A Young Investor's Diary

Swiber Holdings - When Cheap is not Cheap and Perpetual is not Perpetual

2015-09-16T23:10:00.000+08:00

Share price of Swiber Holdings has fallen more than 60% in the past 1 year due to the sharp fall in crude oil prices which has caught many investors off-guards. At the current share price of SGD $0.136, Swiber Holdings is only trading at a price to book ratio of only 0.156x (based on 2Q15 NAV of USD 0.621 and exchange rate of 1 USD to 1.4 SGD). Is it considered cheap?

When Perpetual is not Perpetual

Perpetual bond is an attractive financing tool for company as they are able to treat the security as an equity to lower gearing ratio. The rationale behind the accounting treatment is that 1) the company can choose not to repay the perpetual bond indefinitely 2) the interest paid can be deferred.

However, financiers are known to creative in the way that a security can be structured. In the case of Swiber, the perpetual bond is structured such that Swiber is likely to redeem the security 3 years from the issuance date of 25 Sept 2012 (which they have announced that they have the intention to redeem). A step-up margin of 3% is imposed on the perpetual bond every 3 years. This signifies that Swiber will have to pay an interest rate of 12.75% if Swiber don't redeem the perpetual next month. If Swiber don't redeem in 2018, the interest rate will jump to 15.75%.

Given such onerous step-up margin every 3 years, it is questionable whether these securities meet the accounting treatment of equity. Swiber is not the only company that issues perpetual bond that has high step-up margin and a short reset date of 3 years. Ezra did a dilutive rights issue recently so that it can redeem its S$ 150 million 8.75% perpetual bond issued on 18 Sept 2012 with a similar step-up margin of 3% every 3 years. Ezion also has a S$ 125 million 7.8% perpetual bond issued on 14 Sept 2012 with a step-up margin of 3% every 3 years again. If you have noticed, all 3 perpetuals were issued in Sept 2012 with the same step-up margin every 3 years.

We will do the relevant adjustment for the perpetual later.

When Cheap is not Cheap

The issues that many investors have with Swiber is that it is highly geared and a persistently high receivables outstanding. These are certainly valid concerns and a look at its balance sheet shows a high liquidity risk.

The reported debt to equity ratio for Swiber is 1.45x as of 2Q 2015. The gearing went down slightly after the rights issue early in the year. Gearing ratio gives us a clue of the extent of indebtedness and default risk for a company. However, it is only when a company is unable to repay (default) on a bond/loan, that equity value will be threatened.

Swiber is likely to repay the S$ 80 million perpetual security on 25 Sept 2015 (they have started buying from the open market). Therefore, if the company don't generate any free cash flow or get additional loans from the bank, the cash level for Swiber will dwindle down to USD 60 million.

Next year, Swiber will have 3 bonds with a total principal amount of SGD 305 million to be redeemed upon maturity. It is highly unlikely that Swiber will be able to repay the bonds with its current cash level. What alternatives are available?

http://www.sgx.com/wps/portal/sgxweb/home/listings/listing-debt-securities/evaluated-bond-prices

1) Issue another bond - With the yield to maturity at more than 30% (look at the column - Evaluated Bid Yield) for most of its bonds, Swiber is effectively shut out of the bond market. Swiber will need to offer a bond yield of close to 30% for its new bond issuance, else an investor will be better off to invest in the current bonds which offers higher yield and shorter maturity (lower default risk).

2) Raise equity - Swiber has a current market capitalisation of SGD 136 million. At the current huge discount to book value, a rights issue will only destroy more shareholder value. It is highly probable that Swiber will do another rights issues or share placement, but the amount of equity that can be raised will be highly limited.

3) Sell assets - Swiber has USD 748 million of PPE as of 31 Dec 2014. However, USD 241 million of it is finance lease, which means Swiber don't have ownership of the assets. In addition, Swiber has pledged USD 221 million of assets for bank borrowings. These assets are secured and will be difficult for Swiber to sell (or if sales happen, likely that money will be used to repay the secured loan). This leaves the company with USD 286 million of PPE that can be sold. With the current downturn in O&G industry and the lower charter rates, Swiber will have to sell the remaining salable assets at a discount to its carrying value.

4) Collect trade receivables - Swiber has current trade receivables of USD 443 million, other receivables of USD 377 million. Of the trade receivables , USD 76 million arise from "unbilled receivables arising from variation claims on construction contracts submitted to customers amounting to US$76,447,000". The sum is unbilled and arising from variation claims does not sound good. In addition, 1 debtor represents 50% of the trade receivables in FY 2013 and FY 2014. Who is this debtor and does the debtor has the ability to pay the receivables? There might be a need for further impairment.

As for the other receivables, USD 75 million are capitalised vessel cost which is capitalised expense that is more like prepaid expenses. The rest are mostly receivables and loans from joint venture and associates. The bulk of the other receivables are likely to be in its 27% owned Vallianz Holding. However, if one take a look at the balance sheet of Vallianz, it is doubtful how Vallianz will be able to repay the loans.

http://vallianz.listedcompany.com/newsroom/20150511_070303_545_45TKZ6CY3YPVL8QA.1.pdf

Swiber's Annual Report 2014

5) Borrow from bank to refinance bond - Swiber has a current bank borrowing of SGD 209 million which will be up for repayment. It is possible for Swiber to do a refinancing of its borrowing, but it will be tough to raise additional bank loan since banks will be looking to reduce their oil and gas exposure at this moment. This option will depend heavily on Swiber's banking relationship and the bank's risk management policies.

As an equity investor, we benefit from higher upside when the company reports higher profit. However, when a company is in distress, it is always the holder of the loans and bonds that get the priority claim over the assets of a company. With the limited options that Swiber has, even a successful repayment of the loan is likely to further destroy shareholder value.

Conclusion

Back to the question of whether Swiber is cheap, let's do some adjustment:

Adjustment for associates
Carrying value of its 27% owned associate Vallianz is USD 95.9 million (equity of USD 73.4 million and perpetual securities of USD 22.5).
Market value is 27% * SGD 163 million = SGD 44 million or USD 31 million
Adjustment: USD 42 million

After adjustment, Swiber is trading at around 25-30% of book value. However, this has yet taken into account 1) potential impairment of trade and other receivables of USD 871 million 2) potential impairment in market value of vessels. Swiber will be able to sustain a positive equity as long as it does not impair a maximum of 25% of trade and other receivables and its property, plant and equipment.

Do your own impairment adjustment and it is your call on the value of the equity. This is certainly a highly leveraged play!

Reflection on Silverlake Axis

2015-08-30T00:03:00.000+08:00

Sooner or later, the markets always humble people. I believe in it and have my fair share of being humbled. While I was not hurt in monetary terms as I sold it off 2 years ago on price discipline, it will be good to do a personal reflection.

http://sgyounginvestor.blogspot.sg/search/label/Equity%20Research%20Report%20-%20Silverlake%20Axis

My mistakes were

1) I failed to pay attention to the related party transactions
2) The past deals action did not come across as red flags to me as I thought I had invested in the new entity where the whole Silverlake Group is inside the listco.

I tend to be bias to the short seller and will be glad to have more short report in the market as it improves the market process and mechanism. Who is razor99? razor99 called a short on Longtop months before Citron launched a successful attack on the company. Longtop specialises in software catered to the financial institutions, an area similar to Silverlake. Both his experience with Longtop and the release of a fraudulent claim in May probably led razor99 to look into Silverlake.

The most damaging claim

Razor99 made many claims in his 42 pages report, including concerns of bribery. However, only 1 claim was truly critical. According to razor99's claim, margin at Silverlake was inflated through related party transactions. The evidence was a jump in revenue and margin at to-be-acquired entities. Another evidence was the losses suffered at Goh's private co such as Sprint.

Legally, it might be hard to accuse Silverlake of fraud as the company has followed the proper procedures:
1) The mandate for IPT was approved by shareholders annually since 2008 and had always been disclosed since the 2003 IPO
2) The details of the IPT was disclosed in the annual circular (inclusive of pricing)
( http://www.silverlakeaxis.com/investor-relations/financial-information/circulars.html )
3) Auditors will review every IPT transactions every year

What are the related party transactions (RPT)?

