Investment Mistakes Part 6 – No Sustainable Competitive Advantage
I purchased Trek 2000 on January 9, 2006 at a lofty (on hindsight, it was darn lofty !) price of 61 cents, after doing a preliminary research on the company. After months of waiting for “true value” to show, I sold out at a loss of 15% (52 cents) on November 13, 2006. Subsequently, as I discovered more about value investing, I realized that key aspects of Trek’s business had eluded me when I did my analysis in the first place, forcing me to admit that I had made a fundamental error. When I discovered that, I bit the bullet and cut my losses. The counter is now trading at 35 cents as of today.
So what went wrong ? First, an introduction to the company. Trek 2000 is a company which manufactured and patented the thumb drive or flash disk, the small storage device which people carry around to transfer and store data. This device is handy and compact, making it a useful accessory for storage of up to 2 GB of data. This device was much preferred to the portable hard drive as the latter is heavy and cumbersome and prone to damage if dropped. A thumb drive, on the other hand, is light, portable and can withstand some degree of external shocks (of course, don’t step on it lah !). Trek 2000 would earn licensing revenues from these devices and it was also into R&D, designing new thumb drives which had biometric features in order to enhance the security features of each drive.
All in all, it sounds like a good business plan since they are the ones who came up with the technology and are thus earning revenues from it. Unfortunately, several factors come into play which severely diminished their ability to compete effectively and to scale up their business. They are as follows:-
a) Commoditization of Thumb Drive – Their flagship product, the thumb drive, was viciously copied in countries like China and sold under other brands’ names. Trek 2000 went on a legal spree to recover damages relating to the other companies’ selling their products, and they won the lawsuit ! Despite this, many copycats still copy the technology and re-brand the products under their own name. Since the lawsuit only covers certain territories, Trek 2000 would have to take expensive legal action in all relevant jurisdictions in order to recover the “damage” to their brand. This is cost-ineffective and puts a large drain on their resources. Thus, brand and product erosion took place which means their product is rapidly being commoditized.
b) Competition – The usual culprit called competition comes in to eat away at market share and margins for Trek 2000. Although the thumb drive commands quite a good market share and pricing, the technology sector usually moves so quickly that one product soon becomes obsolete. This may well be the case for Trek 2000 in the near future, which is why earnings clarity is not present. This was my first “brush” with the technology sector and I had read that for most technology companies, product life cycle from introduction to decline is very short as compared to conventional products such as toasters and ovens. Though thumb drives may seem to be the portable storage device of the future, you never have the certainty that it will be the dominant product and market leader for many years to come.
c) Poor Investor Relations – Trek 2000 was fined S$75,000 for “selective disclosure” of an interview with Reuters which was not announced through SGXNet. The CEO Mr. Henn Tan personally paid off this fine instead of allowing the company to foot the bill. However, it was not the first gaffe from the company and it shows that they are inept at managing proper disclosure practices.
d) Unable to Maintain Pricing Power for NAND Chips – In Trek’s 1Q 2007 financial review, they said that even though sales volume of their products increased, the prices they commanded were substantially lower. This led to an overall decline in sales revenues and profitability was affected as well. Looking forward, this does not seem to be a temporary “blip” and will probably continue to persist for the company in the long run.
After this experience, I was more careful about choosing companies without wide “moats” around their business to prevent competitors from assailing them. Still, I continued to make errors in judgement (which will be described later on) by choosing to purchase UTAC. Currently, as of this writing, I am also contemplating if Global Voice will become my next investment mistake. Perhaps I should start to write about it now as the feeling is slowly creeping in on me. I hope the numbers from their 1H 2007 financial statements will prove me wrong.
Saturday, August 11, 2007
Thursday, August 09, 2007
Ezra – Milestone Contract for Pipelay Barge
On August 7, 2007, Ezra announced that they had secured a contract to provide services for a national oil company as part of a US$888 million sub-sea installation project. The vessel in question is Lewek Champion, which is under the care of Emas Construction and Production Pte Ltd (a 100%-owned subsidiary of EOC Ltd of which Ezra has an 88% stake). Lewek Champion is Ezra’s first heavy-lift, accommodation and pipelay barge and was only recently delivered (late FY 2007). Recall that Lewek Champion was also chartered out to ConocoPhillips for 1H FY 2008 in an announcement dated June 11, 2007. For ConocoPhillips, the vessel will be deployed in the Timor Gap where it will be used for accommodation support and de-commissioning work in the planned shutdown of the Bayu Undan platform.
From these two announcements, there appears to be some “overlap”. How can Lewek Champion be chartered to ConocoPhillips and the national oil major at the same time ? The press releases do not provide a timeline for the usage of the vessels and there was also no contract value specified (note that the US$888 million refers to the entire sub-sea project, not Ezra’s portion which only includes the provision of services). The best scenario I can come up with is that the Lewek Champion would be deployed to ConocoPhillips in 1H FY 2008, after which it will be used for the sub-sea project from the remainder of FY 2008 till FY 2010. This will ensure a constant revenue stream for the vessel and if charter rates increase, there may also be a clause in the contract for variable rate adjustments, which was why Mr. Lionel Lee mentioned that he wished to take advantage of the buoyant conditions in the oil and gas industry.
Even though the contract values were not specified (which makes it difficult to estimate the earnings stream from Ezra), the good news is that the vessel will be on charter for at least 3 financial years up till FY 2010. This will ensure a steady and constant stream of revenue even as Ezra decides to scale up its business by expanding their fleet further. Also recall that Mr. Lionel Lee had boldly gave a guidance of snaring one FPSO deal every 18 months. Thus far, the previous FPSO deal was sealed back in October 2006, so this means they are confident of securing another by March 2008 (about 7 months away from now). I am not sure if the company may be over-stretching themselves as they may not have the financial muscle (funds) of the larger players (such as Tidewater and Solstad) to bid aggressively for more FPSO projects. The cost of managing an FPSO is very high even though the charter rates are strong and one charter can last for seven financial years; thus the initial outlay for Ezra will also be a drain on cash flows.
Managing cash is an important aspect of any business, but for Ezra’s case it is particularly important as their vessels are very capital intensive and require a lot of upfront funding before they can be constructed and deployed on charter contracts. Ezra’s use of financing schemes such as sale-and-leaseback have managed to enable them to keep their balance sheet light and ensured that they have cash inflows to fund further expansion. This strategy is sound in the short-term but becomes riskier in the medium-term as Ezra would need to depend on a steady stream of chartering cash inflows in order to sustain their operational leases for the sale-and-leaseback vessels. Fortunately, I was told that Ezra will only embark on a vessel order if it has a firm order from a customer for the use of that vessel. For FY 2009, they have already ordered two 30,000 bhp AHTS and another pipe-lay barge; and the understanding is that they are already able to find customers willing to charter these vessels. The future is unclear at this point as Ezra has not made any indication of ordering more vessels, but more will probably be revealed when they announce their FY 2007 results in late October 2007. Kim Eng’s latest report on Ezra dated August 8, 2007 has forecast a full-year net profit of S$75.1 million while DBSV is more conservative with an estimate of S$71.1 million net profit after tax.
Update: Ezra has obtained in principle approval for the listing and quotation of the bonus shares from SGX. This means that they can go ahead and convene an EGM to seek approval for the bonus issue and the proposed sale of EOC shares.
Global Voice – Comments and Update before their 1H 2007 results release
Thus far, Global Voice (GV) has been announcing contracts on a regular basis every week or so. There have been 19 contracts announced with various companies (some purportedly large and some smaller ones) for FY 2007 (up till today), which boils down to about an average of 2.5 contracts per month. There is, of course, no mention of contract value or duration as this is not allowed in the IT industry and would be tantamount to a breach of client confidentiality. As a result, it is very difficult to estimate revenues and to project revenue growth because each announced contract may only be of a low value or of a short duration.By referring back to the FY 2006 results announcement, notice that under Note 15 on Page 19, the breakdown of sales is provided as about EUR 11 million (after removing the item sales of fixed assets which is a one-off non-recurring item). Essentially, there was almost no growth at all from FY 2005 to FY 2006 as FY 2005 already registered recurring sales of about EUR 11 million (remove the EUR 5.6 million of sales of fixed assets). Some may argue that GV has scaled up their operations a lot more in FY 2007, re-branded themselves as EUNetworks and also hired more sales and marketing staff to aggressively bid for projects.
