 20% in spite of the fact that they inked about 20+ contracts since Jan 2007 (announced on SGXNet almost on a regular basis by now). The problem here is that purchases also grew as they had to set up a datacenter and to extend higher sales-led connections (whatever that means). A lot of the cost of goods is not adequately explained to my satisfaction and this irks me to some extent. If a company has low margins (or in this case, a net loss margin) I would really appreciate it if Management could dissect the numbers and focus more on how to cut costs. This, incidentally, was not done in their commentary of significant trends on pages 9 and 10 of the financial statements.

If one takes into account the jump in staff costs (presumably to boost their sales and marketing workforce in order to clinch the aforementioned contracts) as well as the jump in depreciation expenses due to the setting up on an additional datacenter, you can clearly see why there is no profit from operations. Forget about Management’s excessive (yes, excessive !) focus on EBITDA; the truth is that depreciation is an expense like any other (except that it has no cash basis) and will still affect a company’s bottom line. Saying that they are EBITDA profitable is tantamount to calling a cat “a dog which meows”. This to me stinks of trying to avoid the problems of turning around the business (meaning Management is not being candid).

As can be glaringly seen, finance costs (namely, interest on convertible bonds) was up a whopping 631% to EUR 1.08 million. Looking to Page 2 of the press release, it mentions that GV has signed EUR 11.2 million of new contracts in the first 6 months of FY 2007. A simple computation will tell you that finance costs alone are 10% of new contracted revenues ! This is an extremely high figure compared to other companies where interest costs are typically less than 5% of the revenue figure (for Pacific Andes, this figure is 3.8% of their revenues). Cash flows are also an issue when interest costs are so high, yet revenue cannot keep pace with it.

Balance Sheet

Looking at the Balance sheet does give me the chills. As an accounting-trained guy, I cannot help but wonder how the company’s balance sheet had deteriorated to this extent. Firstly, have a quick look at the current ratio. Their total current assets are EUR 6.715 million while total current liabilities total EUR 9.32 million ! So GV are in negative working capital and their current ratio is a dismal 0.72 (for 1H 2006 the current ratio was marginally better at 0.87). Technically, this means that GV is insolvent as all their current assets are insufficient to service their current liabilities. This is one big danger signal for any company, but more so for GV as I mentioned it has high interest and staff costs.

Interest bearing borrowings are 26.6% of total equity, and about 446% of current assets. Looking at GV’s paltry cash balance of EUR 760K as at June 30, 2007; it seems glaringly obvious that this borrowing would not be paid down anytime soon. In fact, I am seriously concerned about GV’s ability to continue to service the loan interest, assuming their cash flows remain weak (see next section on cash flow statement).Altogether, a very weak balance sheet which may not be able to hold up in future accounting periods.

Cash Flow Statement

The cash flow statement, in all honesty, does not look compellingly attractive either. Take a look at the net cash from operating cash flows and one can see that there is a net outflow of EUR 4.785 million; which implies that they are not generating enough cash to cover their basic operations. This is opposed to EUR 942K of cash inflows for June 30, 2006. The main culprit appears to be the decrease in payables and the increase in receivables, which has provided the “squeeze” for GV. Their cash conversion cycle must be seriously examined as the numbers show that they may be paying off their creditors much faster than they are collecting from debtors, which leads to the problem mentioned above.

Cash flows from investing activities continues to be negative as GV has invested EUR 2.2 million to purchase the datacenter and related equipment. As can be seen under their cash flows from financing activities, the interest paid more than wipes out any cash inflows from further borrowings. It would imply that GV can only seem to raise enough cash through borrowings, which increases their gearing and interest costs. An extremely worrying trend is for any company to rely too much on financing activities to generate cash inflows instead of letting the operations side generate the required cash flow. Contrast this with Boustead’s cash flow statement which showed a healthy operating cash flow which more than covered any interest payments from loans.

Prospects and Outlook

From these numbers alone, warning bells are already sounding. Many people on various forums trumpet their “unwavering support” for GV in hopes of a turnaround and an improvement in its fortunes. For me, I rely objectively on the numbers and all three financial documents present numbers which do not look favourable at all ! I made the mistake of deluding myself back in Feb 2007 that things still looked rosy and the company could improve its earnings through a gain in revenues. Apparently, not only has that not come to pass, but it seems that the company is now technically insolvent and has a major problem managing their cash flows effectively. Management is also not candid as it focuses too much on how to grow their market share and gives a lengthy and often unnecessary description of the changes in the industry and how it will benefit the company. My take is: clean up your own act first (i.e. turnaround) before analyzing the industry and prospects for your company. It’s like trying to run when you have a gaping wound in your leg: all the while it is bleeding but you only think about next week’s races and how many more competitions are coming up instead of focusing on bandaging the wound.