The IPT mandate approved by shareholder annually holds the critical information to understand the RPTs. In addition, lets take a look at Silverlake listco after 2011 since that is the current corporate structure.

Source: razor99 report

The bulk of the RPT revenue is from software licensing while the bulk of the RPT expense is from service fees paid.

RPT Revenue % per segment

To put the information in another perspective, it will be to view the segment revenue and determine how % of segmental RPT revenue against the actual segment revenue. It can be seen that the bulk of the software licensing revenue (more than half of it) comes from RPT. This deserves a deeper look since software licensing has the highest margin (90%) and account for at least 40% of Silverlake's profit.

Master License Agreement

Everything is properly accounted for under the MLA, inclusive of the minimum fee of US$20 million and how the points are allocated. Under the Master License Agreement (MLA), the interested person is granted the right to "resell, implement, copy, customise or use the software" and to "sub-license the right to use the Software to End-Users". Essentially, when the interested person wins a new software contract, Silverlake will earn a license fee while the implementation and employee costs are borne by the interested person. This explains the 90% profit margin for the software licensing revenue. You don't expect to pay any cost other than your R&D amortization and expenses.

Master Services Agreement

Under the Master Services Agreement (MSA), this deals with the receipt of "Customisation, Implementation and Maintenance services by the Group from the Interested Persons". The MSA explains the 50 million service fees paid, which is almost all of the expenses paid out to the related party. With the MSA, Silverlake sub-contracts or outsources part or whole of the implementation and maintenance job to the interested party for a fee. Once again, everything is properly accounted for with the use of "Man-Day Rates" and "estimated man-days required to complete the work"

Peer Analysis, Source: razor99's report

With an understanding of the MLA and MSA, it is a lot clearer why the peer analysis results in Silverlake having a low employee expenses %, much higher profit margin and much higher revenue per employee. A huge portion of a new software contract implementation is outsourced to the Interested Person. An unknown portion of the costs for maintenance and enhancement is also outsourced to the Interested Person.

Legally correct but still a governance concern

Being right legally is not equivalent to being right in principle to the shareholders though it is highly debatable in this case. Inevitably, the question in shareholder's mind will be what kind of profit is Mr Goh's private entity making from these MLA and MSA contracts.

If it is a loss, Mr Goh runs the risk of being accused of hiding expenses and inflating margin (although everything is properly and legally accounted for, so it is a false accusation).

And a subsequent question will be how long is he willing and able to sustain the loss on his own account? Ans: For as long as he continues to be generous. (With regards to the ability, high dividend payout creates a feedback loop and share sales can top up the remaining amount)
If it is a profit, why not share it with the shareholder to show an alignment of interest?
Even if it break-even, why not consolidate all the private co into the listco and nobody can accuse you of anything in the future?

There are of course numerous clues that point to 1 particular scenario above if one read razor99's report and understand what have been written so far on the MLA and MSA.

In any case, for proper corporate governance, it is still best to consolidate the private co into the list co as the Nash Equilibrium. Shareholders can recommend to Mr Goh and they also have the right to vote against the IPT.

OUE C-REIT

2014-02-06T08:56:00.000+08:00

OUE C-REIT, which comprises OUE Bayfront and Lippo Plaza, IPO at a price of $0.80. It offers investor a yield of 6.8% which is considered rather high for a non-industrial REIT. The price-to-book ratio is 0.77x which offers investor a 'discount' to the book value that is one of the largest among all the S-REITs. As always, the devil is in the detail.

Office properties are typically sold at a capitalization rate of 3.5% as compared to 5% for retail properties and 6.5% for industrial properties. However, the average dividend yield for office REIT is around 6.5% as compared to 6% for retail REIT and 7.5% for industrial REIT. Capitalisation rate is similar to PE in that it is Net Property Income (NPI) / Property Value. Obviously, something has to been done to pump up the NPI yield by 3%.

Same Old Tricks Again

Income Support is the favourite trick of all office REITs. It guarantees a minimum level of income and yield for the initial few years that will satisfy the need of the investor. The principle is that rental rate signed at the moment is much lower and is likely to grow in the future. The seller provides income support for the first few years until the positive rental reversion takes place which will render the income support useless. Income support is almost always needed whenever office REITs are looking to acquire new asset. Since 2007, most office properties acquired by REITs have income support in place. Let's examine the track record.

Figure 1 - Office Properties where income support expires

Figure 2 - Office Properties where income support has yet to expire

From figure 1, all 3 properties fail to meet the Income Supported NPI level at the time of acquisition. The final yields were all around 3.5%. Figure 2 refers to properties with income support provision that has yet to expire. Currently, none of them achieves organic NPI yield of more than 4% after exclusion of income support. This brings into question whether income support has merely been a gimmick all these while. Notice the difference in the NPI(With Income Support) and the acquisition price for MBFC (1/3 interest) acquired separately by Suntec REIT and K-REIT (since rebranded as Keppel REIT). The difference in acquisition price is likely due to the difference in net present value of the total amount of income support (difference of 17.6 million yearly) provided. At the end of the day, does not it seem like investors are the one paying for the income support to create the illusion of a higher yield?

The way I view income support is that growth is being purchased upfront. If the forecast growth is achieved, DPU does not increase as the growth in NPI compensates for lost of income support. If the forecast growth is not achieved, investor will suffer a drop in DPU after expiry of income support. Growth in DPU is achieved only if growth in NPI exceeds that of the forecast which is already likely to be aggressive in its assumption.

Figure 3 - Implication of Income Support

Lets get back to OUE Bayfront, the property that's provided with income support to guarantee minimum Gross Rental Income (GRI) of $57 million annually for 5 years. Total amount of income support is subjected to the limit of $12 million a year and $50 million in total for the 5 years. Based on the total NLA of 37,381.8 sq m and forecast GRI of $47.3 million in 2014, this works out to be average rent of $9.84 psf. To achieve the level of $57 million, average rent of $11.81 psf is needed. Current passing rent is only $10.4 as of September 2013. With Bank of America occupying 28.7% of OUE Bayfront's GRI with a long-dated lease term till 2021 (though there will be step-up clause) and that top 10 tenants account for 76.4% of total GRI (less bargaining power), there is likely to be no growth in DPU for next 5 years and a small possible downside after 2018. Figure 4 provides a comparison of how much of the distributable comes from Income Support or Capital Return, which is a sign of how sustainable the dividend is.

Figure 4 - Income Support/Capital Return as % of Distributable Income

Management Fees payable in Units or cash can affect the amount of income distributable to unitholders. It is equivalent to paying staff using share options instead of cash and has been mentioned in an earlier post on SPH REIT. The impact can be significant as seen from the 0.69% increase in distributable income by having 100% of Management Fees Payable in Unit in Figure 5. I have also done a comparison against other office REITs in Figure 6. The key importance here is that when distributable income drops during bad time, it is those who have been paying management fee in cash that can convert them into units and hence reducing the drop in DPU.

Figure 5 - Management Fees payable in Units

Figure 6 - % of Management Fee Paid in Unit

High Gearing is used to lever up the income for distribution. The low capitalisation rate for office building is why all the office REITs are much more geared as compared to other S-REITs. A 35% gearing ratio allows income for distribution to be levered by 1.54x (100%/65%) minus the finance cost (interest rate multiplied by 35%) In the case of OUE C-REIT, the 42.3% gearing ratio provides a leverage of 1.73x minus finance cost of 1.06% (Interest Rate of 2.5% x 42.3%). Therefore, the unlevered income for distribution will be 4.5%. ( [6.8%+1.06%] / 1.73) and leverage increases dividend yield by 2.3%.

Figure 7 - Gearing Ratio of Office REITs

Something Different

However, gearing ratio ( Debt/Investment Properties ) can be manipulated by the denominator. By valuing the investment properties higher than its fair value, REIT can actually artificially depress the gearing ratio to make the balance sheet appears more healthy. In fact, this point is linked to why OUE C-REIT is trading at a 23% discount to book value. The main reason why OUE C-REIT trades at a discount to book is due to the discount over fair value that OUE and Lippo China Resources offer to sell to OUE C-REIT.