All this is well and good, of course. However, it still does not guarantee that GV can turn-around. Here are several danger areas which may play itself out in the coming weeks:-
a) Revenues may not have increased sufficiently to offset increased expenses relating to GV’s aggressive push for market share. Recall that GV said that only 2% of their fibre network was being utilized as at FY 2006, which implies that 98% was still available for “leasing” to customers. However, the costs involved in marketing and selling their fibre may outweigh any potential benefit from it. I expect GV to have increased marketing costs (for its EUNetwork launch as well as sponsor of several network events including Capacity 2007), increased staff costs (to boost their sales team) and increased administrative costs (as a result of the expansion of their sales team, a requisite backup team is necessary to provide support). Finance costs will also remain high because of the interest due on their convertible bonds in April 2007.
b) Cash flows may also be an issue for GV because of their requirement to pay interest cost upfront, while slowly collecting fibre leasing revenue from their customers. In FY 2006 financials, there was an operating cash outflow of EUR 5.5 million and also a net investing cash outflow of EUR 25.8 million for purchase of fixed assets. Most of their cash inflows came from borrowings (about EUR 34.2 million) and thus they are highly geared. The FY 2006 ending cash balance of EUR 8.3 million is not impressive and for the 1H 2007 results, the cash flow statement should be carefully scrutinized to see where the cash has been spent.
c) Demand might be an issue for GV as they are, after all, in the technology industry where services and products can go obsolete faster than one would expect. GV always touts that their private fibre networks are unique in that they have millions of miles of fibre for use all over Europe which can link datacenters together and reduce data redundancy. It remains to be seen how many corporations actually require GV’s services as they provide pan-Europe connections which some companies may either not require or cannot afford.
d) Management has been known to talk about the share price by saying that it is under-valued and that they would support it if necessary. I usually frown upon Management which likes to talk about the share price as this means they are more concerned about the market price than on running the business. I do not know if their remuneration or bonuses are in any way tied to the share price and am not insinuating anything; but take note that an excessive focus on share price is not healthy (the Management of the other companies I own do NOT talk about share price, they just focus on the business)
Even though the frequent announcements of contract wins has ignited hope for GV to turn-around this year, much still remains uncertain. Even if they were to show a marginal profit for 1H 2007, I may still consider divesting as I am not comfortable with the lack of clarity for their earnings, the uncertain demand for their services and their high gearing.
Wishing all Singaporeans a Happy National Day !
On August 7, 2007, Ezra announced that they had secured a contract to provide services for a national oil company as part of a US$888 million sub-sea installation project. The vessel in question is Lewek Champion, which is under the care of Emas Construction and Production Pte Ltd (a 100%-owned subsidiary of EOC Ltd of which Ezra has an 88% stake). Lewek Champion is Ezra’s first heavy-lift, accommodation and pipelay barge and was only recently delivered (late FY 2007). Recall that Lewek Champion was also chartered out to ConocoPhillips for 1H FY 2008 in an announcement dated June 11, 2007. For ConocoPhillips, the vessel will be deployed in the Timor Gap where it will be used for accommodation support and de-commissioning work in the planned shutdown of the Bayu Undan platform.
From these two announcements, there appears to be some “overlap”. How can Lewek Champion be chartered to ConocoPhillips and the national oil major at the same time ? The press releases do not provide a timeline for the usage of the vessels and there was also no contract value specified (note that the US$888 million refers to the entire sub-sea project, not Ezra’s portion which only includes the provision of services). The best scenario I can come up with is that the Lewek Champion would be deployed to ConocoPhillips in 1H FY 2008, after which it will be used for the sub-sea project from the remainder of FY 2008 till FY 2010. This will ensure a constant revenue stream for the vessel and if charter rates increase, there may also be a clause in the contract for variable rate adjustments, which was why Mr. Lionel Lee mentioned that he wished to take advantage of the buoyant conditions in the oil and gas industry.
Even though the contract values were not specified (which makes it difficult to estimate the earnings stream from Ezra), the good news is that the vessel will be on charter for at least 3 financial years up till FY 2010. This will ensure a steady and constant stream of revenue even as Ezra decides to scale up its business by expanding their fleet further. Also recall that Mr. Lionel Lee had boldly gave a guidance of snaring one FPSO deal every 18 months. Thus far, the previous FPSO deal was sealed back in October 2006, so this means they are confident of securing another by March 2008 (about 7 months away from now). I am not sure if the company may be over-stretching themselves as they may not have the financial muscle (funds) of the larger players (such as Tidewater and Solstad) to bid aggressively for more FPSO projects. The cost of managing an FPSO is very high even though the charter rates are strong and one charter can last for seven financial years; thus the initial outlay for Ezra will also be a drain on cash flows.
Managing cash is an important aspect of any business, but for Ezra’s case it is particularly important as their vessels are very capital intensive and require a lot of upfront funding before they can be constructed and deployed on charter contracts. Ezra’s use of financing schemes such as sale-and-leaseback have managed to enable them to keep their balance sheet light and ensured that they have cash inflows to fund further expansion. This strategy is sound in the short-term but becomes riskier in the medium-term as Ezra would need to depend on a steady stream of chartering cash inflows in order to sustain their operational leases for the sale-and-leaseback vessels. Fortunately, I was told that Ezra will only embark on a vessel order if it has a firm order from a customer for the use of that vessel. For FY 2009, they have already ordered two 30,000 bhp AHTS and another pipe-lay barge; and the understanding is that they are already able to find customers willing to charter these vessels. The future is unclear at this point as Ezra has not made any indication of ordering more vessels, but more will probably be revealed when they announce their FY 2007 results in late October 2007. Kim Eng’s latest report on Ezra dated August 8, 2007 has forecast a full-year net profit of S$75.1 million while DBSV is more conservative with an estimate of S$71.1 million net profit after tax.
Update: Ezra has obtained in principle approval for the listing and quotation of the bonus shares from SGX. This means that they can go ahead and convene an EGM to seek approval for the bonus issue and the proposed sale of EOC shares.
Global Voice – Comments and Update before their 1H 2007 results release
Thus far, Global Voice (GV) has been announcing contracts on a regular basis every week or so. There have been 19 contracts announced with various companies (some purportedly large and some smaller ones) for FY 2007 (up till today), which boils down to about an average of 2.5 contracts per month. There is, of course, no mention of contract value or duration as this is not allowed in the IT industry and would be tantamount to a breach of client confidentiality. As a result, it is very difficult to estimate revenues and to project revenue growth because each announced contract may only be of a low value or of a short duration.By referring back to the FY 2006 results announcement, notice that under Note 15 on Page 19, the breakdown of sales is provided as about EUR 11 million (after removing the item sales of fixed assets which is a one-off non-recurring item). Essentially, there was almost no growth at all from FY 2005 to FY 2006 as FY 2005 already registered recurring sales of about EUR 11 million (remove the EUR 5.6 million of sales of fixed assets). Some may argue that GV has scaled up their operations a lot more in FY 2007, re-branded themselves as EUNetworks and also hired more sales and marketing staff to aggressively bid for projects.
All this is well and good, of course. However, it still does not guarantee that GV can turn-around. Here are several danger areas which may play itself out in the coming weeks:-
a) Revenues may not have increased sufficiently to offset increased expenses relating to GV’s aggressive push for market share. Recall that GV said that only 2% of their fibre network was being utilized as at FY 2006, which implies that 98% was still available for “leasing” to customers. However, the costs involved in marketing and selling their fibre may outweigh any potential benefit from it. I expect GV to have increased marketing costs (for its EUNetwork launch as well as sponsor of several network events including Capacity 2007), increased staff costs (to boost their sales team) and increased administrative costs (as a result of the expansion of their sales team, a requisite backup team is necessary to provide support). Finance costs will also remain high because of the interest due on their convertible bonds in April 2007.
b) Cash flows may also be an issue for GV because of their requirement to pay interest cost upfront, while slowly collecting fibre leasing revenue from their customers. In FY 2006 financials, there was an operating cash outflow of EUR 5.5 million and also a net investing cash outflow of EUR 25.8 million for purchase of fixed assets. Most of their cash inflows came from borrowings (about EUR 34.2 million) and thus they are highly geared. The FY 2006 ending cash balance of EUR 8.3 million is not impressive and for the 1H 2007 results, the cash flow statement should be carefully scrutinized to see where the cash has been spent.
c) Demand might be an issue for GV as they are, after all, in the technology industry where services and products can go obsolete faster than one would expect. GV always touts that their private fibre networks are unique in that they have millions of miles of fibre for use all over Europe which can link datacenters together and reduce data redundancy. It remains to be seen how many corporations actually require GV’s services as they provide pan-Europe connections which some companies may either not require or cannot afford.
d) Management has been known to talk about the share price by saying that it is under-valued and that they would support it if necessary. I usually frown upon Management which likes to talk about the share price as this means they are more concerned about the market price than on running the business. I do not know if their remuneration or bonuses are in any way tied to the share price and am not insinuating anything; but take note that an excessive focus on share price is not healthy (the Management of the other companies I own do NOT talk about share price, they just focus on the business)
Even though the frequent announcements of contract wins has ignited hope for GV to turn-around this year, much still remains uncertain. Even if they were to show a marginal profit for 1H 2007, I may still consider divesting as I am not comfortable with the lack of clarity for their earnings, the uncertain demand for their services and their high gearing.