In view of the above analysis and objective number-crunching, I do not see any real reason for being “loyal” to this investment. Loyalty without reason amounts to stupidity in my opinion, especially when faced with such numbers. The fundamentals have deteriorated significantly and I can no longer justify to myself why I should be optimistic or hopeful. Even if (and this is a big IF) GV manages to turn around in future, it will be a huge opportunity cost for me as my money is locked up in this investment without dividends, interest or capital gains.

Thus, I will proceed to divest this investment and re-deploy the proceeds into other worthwhile companies. To the reader, it is up to you (as an intelligent investor) to make your own conclusions and use independent thinking to sort out the facts. I wish all remaining Global Voice shareholders good luck in their investment.

Note: Since I am in no hurry to realize more cash (as I already have a cash stash ready for deployment during this market correction), I will wait for a better price to divest GV as Mr. Market is being excessively manic-depressive right now. Let's wait for one of those days when he is irrationally exuberant, then I can quietly sell him my stake in this company.


kleer said...

hi musicwhiz,

I don't necessarily agree with your strategy of waiting for GV's price to improve before selling out. If you wait for that to happen, then logically the next stock in which you buy into would have probably risen as well, and most possibly by much more especially if it has stronger fundamentals.

My opinion is that you might be better off just making the stock switch now, but I guess that is all subjective.

musicwhiz said...

Hi kleer,

Thanks, actually I was waiting for someone to point that out to me; thus you can say I was expecting it haha.

I agree with you on the valuations part, but the fact that I have excess cash means I can deploy it if I see cheap stocks, without having to sell off GV so soon. I guess this is probably the only time I try to "time the markets" in that I wait for a good opportunity (rally) to sell off a non-performing company with deteriorating financials.


kolslorr said...

Great analysis.... I am on the same boat as you for this... just waiting for a good time to sell it off...

but only worry is it will continue to drop....

musicwhiz said...

Hi kolslorr,

Thanks, I am ready to write off the entire investment as a bad decision and take it as a hard lesson learnt. Since I do not need the $ urgently, I will let it sit there to remind myself to analyze a company more thoroughly before ploughing my money in again....


woods said...

Hi, would like to comment:

1. In yr analysis, what if some of the contracts won in 2007 has yet to be booked as revenue? Hence the impact on cashflow and income is not shown? I am making assumption that this company adhere to common accounting practice of not recognising revenue when the work is not done. For contracts signed in 1H 07, I believe a significant portion of these future revenue are not booked yet.

2. GV has to invest in infrastructure first before the clients will employ their service. What do you think is the possibility that with the current infrastructure in place, the incremental cost for acquiring future clients will decrease progresively, i.e. economy of scale? How would this impact your forecast, noting that GV is still pulling in new accounts up till today?

musicwhiz said...

Hello Woods,

For 1) I would say of course this is possible, but I am always uncomfortable with the fact that contract values are not stated, thus making it difficult at best to estimate the impact to top line. If you notice, 3 of my other companies (Boustead, Ezra and Swiber) all work on a contract basis thus making earnings a tad clearer. For cash flows, I am worried that they cannot generate sufficient incremental revenues to cover their interest and manpower costs, which are likely to increase rather than decrease as they clinch more contracts.

For 2) I am also uncertain about so-called economies of scale and it has not been mentioned by GV or demonstrated in their numbers. While I would like to believe it works something like a production line (economies of efficiency as it is referred to), somehow I think the business of GV would be somewhat dissimilar. It is not that I don't forecase revenue growth, but I just don't see them breaking even as I expect costs to increase in tandem; plus the interest on convertible bonds isn't going to go away anytime soon.

My views are of course arguable and there is no right or wrong, but this is just my take. You are free to disagree...:)

Cheers, musicwhiz

Natasha said...

With regard to the balance sheet. It would be prudent for the purpose of your analysis to evaluate the impact of the recent major convertible bond conversions by Legg Mason.

Would this not significantly reduce the Currently Liabilities that you have pointed out to be excessive?

musicwhiz said...

Hi Natasha,

Yes absolutely, I will include the analysis in my next GV update as an addendum. But I will need some time to do so as am quite tied up these few days.

Thanks for your observation, cheers !