Figure 8 - Valuation of Investment Properties

Figure 9 - Unitholders' Funds

The difference in purchase consideration and value on balance sheet is the revaluation surplus and this is how unitholders get a huge discount on book value in an IPO. For OUE Bayfront, the difference in purchase consideration and value is only 100 million or 10% of the value. At a NPI yield of 3.3%, maybe the valuation on OUE Bayfront is slightly aggressive based on the value on balance sheet. We do not have conclusive evidence for this. However, does not there seem to be a huge gap between the purchase consideration of Lippo Plaza and its valuation? Why is Lippo China Resources (LCR) so generous to offer a 30% discount though LCR is not even owning any equity stake in OUE REIT?

Firstly, Lippo Plaza is a 14 years old building sitting on a 50 years land lease that will expire in 2044. Therefore, investor is buying an older building with only 30 years of lease remaining. This is unlike OUE Bayfront which has a remaining lease of 92 years. The depreciation rate for Lippo Plaza is 3.3% which means that out of the 5.2% NPI yield, only 1.9% is investment return as the rest is form of return of capital. With remaining lease of 30 years, how is the valuation worth $476 million or 3.7% NPI yield? Industrial REITs usually trades at a higher dividend yield to account for their shorter land lease period of 30 to 60 years. Industrial properties tend to be bought at capitalisation rate of 6% to 6.5% to account for the higher depreciation rate.

Secondly, Lippo Plaza Property is based in Shanghai, so it will be different as compared to a Singapore property for REIT. One key benefit of putting a property into REIT is to get tax exemption. Foreign property in S-REIT is exempted from taxation in Singapore but they are still required to pay tax in their local country. In the case of Lippo Plaza, it is supposed to pay 25% of its taxable income and 10% withholding tax for dividend paid to OUE C-REIT. This works out to be around $3.5 million in taxes each year after deducting expenses or 20% of the net property income of $17.4 million. Therefore, the effective NPI yield for a like-for-like comparison with Singapore property will only be 4.2%. If we deduct another 3.3% of capital return, investor is only getting an investment return of 0.9%. And if we take into account expenses like management fee and finance expense, one should really wonder why did OUE C-REIT take up this property and value it at $476 million?

Figure 10 - Forecast Occupancy Rate for Lippo Plaza

Figure 11- Forecast Assumption

For the appraised value, OUE C-REIT adopts the higher of the 2 valuers which is the one by Colliers. Colliers has assumed a 5% annual growth rate in rental which seems aggressive. The assumed occupancy rate of 95% for office seems high as the highest it has achieved is 92.1% in the past 3 years. This is a 14 years old building and it is unlikely to compete well against the newer building when it comes to higher rental and occupancy rate. Perhaps we should look at Lippo China Resources for some clues.

Figure 12 - Snippets from circular

http://www.tricor.com.hk/webservice/00156/file/circular_listing/eng/E_Cir_20131117.pdf

Figure 12 contains some interesting opinions from the board of directors of Lippo China Resources. For LCR, Lippo Plaza is a mature 14 years old asset which requires high maintenance cost of around $6.5 million (not sure if it is one-off or annually). If LCR is realizing full value of its property at a 30% discount to valuation, then OUE C-REIT's revaluation is unjustifiable. The revaluation creates a "discount to book value" as well as reducing the gearing ratio. If we were to value Lippo Plaza simply based on its purchase price, the gearing ratio will now be 47.5% [ 681.4/ (1102+331.8) ]. This is the real incentive for having higher valuation - to disguise a much higher leverage.

This does not seem to be a rewarding deal to OUE C-REIT. LCR does not have to own any equity stake in OUE C-REIT while OUE needs to own 50% of OUE C-REIT. LCR needs not provide any form of income support unlike OUE which has to come up with $50 million for OUE Bayfront. OUE C-REIT bought a property with only 30 years remaining lease and does not enjoy tax-saving. While I do agree that Lippo Plaza only accounts for 30% of the total asset, this shows the incentive of the management. Why does not OUE C-REIT acquires both properties from OUE, instead of 1 from Lippo China Resources? The likely reason is that OUE is at the bottom of the pyramid with listed parent companies like Hong Kong Chinese Limited and Lippo Limited. The incentive is to reward the top more than the bottom. Certain management team and owner always have a consistent reputation and track record for being shareholder friendly or otherwise. It might be a good idea to take a look at the performance of some of the other Riady's companies listed in Singapore.

To conclude, a lot of work has been done to push the yield up and make it looks more attractive. The fundamental difference in office cap rate and dividend yield results in a situation where Office REITs often resort to numerous tricks. Yield accretive acquisition is also unlikely to take place with its current dividend yield and 42% gearing ratio. As with all REITs and investments,it is not about avoiding the risky one but a question of whether the current yield sufficiently compensates for the underlying risk of the REIT. Investor will probably do better to demand a much higher yield than 6.8% for OUE C-REIT.

Purchase of Frasers Centrepoint Limited

2014-01-19T11:25:00.002+08:00

I purchased Frasers Centrepoint Limited (FCL) on the first day of trading after the spin-off. Opportunities seem to be getting lesser in the Singapore market and I decide to venture into my first special situation play. I am guided and inspired by "You can be a stock market genius" by famed investor Joel Greenblatt. He is probably more known for his magic formula than his book on special situation. Given that this is my first time, I am not exactly confident if it will work out well and do correct me if I make any mistake.

A few special situations have occurred after the successful control of FNN by Thai Billionaire's Chareon. The first was when F&N was dropped from the MSCI Index, leading to index selling by many fund managers. The key to spin-off and index selling is to identify motivated seller who are selling not for fundamental reason. The return was 12% gain in 3 weeks, very nice annualized return. In addition, there is the catalyst of a debt-laden LBO owner who is desperate to reduce his debt. This did play out on hind sight as FNN declared a capital reduction of $3.28. At that time, I was not aware of such special situation so I did not catch it though quite a few at valuebuddies manage to make a good profit out of it.

In August 2013, details of the spin-off of FCL was announced. 2 shares of FCL will be given out dividend-in-specie for every 1 share owned in FNN. After the spin-off, FNN will be in 900 mil net cash position while FCL will take on 2 billion of net debt. It took another 4 months before the spin-off, which provides investors ample time opportunity. I looked into it during December when it was around $5.60 to $5.70. Valuation is easy since one has access to the JP Morgan's circular for independent director (during the bid for FNN by OUE and Chareon) and prospectus of FCL. At that time, I estimated a combined value of around $6.03 for FNN - $2.45 per share for FNN (Market Cap of 3,550 mil) and $1.79 per share for FCL (2 shares).

It seem like my valuation of FNN is off by a huge margin as FNN is currently trading at $3.48 per share and was trading probably near $3.80 on the xd date. What happened? Firstly, we will have to understand that FNN is now a holding company whose wholly-owned operations are only FNN Singapore and Publishing. I am sure my figure for the 56% stake in FNN Berhad is correct (http://investing.businessweek.com/research/stocks/snapshot/snapshot.asp?ticker=FNH:MK) since it makes no sense that this 56% stake that FNN owned should be more than the value of FNN Berhad. Even if FNN Berhad is undervalued, it makes more sense to buy FNN Berhad instead of FNN. In any case, with its PER of 25 x, this certainly don't seem to be the case. Net cash of $900 million is also accurate. Vinamilk is a listed entity, so it will be same reasoning as FNN Berhad. Publishing is valued at $300 million using EV/EBITDA method, but I only give it $100 million as it is not profitable. I am not sure if there will be people to buy it at $300 million. Even if it is valued at $300 million, it will only push valuation up to $2.60 per share.

FNN Singapore's valuation

Myammar Brewery Limited's valuation

That leaves us with only FNN Singapore and Myammar Brewery (MBL). FNN Singapore is not profitable and even if we use the transaction favourite metric EV/EBITDA, it is hardly cash generative especially if you subtract the capex. Thus, I just gives it a valuation of $100 million to be conservative unless this is just a temporary dip in net income. It seem like FNN Singapore's role is to own the brand and licensed it to FNN Berhad. Therefore, the only likelihood that market is paying a fair price for FNN at $3.48 will be if MBL deserves a valuation of $1.7 billion for the 55% stake. This will value it at nearly 60x PE, which I supposed the growth and dominance of MBL in Myammar should have been fully priced in. In addition, let's not forget that FNN is fighting a legal battle on the ownership of MBL at the moment. In any case, FNN certainly don't look attractive at the moment.