Wishing all Singaporeans a Happy National Day !
Wednesday, August 08, 2007
Lessons Learnt from the Closure of BiG Superstore
I read with interest (and a certain degree of amazement) the closure and bankruptcy of BiG superstore in Harbourfront Centre, which had just started its operations back in 2003. The managing director, Mr. Robert Young, had bought over the beleaguered Safe Superstore back in 2003 when it was in receivership and attempted to re-brand and re-vitalize the mega-store concept. The business was running smoothly till 6 months ago when problems cropped up. Even after pumping in another S$10 million, the company found itself hounded by creditors and being unable to pay up for merchandise which it had ordered from its suppliers. This posting is to analyze what went wrong with the business (according to the ST article) and what we can learn from it with regards to investing in companies listed on the SGX:-
1) Change in business strategy – BiG changed its business strategy early in 2007, going from a high volume low margin business to one with slightly higher margins on the back of reduced volume. This had the double-whammy negative effect: customers were perturbed by the higher prices and thus bought less; and payments to suppliers had to be higher as a result of the higher-value goods. Because of these effects, turnover plummeted from S$48 million for FY 2006 to S$12 million in the first 6 months of FY 2007 (S$24 million if annualized, representing a 50% drop !). Lesson Learnt: Changes in business strategy and pricing should be evaluated very carefully before being allowed to proceed. In this case, BiG was a retail business and thus catered to customers who were extremely price-sensitive. Demand was also very elastic as the goods were generic and could be found in most other department stores and mega-marts. Thus, a small change in price could have a drastic effect on sales volume, thus hurting revenues and profitability.
2) Competition – BiG had not anticipated stiffer competition as a result of their change in business strategy. Looking at it from the angle of the five forces, this business had low barriers to entry and so new entrants would find it easy to just set up a store and start selling products similar to those offered by BiG. Suppliers also had more power as they could decide which retailer to sell to, and prices and conditions could be dictated more stringently by the supplier, leaving the retailer at a disadvantage. The popularity of neighbouring VivoCity since its opening probably also contributed to BiG’s eventually downfall as it was drawing much of the crowd away from HarbourFront Centre. Lesson Learnt: Do not under-estimate the power of competition. Ensure that expenses and overheads are always kept consistently low and ensure a decent net profit margin in case a price war breaks out. If the price war gets too intense, consider (as a drastic move) scaling down operations by sub-leasing or “giving up” some space to reduce rental expenses - I have noticed some stores doing this in urban malls.
3) Cash-Flow Management – Cash flow started to become a real headache when sales did not hit desired targets, as BiG (being a retail store) naturally operates mainly on a COD (Cash on delivery) basis. As cash inflows slowly dried up, the store faced problems honouring larger payments to suppliers for higher-value goods. In turn, these suppliers then stopped delivering goods when they did not receive the requisite payment. This led to a vicious cycle as the lack of new goods meant that more customers could not buy, leading to even poorer sales. All it took was one creditor to petition for a winding-up order, and the rest, as they say, is history. Lesson Learnt: A business should always keep an eye on cash flow issues, as these are even more important than earning a profit (accounting profits are separate from cash flows). The cash conversion cycle, which measures the time cash is collected minus the time taken to make payments, should be as short as possible to ensure a steady and healthy cash inflow for the business. Many construction companies went bust in the late 90’s as a result of cash flow problems, not profitability problems. In a retail COD business, cash would normally not be a problem unless the cash outflow requirement was a lot higher than the cash inflows which were being received (which was the case for BiG).
4) Sale of Credit Instalment Scheme – To cut it short and sweet, this is linked to the previous point on cash flows as this scheme allowed customers to buy on credit, payment interest monthly which contributed to the cash flows of the store. By selling this away, the store was depriving itself of a steady inflow of cash and literally dehydrating themselves financially ! Lesson Learnt: Businesses should ensure a steady and consistent stream of cash inflows to fund purchases of stocks or fixed assets. Once cash flow dries up, the consequences can be disastrous as problems start piling up one by one, as can be seen in BiG’s case.
As can be seen, the points above illustrate just how easy it is for a company to go from boom to bust. All it takes is several big mistakes to cancel out the effects of years of good management and sound financial strategies. It is a pity that BiG had to shut down so suddenly as it shows that Management had not adequately considered the ramifications of their strategy change until it was way too late. Only when receivers and liquidators come knocking on their door will they know that their policies had gone tragically wrong. Thus, it is always important to do financial forecasts and assume the worst in order to get a more realistic feel of the situation. Business conditions can be cruel and only the fittest survive, according to Darwin’s Theory of Natural Selection.
My next post will be about Ezra's latest contract for Lewek Champion for the US$888 sub-sea installation project, as well as a brief update on Global Voice and why I am cautiously optimistic about its 1H 2007 results.
I read with interest (and a certain degree of amazement) the closure and bankruptcy of BiG superstore in Harbourfront Centre, which had just started its operations back in 2003. The managing director, Mr. Robert Young, had bought over the beleaguered Safe Superstore back in 2003 when it was in receivership and attempted to re-brand and re-vitalize the mega-store concept. The business was running smoothly till 6 months ago when problems cropped up. Even after pumping in another S$10 million, the company found itself hounded by creditors and being unable to pay up for merchandise which it had ordered from its suppliers. This posting is to analyze what went wrong with the business (according to the ST article) and what we can learn from it with regards to investing in companies listed on the SGX:-
1) Change in business strategy – BiG changed its business strategy early in 2007, going from a high volume low margin business to one with slightly higher margins on the back of reduced volume. This had the double-whammy negative effect: customers were perturbed by the higher prices and thus bought less; and payments to suppliers had to be higher as a result of the higher-value goods. Because of these effects, turnover plummeted from S$48 million for FY 2006 to S$12 million in the first 6 months of FY 2007 (S$24 million if annualized, representing a 50% drop !). Lesson Learnt: Changes in business strategy and pricing should be evaluated very carefully before being allowed to proceed. In this case, BiG was a retail business and thus catered to customers who were extremely price-sensitive. Demand was also very elastic as the goods were generic and could be found in most other department stores and mega-marts. Thus, a small change in price could have a drastic effect on sales volume, thus hurting revenues and profitability.
2) Competition – BiG had not anticipated stiffer competition as a result of their change in business strategy. Looking at it from the angle of the five forces, this business had low barriers to entry and so new entrants would find it easy to just set up a store and start selling products similar to those offered by BiG. Suppliers also had more power as they could decide which retailer to sell to, and prices and conditions could be dictated more stringently by the supplier, leaving the retailer at a disadvantage. The popularity of neighbouring VivoCity since its opening probably also contributed to BiG’s eventually downfall as it was drawing much of the crowd away from HarbourFront Centre. Lesson Learnt: Do not under-estimate the power of competition. Ensure that expenses and overheads are always kept consistently low and ensure a decent net profit margin in case a price war breaks out. If the price war gets too intense, consider (as a drastic move) scaling down operations by sub-leasing or “giving up” some space to reduce rental expenses - I have noticed some stores doing this in urban malls.
3) Cash-Flow Management – Cash flow started to become a real headache when sales did not hit desired targets, as BiG (being a retail store) naturally operates mainly on a COD (Cash on delivery) basis. As cash inflows slowly dried up, the store faced problems honouring larger payments to suppliers for higher-value goods. In turn, these suppliers then stopped delivering goods when they did not receive the requisite payment. This led to a vicious cycle as the lack of new goods meant that more customers could not buy, leading to even poorer sales. All it took was one creditor to petition for a winding-up order, and the rest, as they say, is history. Lesson Learnt: A business should always keep an eye on cash flow issues, as these are even more important than earning a profit (accounting profits are separate from cash flows). The cash conversion cycle, which measures the time cash is collected minus the time taken to make payments, should be as short as possible to ensure a steady and healthy cash inflow for the business. Many construction companies went bust in the late 90’s as a result of cash flow problems, not profitability problems. In a retail COD business, cash would normally not be a problem unless the cash outflow requirement was a lot higher than the cash inflows which were being received (which was the case for BiG).