I do have 1 final explanation for the valuation of FNN. Let me quote a paragraph from the Genius, "As a general rule, even if institutional investors are attracted to a parent company because an undesirable business is being spun off, they will wait until after the spinoff is completed before buying stock in the parent. This practice relives the institution from having to sell the stocks of unwanted spinoff and removes the risk of spinoff transaction not being completed."

Purchase of FCL

After I miss the ride on FNN, I have slightly more than a week to look at FCL. Once again, I was inspired by Joel Greenblatt's story on his Host Marriott and Marriott International trade. Marriott got into huge debt and the plan was to leave behind the hotel properties and all of the company debt at Host Marriott while spinning off the debt free and highly desirable management contract business in Marriott International. While everybody will have gone for Marriott International, Joel Greenblatt targeted Host Marriott, the company known to be left with toxic waste. As he thought "Who the hell is gonna want to own this thing?" Nonetheless, this is not just a simple contrarian play, but he bought it as he believed there is some value in Host Marriott that people will not have noticed. You can read his book to understand more about the story, but now I am going to touch on FCL.

Reasons for purchase

I was attracted to look into FCL as I believed that most people buying FNN was looking at the consumer staple business and not the property business. RNAV is out of reach and far too complicated for most people. With the property developer taking a hit after TDSR which has been effective at driving down property sale, property don't seem to be the hottest stock in the market. There is also no brokerage covering the stock before the spin-off and issuing a call. In addition, FNN declared a $0.42 dividend compared to FCL's $0.0173 dividend after the spin-off. FNN is in a net cash position as compared to FCL net debt. Thus, it is likely that most people are going to sell it away on the first day of trading regardless of fundamental. With many selling on the first day and much lesser people buying, this creates an opportunity.

FCL is not exactly just a property developer. It has 2 REITs, Frasers Commercial Trust and Frasers Centrepoint Trust, with total AUM of $3.5 billion. In addition, it has hospitality management contracts of 5,728 rooms where it does not own the serviced residence but is involved in managing the operation. This is an asset-light business similar to Marriott International. In LTM Jun 2013, this generated 37.8 million in profit before taxation for FCL which is rather comparable to ARA which generated 86 million in profit before taxation for FY 2012.

There has been ongoing news from the management that they are looking into setting up a hospitality REIT together with TCC Assets. FCL has 14 hospitality properties with 2280 rooms and book value of around $1.6 billion. It is likely that only a portion will be spin-off at the IPO. This will certainly help drive their AUM further up and allow them to monetise their asset to adopt an asset-light strategy where they will earn more REIT management fee and own the lucrative hotel management contract.

Non-REIT Commercial and Retail Properties

More importantly, FCL will have 3 different platforms to unload their assets to recycle capital - Retail, Office and Hospitality. On the balance sheet, the 50% stake in Changi City Point with book value of $199 million and fair value of $286 million has been classified as properties held for sale. By definition, properties held for sale are properties that the company intend to sell rather than to hold for rental or capital appreciation. It should not be an issue for FCT given its gearing ratio at the moment. FCL also have mature assets that can be offloaded to the REITs.

One of the greater concerns about Singapore residential developer will be that TDSR and the other cooling measures will lower their ability to sell the properties. Private home sales have indeed dropped quite a lot with 2013 annual new home sales volume 30% lower than 2012. However, this should not be a major concern for FCL which has 91% of Singapore residential units pre-sold and total unrecognised revenue of $2.4 billion. In Australia, approximately 56% have been pre-sold and it has a sizeable land bank.

Valuation

Valuation is not that complicated as Knight Frank, CBRE and DTZ have been hired to do the fair valuation (http://fraserandneave.com/contentview.aspx?article_id=3938) back then. I adjusted for the lower valuation of the 2 REITs as well as for the difference in book value of the circular and the latest prospectus. In addition, JP Morgan did not revalue and attribute future profit to the land bank. Do note that this figure is just a ballpark figure and is never the exact RNAV. You might also choose to adjust differently and arrive at your own RNAV. With the bulk of the revaluation surplus attributable to the pre-sold residential units and that an hospitality REIT is likely to come, it seem like there is a possibility for the discount to RNAV to narrow. Thus, I bought it at $1.50 on the first day. If we consider OUE's bid for FNN at 12.7 billion and subtract away the $2.7 billion of F&B business for Kirin, $900 net cash of FNN and $4.6 billion of dividend given out, that will imply that OUE values the property business at $4.5 billion or $1.55 per share. This excludes the interest cost that OUE has to take on to take over FNN.

Downside Risks

I have also identified a few risks that might adversely affect this special situation play.

Firstly, the free float of FCL is only 12% which means that there will be limited number of motivated sellers as compared to a stock with much higher free float. However, with a market capitalisation of around $4.5 billion, this will work out to be $500 million free float. Together with limited buying interest, I think the chance of motivated selling outstripping buying interest should not be too low. On the first day, total volume was around 5 million shares or total value of around $7.5 to $8 million. Thus, the extent of motivated selling was indeed limited though it helps that people are not comfortable with valuation of such company.

Shareholding Structure

Secondly, another concern that arises will be whether Chareon will take advantage of the minority shareholders. This is definitely a valid concern especially in Asia when we are dealing with the Godfathers. Chareon has a control interest of 88% and direct shareholding of 76.5%. Since the difference is only 11.5%, the probability of Chareon taking advantage of the minority shareholders is much lower given the alignment of interest. The danger comes in the form of a series of pyramid structure where the top will benefit at the expense of the bottom. If the asset swap took place, the effective shareholding of Chareon in FCL will rise. On the other hand, shareholders might need to be careful if he starts placing out more of his shares. We shall pay more attention to the hospitality REIT and potential sale of hospitality asset to FCL for signal of how shareholders will be treated.

Lastly, the share swap of FNN shares for FCL might incentivise the management to drive up price of FNN and drive down price of FCL temporarily. TCC Assets is more important to Chareon than Thai Beverage given the difference in ownership. Thus, it does make sense if TCC Assets wants to exchange its FNN shares for more of FCL shares. The share swap is not a market rumour if one looks at pg 63 of FCL prospectus under the Moratorium:
"In this regard, the SGX-ST has granted a waiver from the requirements under Rules 228 and 229(1)
in respect of such InterBev-TCCA Transfer during the Lock-up Period so long as it does not result in a
reduction in the effective interest of the ultimate controlling shareholders of our Company during the Lockup
Period".

No one knows how the share swap will occur as TCCA's 59.4% interest in FNN is almost double that of Thai Beverage's 28.6% interest in FCL even after the capital reduction of $0.42 at FNN. Given that FNN is a holding company, Thai Beverage may not need to buy over all the shares of FNN. Thai Beverage only needs 50% shareholding for control and consolidation of FNN's results into its financial statement. Controlling 100% or 50% of FNN will still gives it the same 55% shareholding right over FNN Berhad without the need to raise further debt or equity to acquire more of FNN.

At the current price of $1.61, I no longer feel as comfortable adding more of it. This has been an experiment into spin-off to apply what I have learnt from Joel Greenblatt's book. I do admit that this is definitely not the best spin-off situation given the limited free float though this is offset by a hidden opportunity in its REITs management, hospitality management business and its 91% pre-sold Singapore residential project. The holding period is likely to be less than a year as compared to my usual holding period of at least more than a year. Many of the points made earlier are speculative in nature so please do your own research and analysis.

(vested)

Divestment of Silverlake Axis and The Hour Glass

2014-01-02T23:20:00.001+08:00

I have divested both companies around the period of October and November. Here's the reason for divestment:

Silverlake Axis

Silverlake was divested at the price of $0.795 though it went on to rise to an all-time high of $0.95. On hindsight, this looks like a mistake especially since it went up by 5% the day after I sell it. When to sell a stock seems to be a harder decision than when to buy and I know that I will never get to sell it an all-time high. Hence, the important thing will be for me to look at my reasons to sell 1-2 year from now to see if it makes sense.

The main reason is because of the high valuation of the stock which I get a bit uncomfortable of. At the price of $0.795, it works out to a market capitalization of $1.786 billion ( based on 2,247 million shares, inclusive of the 100 million share placement in June 2013). This represents a PER of 23.7 x based on exchange rate of 2.6 RM to 1 SGD and FY 13 net profit.