4) Sale of Credit Instalment Scheme – To cut it short and sweet, this is linked to the previous point on cash flows as this scheme allowed customers to buy on credit, payment interest monthly which contributed to the cash flows of the store. By selling this away, the store was depriving itself of a steady inflow of cash and literally dehydrating themselves financially ! Lesson Learnt: Businesses should ensure a steady and consistent stream of cash inflows to fund purchases of stocks or fixed assets. Once cash flow dries up, the consequences can be disastrous as problems start piling up one by one, as can be seen in BiG’s case.
As can be seen, the points above illustrate just how easy it is for a company to go from boom to bust. All it takes is several big mistakes to cancel out the effects of years of good management and sound financial strategies. It is a pity that BiG had to shut down so suddenly as it shows that Management had not adequately considered the ramifications of their strategy change until it was way too late. Only when receivers and liquidators come knocking on their door will they know that their policies had gone tragically wrong. Thus, it is always important to do financial forecasts and assume the worst in order to get a more realistic feel of the situation. Business conditions can be cruel and only the fittest survive, according to Darwin’s Theory of Natural Selection.
My next post will be about Ezra's latest contract for Lewek Champion for the US$888 sub-sea installation project, as well as a brief update on Global Voice and why I am cautiously optimistic about its 1H 2007 results.
Tuesday, August 07, 2007
Swiber – Acquisition of 100% of North Shipyard Pte Ltd
On August 6, 2007, Swiber announced the acquisition of a 100% interest in the share capital of a company North Shipyard Pte Ltd for a sum of S$10.3 million (to be confirmed contingent upon assessed tax payable for the acquiree company). The acquiree company is in the business of building and repairing ships, tankers and other ocean-going vessels. This acquisition is set to complement Swiber’s operations as it provides a base for the Company’s vessel fleet and also allows Swiber to grow their technical design capabilities for more specialized vessels.
Financial Effects and Comments
The consideration for the S&P agreement is S$10.3 million subject to the confirmation of adjustment for provision for tax in North Shipyard’s books. The entire sum will be paid in cash and will be funded from internal resources, thus there will be no additional debt burden or equity dilution. The acquisition will make North Shipyard a 100%-owned subsidiary of Swiber Holdings, which means that upon consolidation, all items in North Shipyard will be added on a line by line basis to obtain the consolidated financial statements for Swiber. I expect this to take effect from August 2007 onwards.
As stated in the announcement, the NTA of North Shipyard is S$6.26 million and the unaudited net profit is S$3.58 million. This means that at the purchase price of S$10.3 million, Swiber is paying for a price-to-book of 1.65 and price-earnings of 2.88 times. This would imply that Swiber can recoup their investment in North Shipyard within 2.88 years; and this is indeed a very attractive valuation at which they purchased this company. The profits will add to their bottom line and boost this for FY 2007, while the NTA may also possibly rise once Swiber begins pumping assets into its new subsidiary.
Operations Analysis and Comments
In terms of strategy, Swiber is trying to move up the value chain with this acquisition as they have found a complementary business in North Shipyard which can integrate with their existing business. Mr. Raymond Goh mentioned that Swiber is positioning itself to become a “top-notch offshore oil and gas specialist”; and it is doing this through improving its margins by moving into higher value-added vessels specially catered for Asian waters, expanding its vessel fleet and vertically integrating their operations. With the new shipyard, Swiber need not rely on outsourced third-party support for the repair and conversion of their vessels. This would mean lower costs and faster turnaround time as there may be time constraints imposed by third-party shipyards.
The importance of project co-ordination and control cannot be over-emphasized for a company such as Swiber. From the recent LOI wins, one can see that some of these contracts are to be executed within a period of 2-3 months on average; thus it is important for the Company to maintain control over its vessel deployment so that they can fulfill their contractual obligations. Thus far, the risk for Swiber is the ability to deliver on their contracts, as they are still a growing company which is in the midst of rapid expansion. I believe that Management is trying to mitigate this risk and reduce it by procuring a company which will allow them to have greater operational control over their vessel fleet. For a project-based company like Swiber, control over processes and costs is important to be able to allow them to fulfill contracts (thereby gaining the confidence of customers and encouraging repeat business) and improve their profit margins (by focusing on in-house conversion and repair activities instead of the more costly option of outsourcing).
Conclusion and Outlook
As detailed above, this acquisition is expected to bring tangible as well as intangible benefits for the Swiber Group of companies. The Management has a long-term vision for growing the company and I am pleased with the foundation that the Company is building in order to establish a foothold in other countries. The key risk is of course the rate of cash burn for the company and whether they can use cash efficiently enough to grow earnings and to ensure a ready cash inflow to cover operations. Thus, in the upcoming 1H 2007 results release, I will be focusing my attention more on their margins and their cash flow statement rather than the absolute profit figure (which should surely be higher as a result of so many new contracts for FY 2007 as compared to FY 2006).
On August 6, 2007, Swiber announced the acquisition of a 100% interest in the share capital of a company North Shipyard Pte Ltd for a sum of S$10.3 million (to be confirmed contingent upon assessed tax payable for the acquiree company). The acquiree company is in the business of building and repairing ships, tankers and other ocean-going vessels. This acquisition is set to complement Swiber’s operations as it provides a base for the Company’s vessel fleet and also allows Swiber to grow their technical design capabilities for more specialized vessels.
Financial Effects and Comments
The consideration for the S&P agreement is S$10.3 million subject to the confirmation of adjustment for provision for tax in North Shipyard’s books. The entire sum will be paid in cash and will be funded from internal resources, thus there will be no additional debt burden or equity dilution. The acquisition will make North Shipyard a 100%-owned subsidiary of Swiber Holdings, which means that upon consolidation, all items in North Shipyard will be added on a line by line basis to obtain the consolidated financial statements for Swiber. I expect this to take effect from August 2007 onwards.
As stated in the announcement, the NTA of North Shipyard is S$6.26 million and the unaudited net profit is S$3.58 million. This means that at the purchase price of S$10.3 million, Swiber is paying for a price-to-book of 1.65 and price-earnings of 2.88 times. This would imply that Swiber can recoup their investment in North Shipyard within 2.88 years; and this is indeed a very attractive valuation at which they purchased this company. The profits will add to their bottom line and boost this for FY 2007, while the NTA may also possibly rise once Swiber begins pumping assets into its new subsidiary.
Operations Analysis and Comments
In terms of strategy, Swiber is trying to move up the value chain with this acquisition as they have found a complementary business in North Shipyard which can integrate with their existing business. Mr. Raymond Goh mentioned that Swiber is positioning itself to become a “top-notch offshore oil and gas specialist”; and it is doing this through improving its margins by moving into higher value-added vessels specially catered for Asian waters, expanding its vessel fleet and vertically integrating their operations. With the new shipyard, Swiber need not rely on outsourced third-party support for the repair and conversion of their vessels. This would mean lower costs and faster turnaround time as there may be time constraints imposed by third-party shipyards.
The importance of project co-ordination and control cannot be over-emphasized for a company such as Swiber. From the recent LOI wins, one can see that some of these contracts are to be executed within a period of 2-3 months on average; thus it is important for the Company to maintain control over its vessel deployment so that they can fulfill their contractual obligations. Thus far, the risk for Swiber is the ability to deliver on their contracts, as they are still a growing company which is in the midst of rapid expansion. I believe that Management is trying to mitigate this risk and reduce it by procuring a company which will allow them to have greater operational control over their vessel fleet. For a project-based company like Swiber, control over processes and costs is important to be able to allow them to fulfill contracts (thereby gaining the confidence of customers and encouraging repeat business) and improve their profit margins (by focusing on in-house conversion and repair activities instead of the more costly option of outsourcing).
Conclusion and Outlook
As detailed above, this acquisition is expected to bring tangible as well as intangible benefits for the Swiber Group of companies. The Management has a long-term vision for growing the company and I am pleased with the foundation that the Company is building in order to establish a foothold in other countries. The key risk is of course the rate of cash burn for the company and whether they can use cash efficiently enough to grow earnings and to ensure a ready cash inflow to cover operations. Thus, in the upcoming 1H 2007 results release, I will be focusing my attention more on their margins and their cash flow statement rather than the absolute profit figure (which should surely be higher as a result of so many new contracts for FY 2007 as compared to FY 2006).