However, one has to take note that only the maintenance and enhancement services is recurring in nature and this accounts for only 40% of the EBIT, which works out to be around RM 92 million in NPAT. PER based solely on the maintenance and enhancement business will be around 50x. Obviously, it is not realistic to value Silverlake solely based on its recurring segment, but it should be somewhere in between. The rest of the business is largely order book driven and is likely to be more volatile in nature.

The next question will be how well is Silverlake Axis expected to perform going forward since it is the future profits that matter. Back in 2010, Silverlake Axis secured 4 contracts worth SGD 210 million, with the HNA and CIMB contracts contributing the bulk of it. Since then, they have secured 2 integration project in 2011, 2 small licensing project in Malaysia, RM 135 million contract in 2Q 2013, Hong Leong's EPP and Union Bank of Colombo in 3Q FY 2013. Ever since the bumper crop in 2010, the total dollar value of contracts secured from 2011 to 2013 are still likely to be much lower than SGD 210 million. Total software project services and licensing contract remaining should be around RM 300-350 million which is around 1.5 year of the segmental revenue in FY 2013.

Silverlake Axis cannot really be blamed since CIMB is the 2nd largest bank in Malaysia. 5 of 7 largest banks in Malaysia, UOB, OCBC, 4 of 10 largest banks in Indonesia are already using their software. To get another project of similar size, the only potential client is RHB. Thus, it is unlikely that Silverlake Axis can continue to achieve its current level of software licensing revenue after FY 2014. At the current valuation, market seems to have priced in more than its achievable growth, believing that Silverlake will be able to grow its orderbook further than the level in 2010. 1Q 2014 results has been boosted by a RM 8.3 million gain in forex and inclusion of Merimem results.

Back when I initiated it in March 2012, the key thesis is that maintenance and enhancement profit will rise significantly such that PER based solely on the recurring segment will decrease from 20x to ~15x while the other order book revenue will serve as bonus. This has worked out and given that the market has more than priced in the growth potential, a decision to sell has been made. As of writing, price has gone to $0.910, which is at a PER of 28x. Potential catalyst will be new mega order win and perhaps the listing of its Chinese associates.

The Hour Glass

The Hour Glass (THG) was divested at the price of $1.645, at a PER of 8x. Due to the high working capital requirement, free cash flow has been around 30-45% of net profit which is a reason why it may be hard to expect much positive re-rating of stock.

Days Inventory Turnover has been more than 200 days as the luxury industry is hit by unexpected clampdown on luxury spending by the government in China since last October. Despite increase in sales by 14% from the increase in store network, profit has dropped by around 6% for past 2 quarters as gross margin has been hit. While THG has remained relatively more resilient, the margin pressure comes from industry wide inventory clearance as they are trying to de-stock. This does show the inherent weakness of retailer as the consumers identify more with the brand of the watch than the retailer. The ability to fend off competition is limited though the operation has been well managed as compared to others.

Return has been good since it was bought at 5x PER and decision to sell was made to clear off the weaker stock in the portfolio.

It has been quite some while since I last posted as I had been pretty busy with school. Not that I have given up analyzing stocks as I have actually analyzed more companies in greater detail than 2012, but it is just not blogging about it. Going forward, hopefully I will have more time to do so.

Currently, I am left with VICOM and Boustead, being in 55% cash position. There has been a lingering thought to liquidate the whole portfolio since the potential upside has been greatly reduced given current price. It is not too hard to sell away 2 stocks too. While the portfolio has delivered good return, I have also learnt about the numerous blind spots that I have missed in each companies that I have owned. I have learnt a lot more stuff over the past 2 years and it might be a good idea to restart to apply what I have learnt.

SPH REIT - A Lesson on Financial Engineering 101

2013-07-22T08:25:00.000+08:00

SPH REIT is a spin-off from SPH, comprising of Paragon Mall and Clementi Mall, offering an annualised yield of 5.58% for FY 2013. At this income supported yield, it offers a 0.5% higher yield than CMT and 0.2% lower than Fraser Centrepoint Trust. Retail REIT has always been a favourite of REIT investor due to their defensiveness and ability to squeeze extra rental cost from the tenant.

However, why is it that they delayed their listing on 24th June 2013 before lodging their prospectus on 9th July 2013? In a mere 3 weeks, an unattractive IPO is now the hottest thing on the market, with an indication of interest from institutional investor being 42x the placement tranche. http://www.stproperty.sg/articles-property/singapore-property-news/sph-reit-attracts-strong-institutional-interest/a/128627 . At the end of the day, many investors define the attractiveness of a REIT based on the yield. This prompts me to look at what forms of financial engineering have been used to increase the yield. Shall start the analysis with the most obvious and end with the hidden trap. The hidden trap is what that allows SPH REIT to be priced at 0.5% higher yield than CMT.

99 Years Lease. Similar to K-REIT, SPH sold a 99 years lease of Paragon Mall to SPH REIT while retaining the freehold ownership of Paragon Mall in our prized Orchard Road. According to the Knight Frank valuation certificate on the circular by SPH, Paragon mall is worth $2.61 billion as a freehold property and $2.5 billion as a 99 years leasehold property. The Freehold Lease is worth only $110 million, which is ridiculous. Who will not want to pay an extra 4% of their property value to upgrade their property from a 99 years lease to freehold? 99 years lease represent a 1% depreciation each year, which means the payback is theoretically 4 years to secure the freehold right. Of course, it is likely that maintenance and capex will be needed for an asset past 99 years.

Income Support. SPH has guaranteed that Clementi Mall will produce $31 million in NPI for the next 5 years. The reason is that Clementi Mall is a relatively new mall and that the current rent signed is lower than the market rental. Income support is common for such new property, but does SPH really lose money from providing income support? According to the valuation report in the prospectus, the $570 million Clementi Mall is only worth $550 million without the income support. Projected NPI from Clementi Mall is $26.7 million in FY 2014. On the conservative assumption that it remains the same for the next 5 years, SPH will provide a total income support of $4.3 million x 5 = $21.5 million. Thus, SPH is unlikely to have to fork out more money by providing the income support on a net basis (it earns extra $20 million from selling at $570 million). Yet, investor can be sold on a higher dividend yield though it is a partial capital return of the IPO investor. In addition, given the income support for 5 years, it means that growth for Clementi Mall will already be factored in for the unitholders unless they can grow their NPI beyond the income support mark of $31 million.

Lower capitalisation rate in valuation. The gearing ratio of 27% looks attractive and helps to alleviate fear of rising interest rate. However, gearing ratio can be engineered through a change of the property valuation which is the denominator. A cap rate of 4.75% and 5% have been used to value Paragon Mall and Clementi Mall (the income support has been taken into account) respectively. In comparison, CMT uses an average cap rate of 5.4% to 5.85% while FCT uses an average cap rate of 5.50% to 5.75% to value their properties. Some might argue that as 99 years leasehold asset, they should be worth a much higher valuation than the 70+ or 80+ years remaining leasehold asset. However, Atrium@Orchard with 94 years remaining lease and Yee Tee Point with 92 years remaining lease do not have a lower cap rate. This reflects how conservative or aggressive a management has been in valuing the property and thus tweaking the gearing ratio.

Source:

http://capitamall.listedcompany.com/newsroom/20130514_175959_C38U_4FA4342B033816C448257B6B00363F02.1.pdf

http://infopub.sgx.com/FileOpen/Investor_Prestn_June_2013_Cit_Asean_Conf.ashx?App=Announcement&FileID=245672

Lower interest rate. According to the prospectus, SPH REIT has been assumed to pay a constant 2.35% interest rate on its loan. The $850 million loan is to be repayable 1/3 each in 3,5 and 7 years time which gives an average loan maturity of 5 years. s of 31 March 2013, the effective interest rate for FCT and CMT are 2.73% and 3.3% on average term to maturity of 3.35 years and 4 years respectively. How did SPH REIT manage to secure a lower interest rate of 2.35% and higher term to maturity of 5 years when the fear is that interest rate is going to rise in the near term? Firstly, I cannot find the exact interest rate charged on the loan in the prospectus and the 2.35% has been quoted as an assumption. Thus the actual interest rate might be much higher than the assumed 2.35%.

Even if the assumption is true, how did SPH REIT do it? They actually got a secured loan over Paragon Mall which accounts for 80% of their total value. CMT's unencumbered assets as % of total asset is 76.7% and FCT is 43% compared to 20% for SPH REIT. (Unemcumbered means the asset has not been mortgaged. A secured loan is cheaper than an unsecured loan. However, when financial crisis comes, an unsecured asset might be what that will give the bank the confidence to lend you money. Thus, by taking a secured loan up to 80% of their total asset, SPH REIT is taking a higher refinance risk as compared to CMT and FCT just to inch out a lower interest rate and hence 0.19% higher dividend yield. On the other hand, it is likely that CMT will not face much refinancing issue given their unencumbered assets and well-spread debt profile.

The Finale

This is the most important point to take note of on how SPH REIT actually financial engineered a 0.5% higher dividend yield than CMT using an old, legal and similar technique of option expensing.

The Manager's management fee is $15.2 million in FY 2014 and they have chosen to be paid 100% in units. This is equivalent to taking a stock option, which convert employee's cash expense into 0 though it actually results in dilution in EPS the subsequent year. The $15.2 million to be paid in units is equivalent to 11.6% of the Income Available for Distribution. In contrast, the proportion of management fees paid in unit as percentage of Income Available for Distribution is only 1.5-2.5% for CMT and FCT.

Looking at the DPU sensitivity yield above, if SPH REIT were to take 100% of management fee in cash, the annualised yield for SPH will drop to 4.93% and 5.15% for FY 2013 and 2014, which will price it at a lower dividend yield than CMT. This is but a financial engineering move as the dilutive effect and selling of shares will weigh on the share price in the long run. The reason why the management fee is such a high percentage of distributable income is because SPH charges 0.25% of asset value and 5% of NPI as a REIT Manager and 2% of Revenue and 2% of NPI as a Property Manager.

To conclude, it is certainly not fair to simply compare the dividend yield of the REIT and determine how attractive it is. As always, the devil is in the details and I believe the market is a weighing machine in the long run.

Random Thoughts on Investing

2013-07-01T20:10:00.000+08:00

Ever since I got started in Sep 2011, I have been in the market for close to 2 years. I have had many thoughts about investment but have yet to pen them down. This will be random thoughts about investing and the lessons that I have learnt. I can't find a way to categorise them, so there's no structure and it's pretty messy.

Value investment is not about buying something at ridiculously low PE/PB nor buying a company with a sustainable competitive advantage. Neither is it about buying low nor selling high. Who purchases an equity share without believing that he is buying low and selling high? Or rather who buys the share of a company believing that he is buying high and will be selling low? No one, but belief and action often diverge in the market.

Whether it is buying Graham's net-net or buying Buffett's strong moat company, these are merely manifestation of the underlying value investment philosophy. It is easy to be confused that anyone buying the same "value investment kind" of company as Buffett, Seth Klarman and e.t.c. are value investors. One might even buy the exact same companies at the exact same price as the renown value investors are, but that will not make you as successful as they are.

The 2 key principles that define a value investor lies in Mr Market and margin of safety. They are mentioned in the famous chapter 8 and 20 of The Intelligent Investor. Mr Market is the fluctuation in prices of securities and mood of the market. One can profit from the maniac of Mr Market if he is able to control his emotion and avoid being a slave to Mr Market. Understanding the existence of Mr Market entails that price fluctuation and volatility is part and parcel of the market. Price can move in either direction and intensity regardless if you have made the right decision. However, by making the right decision, you know you will come up right in the long run.

Margin of safety is about protecting your downside and reducing the risk. This is often quoted as buying something worth $1 for $0.50. There're many reasons for it:
1) We might make an error in our judgement of its fair value
2) We do not have perfect information to make a good judgement
3) There's no way we can predict the future with 100% accuracy
4) It might be fake/fraud
5) Black Swan ( Anything that you can't think of - that's why it's called black swan)

Margin of safety is demanded in areas other than the price. Diversification is needed because you do not want to let a single mistake or black swan wipe you off the game. However, the problem is that people often diversify for the sake of diversifying, which increases their risk instead of reducing it. Diversification should be done only if one can find a company that can offer similar or even better risk return profile than the portfolio.

Investing is a game of probability or even a gamble. Before the outcome is out, there's no way to know if we will win or lose. In a casino game, the edge is always with the house and statistically we will lose money in the long run. However, the game in the market differs from the casino as the autonomy is with us. We get to decide the probability of the game by choosing which hand we are interested to play. If we consistently choose to play a game where the risk reward ratio is not attractive, we are likely to lose money in the long run. If we choose to play a game only when the odd is highly tilt to our favours, we are likely to profit in the long run.

Over a long period of time, the law of large number will ensure that your investment return will track the kind of odds that you play with. However, in the short run, it is easy to assume that early success equates ability to spot games with asymmetrical risk return profile where others are not capable of. Success in investing does not come from out-performance in the market, though that is the easiest method of evaluation. Instead, an investor should focus on the analysis and decision that he has made.

As it is a game of probability, excellent analysis and decision made does not equate to a rise in share price. Even if the share under-performs, an investor should not blame himself if he knows that he has made the right analysis and decision at that point in time. Instead, he should continue making the same kind of decision if he knows that he did not make any mistake. Do not let a good decision gone wrong becomes a baggage for you in the future. In a game of probability, we can never be right 100% of the time even if we made the right decision 100% of the time. Similarly, if you have profited in a situation where you made an erroneous analysis or decision, be glad that it didn't cost you a penny but remind yourself that you should not repeat the same mistake.

While a fan of Buffett might not be interested in cigar butt or a fan of Graham will not be interested in investing in an excellent business at fair value, they are not contradictory in nature. One is buying at a discount to future value while another is buying at a discount to present value. Benjamin Graham knew that he cannot predict the future with much accuracy and feel that it is much safer to look at the current state of the company than future profitability. Warren Buffett's experience with Berkshire Hathaway as a textile business taught him that finding great companies that are able to consistently deliver return above the cost of capital is likely to present a more attractive option. Both are great and they play the game according to their personality, style and area of competency. It is not the style that matter but the underlying philosophy and principles that drive their decision.

Investing is never easy but there will always be people that try to convince you that by obeying a set of rules and formulas you can easily outperform the market and compound your wealth. Because the famous investor has been using it, copying them will allow you to reach the level of wealth and competence they have. Before you can get your hand onto it, you will have to pay a significant fee to attend the course or even buy some robots.

Investing is not easy as it is often a zero-sum game. A trade constitutes a buyer and a seller who have similar motive in making profit but whose action contradicts one another. Either the buyer or the seller is right, it is rare to have both correct. How do you know that you are on the correct side of the trade? You can try to increase the chance that you are right by asking yourselves what insights do you have about this company that others do not? It is not about possessing insider information, but forming your own independent opinion and analysis about the company. If everybody thinks that Myanmar is going to experience fast growth, obviously this will have been factored into the price of the stock and there will be not be significant upside potential other than speculation.

Investing is when you buy an asset at a discount to its fair value and expect that the fair value can be realised or the fair value can grow. On the other hand, speculation is when you buy an asset in the expectation that a greater fool is going to buy it from you one day. It is often hard to distinguish investing from speculation merely by looking at the stock purchased or the price paid. Famous phrase like "This Time is Different" is often used to justify the act of speculation. Perhaps, only the investor/speculator will know whether he is investing or speculating, that's if he has been able to control his emotion and think rationally.

Croesus Retail Trust

2013-05-05T09:24:00.000+08:00

This May, we will be seeing IPO of Asian Pay TV and Croesus Retail Trust (CRT). They are both business trust (not REITs), highly geared and most importantly offering a 8% yield. Where else on SGX can you find a 8% dividend yield? The question should then be why are they not pricing at lower dividend yield and hence leaving money on the table?

Total unit is 430,178,000, NAV is $378,337,000 or $0.88. The IPO price is trading 1.05x NAV.
CRT is made up of 4 main assets situated in Japan worth 57 billion yen. As seen from the table below, other than Luz Shinsaibashi, they are mostly located in small cities with population of 200,000 and below.

Figure 1 - Classification of Cities for Asset

Lease Structure

Figure 2 - Breakdown of NPI in 2014

The figure above shows the contribution of the 4 assets, where Mallage Shobu contributes the largest proportion of Net Property Income (NPI).