Monday, August 06, 2007
Research Series Part 5 – The Income Statement
For Part 5 of the research series, I will focus on the Income Statement which is also called the Profit and Loss Statement. The aim is to highlight key areas for investors to review so that one may get a feel of how the company is doing and whether things look good for it in future. This is the (usually) first financial document most investors (and punters even) look at, as it tells immediately if the company is doing better or worse than the previous year. Remember though, that the Income Statement itself is a good reflection of the company’s business, and by going through the details one can readily pick up many signals about how the company is performing, and what its future will be like.
Below are listed several aspects of the Income Statement which are worth noting, please note that this list is far from exhaustive and that every company has its own unique items within the Income Statement; but this is meant to serve as a guide for most businesses:-
1) Revenue Growth – This is measured as the revenue increase in a given period versus the revenue from the previous period, as a %. Generally, a company should exhibit revenue growth, otherwise it’s obvious the company’s products and services are not selling well ! Another reason for revenue growth could also be increased prices of products for sale, when a company which is a franchise has pricing power to raise prices without affecting demand (e.g. SMRT and SBS Transit). Demand has to be relatively inelastic in order to price increases to justify revenue growth. In most cases, companies grow sales by selling more products or increasing their product lines.
2) Cost of Goods Sold – The relationship between revenue growth and COGS growth is very interesting. Most companies would report an increase in revenue (otherwise, why be in business right ?); but not many can report a correspondingly high or higher increase in gross margin. Why is this so ? Because cost of goods increases to eat up margins, such that even though revenues may grow, costs grow even more (see “Gross Profit” section below).
3) Gross Profit and Gross Margin – Gross profit is simply sales minus cost of goods sold; but this relationship is very important as it represents each additional dollar of earnings from one dollar of product cost. After all, the main aim of a business is to buy something cheaper in order to sell it more expensively (thus the term profit). Gross margin is defined as gross profit divided by revenue. In some cases, margins can get squeezed. A simple example to illustrate the gross profit cum margins scenario: assume revenues are $10K and costs of goods sold $5K in the FY 2006 for company X (thus yielding a gross profit of $5K or a gross margin of 50%). For FY 2007, revenues are up 100% to $20K, while costs are only up 80% to $9K. This yields a gross profit of $11K (a 120% increase) which is a margin of 55% (improvement of 5 percentage points for gross margin).
Notice how the gross profit improvement exceeds both the increases in revenues and COGS ? This is the power of reducing costs while keeping revenue growth steady. A lower than proportionate increase in COGS will ensure a higher gross profit increase and a higher gross profit margin.
Usually, companies which see their GP margin decrease are facing some sort of price pressure, or stiff competition. Industries which are becoming commoditized will face declining margins even as sales volume and value increases, to the detriment of shareholders. If a company is in a franchise position and is able to increase prices without suffering a corresponding increase in COGS, then it is able to improve margins in the long run. There are also companies which cut costs rigorously by employing economies of scale or better techniques and processes; all of which are a result of internal restructuring. Remember that cost cutting usually affects only the net margin (to be elaborated on) line and that gross margin will represent the fundamental nature of the business. If gross margins fall, this is a clear danger signal which should be investigated without hesitation.
4) Selling and Marketing Expenses – This expense tends to remain relatively constant in proportion to sales. Instances which could jack up this item disproportionately will include intensive promotions or advertising to increase sales, more roadshows and higher expenses incurred to close sales or to provide services. If a company has to spend additional marketing dollars just to generate an equivalent level of sales, then there must be something seriously wrong with its current product or service offering. It is best that the company re-examine their strategy in order to ensure no marketing dollars are wasted in a bid to maximize sales.
5) General and Administrative Expenses – The two main “large” items within this category usually relate to rental costs (for office and/or warehouse and factory) as well as staff costs. Rental cost will only get higher with the current property boom with rentals in office areas going as high as S$10 per square foot. Note that rental expenses are not applicable if a company has purchased the land and building in which it is operating on (in this case, refer to depreciation expense which should be a constant year-on-year). Staff costs are also set to rise due to higher salaries being demanded in the market as well as the restoration of the 1.5% to employer’s CPF. Even staff costs in China companies may escalate as the economy is booming and growth is projected to exceed 10%. This would imply that the cost of living will eventually get higher and companies will have to pay correspondingly higher wages to maintain the same staff pool.
6) Finance Costs – Trust me, this item can be a killer expense if it gets out of control. Finance costs would include costs of borrowings which literally means interest expenses on loans and convertible bonds. If a company is highly geared (i.e. high debt/equity ratio), then expect interest costs to be relatively high with respect to earnings. In a rising interest rate environment, this can be the nail in the coffin as interest expenses keep ramping up and eating into cash. Thus, always be wary of high gearing companies. As PAH is highly geared currently (117%), I am also keeping a watchful eye on their Cash Flow Statement to see if they are able to generate sufficient cash to cover their finance costs.
7) Exceptional Items – Exceptional items usually consist of one-time non-recurring charges or credits to the Income Statement. Some examples are write-down of inventory, writing off of bad debts, impairment losses from an investment (e.g. DBS has to write-down as impairment losses part of their stake in a Thai bank) or gain from sale-and-leaseback transactions. These must be taken out of net profits and adjusted before earnings per share calculations, as they will distort the picture for the investor. Only CORE earnings from operating activities should be used to compute EPS, as this represents the earnings from the business which can be reinvested back into the business to grow it. Some charges (e.g. impairment losses) can also be written back, and it is up to the individual investor to educate himself on the accounting aspects of such items.
8) Net profit and NP margin – Net profit increases usually indicate that Management has been effective in keeping costs to an acceptable level while growing the business. The net profit margin (adjusted for exceptional items) is a good indication of whether the selling and admin expenses of the company are growing faster than revenues. The two margins (i.e. gross and net) must be read in tandem and compared against previous quarters and/or years in order to ascertain if the business is improving or deteriorating.
This brief write-up should act as a useful summary for those who wish to begin analyzing the Income Statement. Remember to be on the lookout for the above items and practice looking at many companies’ statements in order to get a feel of things. I myself try to download 80-90% of all listed companies’ Income Statements just to practice my analysis skills. Usually, there will be a disconnect between the press release (which tends to promote the good stuff and gloss over the bad) and the actual financials. Try to go through it on your own with a fine-tooth comb and you’ll be surprised what you can find !
The next part of the research series shall focus on the Balance Sheet and show readers the important aspects to look out for in this often-neglected financial document.
For Part 5 of the research series, I will focus on the Income Statement which is also called the Profit and Loss Statement. The aim is to highlight key areas for investors to review so that one may get a feel of how the company is doing and whether things look good for it in future. This is the (usually) first financial document most investors (and punters even) look at, as it tells immediately if the company is doing better or worse than the previous year. Remember though, that the Income Statement itself is a good reflection of the company’s business, and by going through the details one can readily pick up many signals about how the company is performing, and what its future will be like.
Below are listed several aspects of the Income Statement which are worth noting, please note that this list is far from exhaustive and that every company has its own unique items within the Income Statement; but this is meant to serve as a guide for most businesses:-
1) Revenue Growth – This is measured as the revenue increase in a given period versus the revenue from the previous period, as a %. Generally, a company should exhibit revenue growth, otherwise it’s obvious the company’s products and services are not selling well ! Another reason for revenue growth could also be increased prices of products for sale, when a company which is a franchise has pricing power to raise prices without affecting demand (e.g. SMRT and SBS Transit). Demand has to be relatively inelastic in order to price increases to justify revenue growth. In most cases, companies grow sales by selling more products or increasing their product lines.
2) Cost of Goods Sold – The relationship between revenue growth and COGS growth is very interesting. Most companies would report an increase in revenue (otherwise, why be in business right ?); but not many can report a correspondingly high or higher increase in gross margin. Why is this so ? Because cost of goods increases to eat up margins, such that even though revenues may grow, costs grow even more (see “Gross Profit” section below).
3) Gross Profit and Gross Margin – Gross profit is simply sales minus cost of goods sold; but this relationship is very important as it represents each additional dollar of earnings from one dollar of product cost. After all, the main aim of a business is to buy something cheaper in order to sell it more expensively (thus the term profit). Gross margin is defined as gross profit divided by revenue. In some cases, margins can get squeezed. A simple example to illustrate the gross profit cum margins scenario: assume revenues are $10K and costs of goods sold $5K in the FY 2006 for company X (thus yielding a gross profit of $5K or a gross margin of 50%). For FY 2007, revenues are up 100% to $20K, while costs are only up 80% to $9K. This yields a gross profit of $11K (a 120% increase) which is a margin of 55% (improvement of 5 percentage points for gross margin).
Notice how the gross profit improvement exceeds both the increases in revenues and COGS ? This is the power of reducing costs while keeping revenue growth steady. A lower than proportionate increase in COGS will ensure a higher gross profit increase and a higher gross profit margin.