Aeon Town Suzuka and Moriya
Aeon Town Suzuka and Moriya are master-leased to Aeon Town, a subsidiary of Aeon Group, that catered towards neighbourhood shopping centre (NSC) as compared to Aeon Mall which specialises in higher end shopping centre. In a master lease, the owner of the property will lease it usually to 1 master leasee who will be put in charge of the sublease and running of the mall. The NPI margin will be much higher as most of the operation expense is bore by the master leasee which gives CRT a 90% NPI margin for its 2 master leased mall.

The master-lease is signed for a long period of 20 years from 2007 to 2027. Unlike most master lease we see in S-REITs, there is no step-up rental which means that the total rental revenue to be earned by CRT is FIXED for the next 20 years - 932 million Yen and 660 million Yen respectively. The good thing about master lease is that unit holder has a great certainty about what they are likely to get and will get. However, with no step up rental, the real yield after accounting for inflation (in Singapore) will get lesser and lesser. This is not unexpected as Japan has been in a deflationary environment for decade and hence no step up has been in place to account for possible inflation. In comparison, most leases in Singapore will take into account inflation, introducing step-up and positive rental reversion each year.

The only potential for growth for these 2 assets which account for 45% of total NPI will be a restructure of the lease, converting it from master lease to individual lease with the tenant. However, this option don't look much more attractive as Mallage Shobu (not a master lease) only has a NPI margin of 50% as compared to the 90% that these 2 assets enjoy. Such a conversion is not likely to bring in much positive as the margin will be lower and there will be an added risk of re-branding the mall and ensuring full occupancy.

In addition, the master lease has been structured such that from 2016 and 2017 onwards, contracts will be renewed every 2 years subject to agreement between both parties. Thus, there exists a risk that Aeon Town might not want to master lease the mall, leaving CRT in a lurch. Though this risk is remote as Aeon Group is the 2nd largest Japanese retailer by sale which makes them a strong counter-party, it is still something that unit holder should be aware of.

Luz Shinsaibashi
This is their prime asset in Osaka, though it accounts for only 14.4% of NPI. H&M is the major tenant here accounting for 58.4% of the space with the rest of the space occupied by 2 restaurant and 1 karaoke lounge. Once again, H&M has signed a long term lease that will only expire after 2024 and they accounts for 85% of the asset's total rental income. The 4 tenants have a lease term of 7-15 years which is very long lease term as compared to the standard 2-3 years in Singapore retail. While 2 leases are on variable rent, it is stated in the prospectus that "the Trustee-Manager expects that the turnover threshold which trigger variable rent will not be met." Once again, growth is not to be expected. The earliest expiry of rental will be in 2017, where 1 leasee that accounts for 5.6% of the rental income of the asset will be up for renewal. This leaves us with only 1 asset - Mallage Shobu which accounts for the largest proportion of NPI.

Mallage Shobu
This is their only asset with the potential to grow the NPI as they are generally variable rental and not a master lease structure. They have 7 anchor tenant with lease term of 6-20 years and account for 1/3 of Net Lettable Area. The rest of the lease are variable rental and the contract term is typically 6 years. According to the prospectus, 151 out of 243 fix term leases are up for renewal in November 2014 and significant rental reversion is expected given the low rent signed during 2008.

These rental will account for 26% of gross rental income of CRT which works out to be 1.3 billion yen. From the prospectus, NPI in 2014 from Mallage will increase by 13% from 1.26 billion yen to 1.43 billion yen. Overall, the NPI will increase by 5% for CRT and the net impact to dividend yield will be that it will increase from 8.0% to 8.1%. Thus, their only hope for growth is not going to be of much impact in 2015. After 2015, the lease term will be on market rate and hence not likely to see much positive rental reversion. Given it is another 6 years before lease renew in 2021, this one-off reversion is not going to happen soon.

Examining Mallage Shobu, it is located in a mid-sized city called Kuki-Shi in Saitama. It is 7km from Kuki Station and 10km from Kitamoto Station which is really far away. The figure below is the age profile of those staying 5km within the mall. 44.5% of the population is older than 50 years and this is the highest among the location of its 4 malls and is higher than the national average. Population is stagnant and large-scale retail sales for Saitama has dropped almost every single year since 1998 other than in 2002 and 2005-2007. Thus, the variable rent structure is not going to be of much help.

Figure 3 - Age Profile within 5km of Mallage Shobu

Figure 4 - Large-Scale Retail Store Sales for Saitama

Macro Retail Trend

Figure 5 - Total Retail Sales

Figure 6 - Average Retail Floor Space

As seen from figure 5, the total retail sales of Japan since 2001 has been flat. Shopping Centre Sales only grown from 19.5% to 20.5% of total retail sales which is insignificant growth considering a 12 years period. However, from figure 6 the dark green line, retail floor space has grown and is on a upward trend. Thus the annual sales per sqm has dropped since 1991. This is obviously not a good sign for any shopping mall owners. The key to positive rental reversion is growth in sales of the tenant. Only when your tenant is making more money, will you be able to increase your rental as no tenants will enjoy a lower profit margin. This is perhaps why malls in Japan are generally master-lease or of long-term lease structure unlike in Singapore.

Figure 7 - Large-Scale Retail Store Sales for the perfecture of its 4 malls

Figure 7 is large-scale retail store sales for the perfecture of its 4 malls. As we can see for the past 15 years, they are all on a downward trend else flat. Ibaraki has done the best by staying flat while Osaka has seen sales dropping by 25%.

Figure 8 - Historical Shopping Centre Rents

Looking at the historical rental, they have also stayed flat just like the total retail sales. The perfecture which CRT's malls are located are Osaka (Orange), Saitama (Light Red), Ibaraki (Light Blue) and Mie (Purple). On the macro level, there really don't seemed to be much of a growth unless Abenomics is successful.

Leverage
Before people starts to jump into CRT for its 8% dividend yield, maybe the leverage should be considered. Leverage plays an important role in determining the dividend yield of a REIT. Assuming an unleveraged REIT with an Return on Asset of 3%, a unit holder who purchases the REIT at NAV will get a 3% dividend yield. This is obviously unattractive considering that some blue chips can yield 4-5%. Thus, REIT will often borrow more money to buy more asset, so that the dividend yield will be higher. By borrowing 30 cents on $1 of equity, the yield of the REIT will now be 3% x 1.3= 3.9%. This is why almost every single reit is borrowing near the 35% gearing ratio as allowed by MAS for those that do not get rated by a credit rating agency.

In the case of CRT, the gearing ratio (calculated by debt/value of property) is 48% whereas most S-Reit stays within 30-35% after learning their lesson in the GFC 2008. Thus, how can it be fair to compare the levered 8% dividend yield to a less levered yield reit? If we were to compare CRT with a S-REIT with a 30% gearing ratio, the 30% levered dividend yield will be 8% /(100/52) * (100/70) = 5.94%! What a big difference the high gearing can bring about. Leverage is always attractive and I am sure many folks are more than willing to dismiss it.

Given the high gearing, it is imperative that we look at the way the debt has been structured. Leverage is particularly dangerous for REIT/ business trust given that most practices 100% payout ratio on distributable income. Thus, when the time comes to pay the loan, they will refinance it as they have no mean to pay it back since they do not retain cash.

What struck me when I look at their debt is that they are only funded by 2 sources of debt - S$299.8m in loan and S$31.9 million in bond. Both debts are provided by only 1 bank, Mizuho Corporate Bank, and the tenor will be 5 years with an additional 2-year Tail period. The interest rate will be Base Rate + 0.5 % (0.75% for bond). The problem I have is that it is very dangerous to borrow from only 1 bank with the same repayment date when they need to re-finance their debt. If CRT just happen to have to refinance their debt during a crisis, bank will tighten their lending activity and CRT will find that it may not be able to borrow the same sum of money again. The result will be either to sell off your asset or to do a much dreaded cash call. A good reit/ business trust manager will not only diversify the source of funding but also spread the repayment date over several years.

For the issue of debt covenant, there do have quite a bit of buffer.2 main covenants will be to maintain a minimum stressed debt service coverage ratio of 1.3, calculated based on NPI dividend by 6.6% of debt and not to exceed the maximum loan-to-value ratio of 60%. Current debt service coverage ratio is 1.88 while LTV is 48%. NPI will have to drop by 30% which is unlikely given the master lease structure and value of property needs to drop by 20%.