Usually, companies which see their GP margin decrease are facing some sort of price pressure, or stiff competition. Industries which are becoming commoditized will face declining margins even as sales volume and value increases, to the detriment of shareholders. If a company is in a franchise position and is able to increase prices without suffering a corresponding increase in COGS, then it is able to improve margins in the long run. There are also companies which cut costs rigorously by employing economies of scale or better techniques and processes; all of which are a result of internal restructuring. Remember that cost cutting usually affects only the net margin (to be elaborated on) line and that gross margin will represent the fundamental nature of the business. If gross margins fall, this is a clear danger signal which should be investigated without hesitation.
4) Selling and Marketing Expenses – This expense tends to remain relatively constant in proportion to sales. Instances which could jack up this item disproportionately will include intensive promotions or advertising to increase sales, more roadshows and higher expenses incurred to close sales or to provide services. If a company has to spend additional marketing dollars just to generate an equivalent level of sales, then there must be something seriously wrong with its current product or service offering. It is best that the company re-examine their strategy in order to ensure no marketing dollars are wasted in a bid to maximize sales.
5) General and Administrative Expenses – The two main “large” items within this category usually relate to rental costs (for office and/or warehouse and factory) as well as staff costs. Rental cost will only get higher with the current property boom with rentals in office areas going as high as S$10 per square foot. Note that rental expenses are not applicable if a company has purchased the land and building in which it is operating on (in this case, refer to depreciation expense which should be a constant year-on-year). Staff costs are also set to rise due to higher salaries being demanded in the market as well as the restoration of the 1.5% to employer’s CPF. Even staff costs in China companies may escalate as the economy is booming and growth is projected to exceed 10%. This would imply that the cost of living will eventually get higher and companies will have to pay correspondingly higher wages to maintain the same staff pool.
6) Finance Costs – Trust me, this item can be a killer expense if it gets out of control. Finance costs would include costs of borrowings which literally means interest expenses on loans and convertible bonds. If a company is highly geared (i.e. high debt/equity ratio), then expect interest costs to be relatively high with respect to earnings. In a rising interest rate environment, this can be the nail in the coffin as interest expenses keep ramping up and eating into cash. Thus, always be wary of high gearing companies. As PAH is highly geared currently (117%), I am also keeping a watchful eye on their Cash Flow Statement to see if they are able to generate sufficient cash to cover their finance costs.
7) Exceptional Items – Exceptional items usually consist of one-time non-recurring charges or credits to the Income Statement. Some examples are write-down of inventory, writing off of bad debts, impairment losses from an investment (e.g. DBS has to write-down as impairment losses part of their stake in a Thai bank) or gain from sale-and-leaseback transactions. These must be taken out of net profits and adjusted before earnings per share calculations, as they will distort the picture for the investor. Only CORE earnings from operating activities should be used to compute EPS, as this represents the earnings from the business which can be reinvested back into the business to grow it. Some charges (e.g. impairment losses) can also be written back, and it is up to the individual investor to educate himself on the accounting aspects of such items.
8) Net profit and NP margin – Net profit increases usually indicate that Management has been effective in keeping costs to an acceptable level while growing the business. The net profit margin (adjusted for exceptional items) is a good indication of whether the selling and admin expenses of the company are growing faster than revenues. The two margins (i.e. gross and net) must be read in tandem and compared against previous quarters and/or years in order to ascertain if the business is improving or deteriorating.
This brief write-up should act as a useful summary for those who wish to begin analyzing the Income Statement. Remember to be on the lookout for the above items and practice looking at many companies’ statements in order to get a feel of things. I myself try to download 80-90% of all listed companies’ Income Statements just to practice my analysis skills. Usually, there will be a disconnect between the press release (which tends to promote the good stuff and gloss over the bad) and the actual financials. Try to go through it on your own with a fine-tooth comb and you’ll be surprised what you can find !
The next part of the research series shall focus on the Balance Sheet and show readers the important aspects to look out for in this often-neglected financial document.
Sunday, August 05, 2007
Some scattered thoughts on Investing
Just some passing thoughts on investing as we pass through another weekend. The maco-economic factor which are dogging the market currently is of course, the USA sub-prime mortgage loan crisis. Unless you were living on another planet these few months, you would probably have heard of the problems this is causing and why DJIA has crashed considerably these past few trading sessions. This also explains why there are more threads in forums now stating “I lost $xxx in the market”.
On Books
I had the fortune of staying in a bookstore for most of today and browsing through several books on value and long-term investing. I also quickly flipped through Phillip Fisher’s “Common Stocks and Uncommon Profits”. Needless to say, my view is one of “ever-increasing knowledge is good for the soul”, but this knowledge also must be the “right” sort. No use aspiring to be a value investor then reading all you can about warrants or technical analysis, for instance.
I managed to cover key principles on value investing including rationality, sloth and patience just to name a few; as well as how to tell if a company is a good buy (from Phil Fisher’s book). One of the points I stayed on was the profit margins portion, as it reminded me of my investment in PAH and how the company was not generating a very high profit margin. However, Management has undertaken efforts to improve the margins through the elongation of super-trawlers and buying up more Peruvian companies to enhance economies of scale. Thus, this would still qualify to be a growth company as Management is still actively seeking opportunities to enhance shareholder value.
Another book offered insights into bubbles: how they are formed and how they will eventually burst. I read with interest on the tulip blub craze in the 1600’s, the South Sea Bubble in Britain and of course the now infamous “tech bubble” which massively inflated the NASDAQ to 5,000 points. It is interesting to note that during the market bubble for Internet stocks, analysts came up with all sorts of innovative ways to measure the “performance” of these loss-making companies, such as “eyeballs” to indicate how many people visited a website. Obviously, these companies could get away with making zero profits as long as they got tons of “eyeballs” on their websites. That is the problem with analysts – they see where the tide flows and adapt accordingly, adding almost no value to the investing process except providing basic information on the company. How many times have we seen a company being continually upgraded during bull markets, only for the same analysts to remain silent when the company’s price starts going downhill during a correction or crash ? To me, they all seem like hypocrites.
On Patience
Somehow, bull markets bring out the very worst in all of us, greed and avarice ! During the weekend, when we all have time to think, it strikes me that greed is an ever-growing part of our lives. Singapore is a place which is getting more and more materialistic by the day, what with the Sunday Times running articles on super-expensive items to purchase and the Straits Times running another article on how new the cars on our roads are. As I approach the age most commonly associated with “middle-age” (i.e mid-30’s), I realize that more and more of my friends and associates rate themselves based on their financial worth, car, property etc. Why this should be so continually stumps me: A person’s worth, to me, should be a reflection of his moral character, attitude towards helping others and his zest for life and living; rather than being measured based on monetary terms. In an increasingly capitalistic society where even the press continually bombard us with being rich and getting rich, one can get totally drowned and lose focus of what’s important in life.
On important things in life
I know this may sound a little preachy and philosophical, but for those readers who think material wealth and money are closely linked to success, think again. Ask yourself how much money can you bring with you when you pass on ? Money is the means to achieve stability and peace of mind, but it should not be seen as a means to an end. We can NEVER have enough money, so one should settle with being comfortable with what they have and turn their attention to doing other useful things in life. My important aspects (called the 4 “Fs”) are listed below:-
Family – The most important aspect of my life. Spending time with my family and loved ones is immeasurable in terms of satisfaction. Remember: money cannot buy happiness, especially with your loved ones.
Friends – Someone to share your interests, pains, joys and sorrows. Humans are social animals and need to find solace and comfort in having a social circle. For me, friends are important not just for sharing common interests but also for helping each other out in times to need, not to mention having someone to chat with.
Fun – Take some time off making money and have some well-deserved fun ! Cut back on that overtime at work, take your mind off the stock market and indulge in a pleasurable weekend playing sports, doing some shopping, going for a short trip or just basically going to the beach to hear the waves ! Having fun is important to me as it means I can sooth my soul from the worries and stress from work.
Freedom – When I say freedom, I mean freedom to make choices without duress or pressure. This is the freedom to make choices on my own and without influence from others. Continually throughout our lives, we get bombarded by media and peers telling us how we should live our lives and what we should do with our money. For me, I truly relish the freedom that comes with planning my own life, instead of letting others dictate it on my behalf.
On Research and Mistakes
Sorry for the delays in writing on the research series and investment mistakes. As readers would know, I have been traveling frequently these past few weeks and have little time to write a proper article on each. I would rather promise readers a quality article than one which was hastily thought up just to “fill the space” in my blog. So dear readers, please be patient as I endeavour to write a good post on doing research. In the future, I plan to start a new series on investment sins and how to avoid them, so stay tuned for that too !
Saturday, August 04, 2007
Initial Public Offerings – To Invest or Not To Invest ?
Firstly, a brief introduction and summary: Initial Public Offerings or IPOs are companies which wish to go public in order to raise more funds through an equity offering to institutional investors and the public (also called retail investors). A company can either list on the Main Board of SGX or the second board called SESDAQ which has less stringent requirements. I do not exactly know what the requirements are (you can check this out on SGX) but I do know you need a three-year profit record for Main Board listings.
Everyone seems to be jumping on the IPO bandwagon these days. In a bull market (as is the case now, notwithstanding the corrections), all the newly listed companies’ valuations can go pretty crazy. If one actually follows and tracks the balloting ratios for the more recent IPOs (in the last 6 months), you will see that the retail float is usually very small (about 2-3 million shares) and the chances for allotment can get as low as 1/99 for one lot ! To me, this is hardly worth the effort to apply as you will use up your S$2 application fee and get a 1% chance to get 1,000 shares ! If you factor in the brokerage from the sale of the IPO (assuming you stag it), it can barely give you a decent profit ! Thus, I would advise readers to concentrate on companies which have a track record or earnings visibility, in order to have a greater margin of safety.
Another point I would like to mention is that most companies tend to list at the peak of their “cycle”, meaning that they choose the most opportune time to go public (when sales or profits have hit a peak). I have seen this for several companies as I read their prospectuses; profit seems to just leap up suddenly for FY 2006 seemingly for no reason at all. The question a discerning investor should ask is whether the continued good performance is sustainable. Most IPOs are marketed with glossy front covers, full pages photos and marketing jargon drumming up the merits of the company while playing down the risks. Large bar charts are used to trumpet high CAGRs for revenues and earnings, but again one should ask if this is sustainable and whether the industry is a cyclical one. Also, remember to apply a simple Porter’s 5-Forces analysis on the company’s industry to see if it is a market leader, or whether it has prospects.
One crucial thing most investors may miss are the margins for the 3 preceding years, as well as the risk factors mentioned within the prospectus. In the first place, the prospectus is one huge, thick stack of paper which is heavy enough to kill a small mammal ! There was an article some time back in the Business Times which suggested that companies drastically reduced the amount of information in the prospectus and just summarize the key points which are relevant to retail investors. This would save lots of paper and make people less averse to reading these thick manuals ! On the issue of margins, an investor should note that for some of the recent IPOs, the company actually had declining gross profit margins which were not captured in the “marketing” section of the prospectus. Such details are conveniently “hidden” right smack in the centre of the prospectus and investors (most of whom may be laymen to accounting jargon) have to dig through a pile of information just to find something relevant. I sincerely hope that the authorities at MAS will streamline the whole IPO process and make it less tedious and cumbersome both for the company and for retail investors.
My final point to make is that most companies, even if they have sound fundamentals and are in a growth industry, may not have an adequate track record to make it a worthwhile investment. Not much is usually known about newly listed companies, they may not have websites and analysts may hesitate to write reports because they are waiting for either a results announcement or some significant event. Thus, investing in IPOs on the first day of listing can be considered almost a gamble as the company’s intrinsic value cannot be calculated or estimated with reasonable certainty. Just to give an example, I hesitated on investing in Swiber because it was a new IPO. Only after it released its 4Q 2006 results and after it clinched the Brunei Shell’s US$146.6 million contract did I decide to buy part of the company. Even then, it was after much tracking of its announcements, reading up on the industry and the business and the usual homework to be done before an investment is made.
My Conclusion: Do NOT be an eager beaver to invest in newly-listed companies. Most have non-existent track records and may list at the peak of their business cycle. Plus, in the current bull market, most IPOs are opening at super inflated prices versus their offer price, and are thus extremely risky to invest in. My advice is to do your homework and exercise patience in order to sift out the outstanding companies from the weak/mediocre ones. Once enough information has been obtained to make an informed decision, one can then safely invest in an IPO.
Firstly, a brief introduction and summary: Initial Public Offerings or IPOs are companies which wish to go public in order to raise more funds through an equity offering to institutional investors and the public (also called retail investors). A company can either list on the Main Board of SGX or the second board called SESDAQ which has less stringent requirements. I do not exactly know what the requirements are (you can check this out on SGX) but I do know you need a three-year profit record for Main Board listings.
Everyone seems to be jumping on the IPO bandwagon these days. In a bull market (as is the case now, notwithstanding the corrections), all the newly listed companies’ valuations can go pretty crazy. If one actually follows and tracks the balloting ratios for the more recent IPOs (in the last 6 months), you will see that the retail float is usually very small (about 2-3 million shares) and the chances for allotment can get as low as 1/99 for one lot ! To me, this is hardly worth the effort to apply as you will use up your S$2 application fee and get a 1% chance to get 1,000 shares ! If you factor in the brokerage from the sale of the IPO (assuming you stag it), it can barely give you a decent profit ! Thus, I would advise readers to concentrate on companies which have a track record or earnings visibility, in order to have a greater margin of safety.
Another point I would like to mention is that most companies tend to list at the peak of their “cycle”, meaning that they choose the most opportune time to go public (when sales or profits have hit a peak). I have seen this for several companies as I read their prospectuses; profit seems to just leap up suddenly for FY 2006 seemingly for no reason at all. The question a discerning investor should ask is whether the continued good performance is sustainable. Most IPOs are marketed with glossy front covers, full pages photos and marketing jargon drumming up the merits of the company while playing down the risks. Large bar charts are used to trumpet high CAGRs for revenues and earnings, but again one should ask if this is sustainable and whether the industry is a cyclical one. Also, remember to apply a simple Porter’s 5-Forces analysis on the company’s industry to see if it is a market leader, or whether it has prospects.
One crucial thing most investors may miss are the margins for the 3 preceding years, as well as the risk factors mentioned within the prospectus. In the first place, the prospectus is one huge, thick stack of paper which is heavy enough to kill a small mammal ! There was an article some time back in the Business Times which suggested that companies drastically reduced the amount of information in the prospectus and just summarize the key points which are relevant to retail investors. This would save lots of paper and make people less averse to reading these thick manuals ! On the issue of margins, an investor should note that for some of the recent IPOs, the company actually had declining gross profit margins which were not captured in the “marketing” section of the prospectus. Such details are conveniently “hidden” right smack in the centre of the prospectus and investors (most of whom may be laymen to accounting jargon) have to dig through a pile of information just to find something relevant. I sincerely hope that the authorities at MAS will streamline the whole IPO process and make it less tedious and cumbersome both for the company and for retail investors.
My final point to make is that most companies, even if they have sound fundamentals and are in a growth industry, may not have an adequate track record to make it a worthwhile investment. Not much is usually known about newly listed companies, they may not have websites and analysts may hesitate to write reports because they are waiting for either a results announcement or some significant event. Thus, investing in IPOs on the first day of listing can be considered almost a gamble as the company’s intrinsic value cannot be calculated or estimated with reasonable certainty. Just to give an example, I hesitated on investing in Swiber because it was a new IPO. Only after it released its 4Q 2006 results and after it clinched the Brunei Shell’s US$146.6 million contract did I decide to buy part of the company. Even then, it was after much tracking of its announcements, reading up on the industry and the business and the usual homework to be done before an investment is made.
My Conclusion: Do NOT be an eager beaver to invest in newly-listed companies. Most have non-existent track records and may list at the peak of their business cycle. Plus, in the current bull market, most IPOs are opening at super inflated prices versus their offer price, and are thus extremely risky to invest in. My advice is to do your homework and exercise patience in order to sift out the outstanding companies from the weak/mediocre ones. Once enough information has been obtained to make an informed decision, one can then safely invest in an IPO.
Thursday, August 02, 2007
End-July 2007 Portfolio Review
The final two weeks of July consisted of news flow as well as meetings with Management. Boustead held their AGM on July 30, Pacific Andes on July 31 while Swiber held their EGM on July 31. I attended all 3 events in order to speak to Management about the company’s direction and strategies and my comments were posted in separate blog posts for readers’ pleasure. Of course, at this time of writing, an interesting fact is that the market had just crashed 115.95 points on August 1 as a result of USA sub-prime mortgage worries. It is when companies are being priced cheaper by Mr. Market that they become more attractive to purchase. Of course, the reflex reaction from most people is to avoid, as some may end up being served with margin calls or left high and dry on contra. Investors usually see such sell-downs as ripe opportunities for picking up good stocks at cheap prices.
Below is my usual summary and rundown of my investments and related news as at July 31, 2007 (STI at 3,547.66 points):-
1) Ezra - Buy Price $1.30 (bonus adjusted), Market Price $6.25, gain 380.8%. On July 18, 2007, Ezra announced the appointment of Dr. Ngo Get Ping as the Group’s latest independent director. With 20 years of experience in the finance and stock-broking industry, Dr Ngo is qualified to add value to Ezra’s corporate governance and disclosure practices, even as the Group becomes more diversified as it grows.
2) Boustead - Buy Price $1.295 (average), Market Price $2.22, gain 71.4%. Mr. Wong (chairman of Boustead) bought more shares in Boustead, boosting his stake to 31.96% in this lightly-traded company. Their most significant announcement to date was on July 30, 2007 when they announced that their 91.7% owned Boustead Projects Pte Ltd had been awarded their largest contract to date: a S$74 million contract to build a high-tech building in Ubi, Singapore. This should contribute strongly to earnings for FY 2008, as well as FY 2009.
3) Swiber - Buy Price $1.01, Market Price $3.20, gain 216.8%. On July 25, 2007 Swiber announced the clinching of a US$12 million LOI in Malaysia. This will push their order book beyond US$200 million and cements their expansion in Asia-Pacific waters. An informal chat with the CEO Mr. Raymond Goh during the EGM told me that he is confident of breaking new markets as there is a “lot of potential” there, but Swiber has to rapidly build up its fleet first so that it can have vessels to deploy for its EPCIC activities.
4) Global Voice - Buy Price $0.1775 (average), Market Price $0.20, gain 12.7%. To make it short and sweet, GV announced two contracts between mid-July and end-July, one with ICE, and the other with Caveo. Investors can read the separate announcements on the technical details from the company’s website. Suffice to say that the only thing to do now is to wait for the company’s results in late August 2007. I am beginning to have a nagging feeling that this may yet turn out to be another one of my investment mistakes. If proven, it will be a good one to tell and learn from.
5) Suntec REIT - Buy Price $1.11, Market Price $1.90, gain 71.2%. Suntec REIT announced a good set of results on July 30, with DPU increasing 11.9% to 2.1 cents/unit from 3Q FY 2006. The dividend will be paid on August 29. In addition, Suntec also announced that they will be purchasing 1/3 of One Raffles Quay for S$941 million from Cheung Kong Holdings, which is held by Hong Kong tycoon Mr. Li Ka Shing. They have also purchased a piece of state land along Penang Road for S$15.9 million. This piece of land is 1,261 square metres and will be used for amalgamation with the existing Park Mall (which is under Suntec REIT’s portfolio of properties) to create an additional floor area of 5,825 square metres. These moves should greatly increase yield in the future and an EGM will have to be convened to seek shareholders’ approval on the acquisitions of One Raffles Quay.
6) Pacific Andes - Buy Price $0.665 (rights-adjusted), Market Price $0.80, gain 20.3%. Nothing much to report for PAH except my attendance at the AGM. This was my first time seeing the faces of the chairman and Board of Directors as their faces are usually conspicuously missing from the Annual Report. The business model seems sound and fishmeal prices have been steady, thus presenting the Group with a new viable revenue stream. One major worry and concern is the high gearing for PAH at about 117%, which Management did little to reassure shareholders about. I will be monitoring the 1Q 2008 results closely.
Overall Portfolio
My overall portfolio has increased by about 118.5% from a new cost of about S$44K as at July 15, 2007. The market value of my portfolio is around S$96.8K. Just for the record, this market value has yet to be supported by concrete earnings; we shall be seeing more earnings reports from Swiber, Global Voice and Pacific Andes in the month of August 2007.
My next portfolio review will be on Wednesday, August 15, 2007 after market close.
P.S. – Sorry for not using an Excel chart as I am in China now and can’t even view my own blog ! (China blocks access to all blogs) Thus, I am posting this directly from blogger.com. Please do leave your comments and I will answer them when I get back to Singapore by Saturday.
The final two weeks of July consisted of news flow as well as meetings with Management. Boustead held their AGM on July 30, Pacific Andes on July 31 while Swiber held their EGM on July 31. I attended all 3 events in order to speak to Management about the company’s direction and strategies and my comments were posted in separate blog posts for readers’ pleasure. Of course, at this time of writing, an interesting fact is that the market had just crashed 115.95 points on August 1 as a result of USA sub-prime mortgage worries. It is when companies are being priced cheaper by Mr. Market that they become more attractive to purchase. Of course, the reflex reaction from most people is to avoid, as some may end up being served with margin calls or left high and dry on contra. Investors usually see such sell-downs as ripe opportunities for picking up good stocks at cheap prices.
Below is my usual summary and rundown of my investments and related news as at July 31, 2007 (STI at 3,547.66 points):-
1) Ezra - Buy Price $1.30 (bonus adjusted), Market Price $6.25, gain 380.8%. On July 18, 2007, Ezra announced the appointment of Dr. Ngo Get Ping as the Group’s latest independent director. With 20 years of experience in the finance and stock-broking industry, Dr Ngo is qualified to add value to Ezra’s corporate governance and disclosure practices, even as the Group becomes more diversified as it grows.
2) Boustead - Buy Price $1.295 (average), Market Price $2.22, gain 71.4%. Mr. Wong (chairman of Boustead) bought more shares in Boustead, boosting his stake to 31.96% in this lightly-traded company. Their most significant announcement to date was on July 30, 2007 when they announced that their 91.7% owned Boustead Projects Pte Ltd had been awarded their largest contract to date: a S$74 million contract to build a high-tech building in Ubi, Singapore. This should contribute strongly to earnings for FY 2008, as well as FY 2009.
3) Swiber - Buy Price $1.01, Market Price $3.20, gain 216.8%. On July 25, 2007 Swiber announced the clinching of a US$12 million LOI in Malaysia. This will push their order book beyond US$200 million and cements their expansion in Asia-Pacific waters. An informal chat with the CEO Mr. Raymond Goh during the EGM told me that he is confident of breaking new markets as there is a “lot of potential” there, but Swiber has to rapidly build up its fleet first so that it can have vessels to deploy for its EPCIC activities.
4) Global Voice - Buy Price $0.1775 (average), Market Price $0.20, gain 12.7%. To make it short and sweet, GV announced two contracts between mid-July and end-July, one with ICE, and the other with Caveo. Investors can read the separate announcements on the technical details from the company’s website. Suffice to say that the only thing to do now is to wait for the company’s results in late August 2007. I am beginning to have a nagging feeling that this may yet turn out to be another one of my investment mistakes. If proven, it will be a good one to tell and learn from.
5) Suntec REIT - Buy Price $1.11, Market Price $1.90, gain 71.2%. Suntec REIT announced a good set of results on July 30, with DPU increasing 11.9% to 2.1 cents/unit from 3Q FY 2006. The dividend will be paid on August 29. In addition, Suntec also announced that they will be purchasing 1/3 of One Raffles Quay for S$941 million from Cheung Kong Holdings, which is held by Hong Kong tycoon Mr. Li Ka Shing. They have also purchased a piece of state land along Penang Road for S$15.9 million. This piece of land is 1,261 square metres and will be used for amalgamation with the existing Park Mall (which is under Suntec REIT’s portfolio of properties) to create an additional floor area of 5,825 square metres. These moves should greatly increase yield in the future and an EGM will have to be convened to seek shareholders’ approval on the acquisitions of One Raffles Quay.
6) Pacific Andes - Buy Price $0.665 (rights-adjusted), Market Price $0.80, gain 20.3%. Nothing much to report for PAH except my attendance at the AGM. This was my first time seeing the faces of the chairman and Board of Directors as their faces are usually conspicuously missing from the Annual Report. The business model seems sound and fishmeal prices have been steady, thus presenting the Group with a new viable revenue stream. One major worry and concern is the high gearing for PAH at about 117%, which Management did little to reassure shareholders about. I will be monitoring the 1Q 2008 results closely.
Overall Portfolio
My overall portfolio has increased by about 118.5% from a new cost of about S$44K as at July 15, 2007. The market value of my portfolio is around S$96.8K. Just for the record, this market value has yet to be supported by concrete earnings; we shall be seeing more earnings reports from Swiber, Global Voice and Pacific Andes in the month of August 2007.
My next portfolio review will be on Wednesday, August 15, 2007 after market close.
P.S. – Sorry for not using an Excel chart as I am in China now and can’t even view my own blog ! (China blocks access to all blogs) Thus, I am posting this directly from blogger.com. Please do leave your comments and I will answer them when I get back to Singapore by Saturday.
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