Lastly, I find that the interest rate of 1.7% paid by CRT seemed a bit too low and is more than likely to rise in the future. If interest rate were to rise by another 1%, it will incur additional interest expense of 2.5 billion yen which will reduce the distributable income and hence dividend by 10%.

Corporate Structure
Why is CRT not offering it in Japan where the Japan Reit Index has an average dividend yield of 3-4%? In Japan, there is not limit on the gearing ratio and they will also be able to enjoy tax transparency. One possible reason could be that their asset size of 57 billion yen will make them the third smallest reit among the 40 listed in Japan. There was a wave of merger and consolidation since 2008 such that number of J-Reit has dropped from 42 in 2008 to 36 in 2010. Currently, there are 39 J-Reits that are listed after 2 new listing in 2013. http://jreit-view.ares.or.jp/jreit_e/pdf/monthly/ares_jreitreport_vol41_en.pdf

So why are they listed as a business trust and not as a REIT? Most J-REITs are highly geared as they do not have any limit on gearing ratio. CRT is highly geared and will have to get a credit rating agency to rate their credit standing if they want to be listed as a REIT. Since they do not want to be rated, it is better off for them to list as a business trust. Neither will they be required to distribute 90% of their profit to be exempted from paying corporate tax.

Fee Structure
I find the fees earned by the asset manager much higher than the almost all S-REIT. The base fee charged is 0.6% of the value of property and 3% of NPI. The common fee charged is 0.3% of value of property and 3% of NPI. I believe this is one of the highest management fees being charged.

Secondly, I find that the property management fee for Mallage Shobu is incredibly high at 9.5% of gross rental income and 30% of amount of net operating income in excess of an unspecified agreed figure. In comparison, ARA only earns 3% of gross rental income for managing Suntec Convention Centre. It seemed like Sojitz is getting a much better deal than unit holder. The reason given below seemed unconvincing.

"However, the Trustee-Manager believes that the incentive fee payable to the property manager of Mallage Shobu is commercially fair and reasonable for the reasons stated below.

Mallage Shobu faces competition from Viva Mall and Ario Washinomiya (newly opened in November 2012), both located within a 5km radius from the Property.
In addition, the property manager has been managing Mallage Shobu since November 2008 (being the opening of the retail mall) and is therefore well placed to continue with the management of Mallage Shobu given its knowledge and experience with Mallage Shobu. In the context of the competitive operating
environment, the experience of the property manager and the substantial level of operating and management effort required in respect of the large number of sub-tenants, the Trustee-Manager believes that such
incentive fee is commercially fair and reasonable to incentivise the property manager towards realising revenue growth for Mallage Shobu and achieving performances that are challenging to attain."

Other Risks
No Insurance Against Earthquake - Earthquake insurance is expensive in Japan given that it is a common phenomenon. Earthquake insurance will be taken up only "where the Probable Maximum Loss for a Property is in excess of 15% of current building replacement construction cost. Probable Maximum Loss is
defined as the probable maximum loss (i.e. repair and reprocurement expenses) that would be
incurred if a major earthquake struck. Specifically, it means the loss generated by the largest
earthquake that has a 10% probability of occurring during a 50 year assumed service life of a
building." The probable maximum loss for the 4 shopping centres are 1%,5.5%, 7.2% and 2.1%. I always have my doubt about such statistics and we should never forget about Taleb distribution.

Currency Risk - Currency risk is another real risk that we face.Successful Abenomics will cause Yen to depreciate whereas MAS is likely to continue letting SGD appreciate. Dividend translated will then be lesser by the amount of which Yen depreciate. Currency risk is a real risk that anybody should be prepared for. Just look at how much USD and GBP have depreciated against SGD.

One common counter-argument will be that if Japan succeeds in its monetary policy, inflation will resume and hence rental will go up which will counter-act the depreciation in Yen. However, the rental structure of CRT is long term such that the shortest lease is usually 6 years. It will take time to renew the rental at the market rate should the market rate goes up. Many leases expire beyond 2020 as many simply do not expect any inflation given the 20 years history.

Conclusion
While 8% yield is high, lets not forget that high yield usually comes with higher risk. The 8% yield is achieved as a result of its much higher gearing ratio. Unlike many S-REITs where we can expect organic growth coming from step-up or positive rental reversion, there is not going to be any significant growth for the years to come. It will also be hard to conduct any AEI as 3/4 leases are long term leases where it is unlikely that the leasee has the incentive to conduct AEI. Neither should we expect too much from Abenomics as there are certainly much better play out there on Japan's depreciating currency and inflation than CRT.

The debt seemed dangerously structured and lets hope that 2018-2020 will be recession-free else they will be having trouble refinancing their debt. All unit holders should also be prepared for a cash call given the high gearing. Any acquisition is going to come from the pocket of unit holder.

Inevitably, I am sure that this will be oversubscribed because there will be chase for yield and those that are going for a stag in expectation of those chasing the yield. Will be interesting to see what kind of yield and price it fetches when trading begins. Doing a simple Dividend Discount Model shows that at $0.93 it is rather fairly valued.

Review of 2012

2013-01-01T16:14:00.001+08:00

The year 2012 marks my first full year as a serious fundamental investor, having indulged in 3 months of speculation in late 2011. It has been a great learning journey through the many ups and downs of the STI as well as my personal portfolio. Early in the year, STI rebounded sharply from the lows to the 3000 level and stayed there until May where the upcoming Greece Election resulted in a temporary flu that saw a 10% dip. Subsequently, STI broke past the 3100 level in October before dropping to 2945 in mid-November. And out of the blue, STI rebounded strongly past the 3100 level before ending at 3167.08 for the year.

My Portfolio

Anyone that has stayed invested throughout 2012 will have reaped substantial return with the STI returning 19.68% year-to-date so long as they have held tight to their stocks during some of the panics. My portfolio (including idle cash) has returned 37.28% through some luck as well as a highly concentrated portfolio that now only consists of 4 stocks: Boustead Singapore, The Hour Glass, Silverlake Axis and VICOM. Given the high concentration of the portfolio, return from any stock will have a huge impact on the portfolio return, be it negative or positive.

Personally, I do not expect such spectacular return every year and neither should you believe that anyone is going to deliver such return year after year. For our public listed companies, quarterly and annual result are sometimes of little guidance to how a company will perform in the long run. For our individual investment track record, it is not the 1 or 2 years of out-performance that counts but rather the total return in 1 full investment cycle (from one big bear [>50% decline] to the next) against the benchmark index return.

My targeted annual return will be 15% in the long run, which comes from a 4-5% dividend yield coupled with a 10% capital appreciation. Dividend has been an important factor for my return this year as they provided me with a 5% return in 2012. The 15% return will be achieved through investing in undervalued stock with great underlying business, through adopting a minimum investment time frame of 1 year and preferably 3 years and beyond. For more details, you can look at this post which I have written a while ago for my selection criteria of companies.

Portfolio Component

As of 31st December 2012, I have 32.1% of portfolio in cash and 67.9% invested in stock. Cash is king and especially in crisis where it can generate extraordinary return when rightly deployed. I have been building up my cash position as I have not bought anything for the last 6 months as a result of the market rebound and that there seemed to be no feasible target at the right price at the moment. Patience is a virtue in the market and I shall continue to wait for the right opportunity to surface. Preferably, I will hope to raise the invested portion to 80-85% to ride with the companies for the long term.

Boustead Singapore

Purchased in Mid-April 2012, this company has returned me one of the highest dividend yield among all my holdings. This is certainly a deeply-valued company that's not easy to understand with 4 divisions and 3 investments. Neither are the divisions easy to understand for the general public, being involved in Geospatial Technology as well as items like Process Heater and Waste Heat Recovery Unit.

The crown jewel in the company lies in its distributorship of ESRI as well as its slowly growing Design Build & Lease portfolio which generates recurring income. ESRI is likely to continue to enjoy double digit growth as GSI still has immense potential and coupled with the fact that both Indonesia and Malaysia have chosen ESRI as the official platform for the government.

Boustead International Heater is a well-established player in the field of process heater where competition is sparse. Their margin for this division has been slightly impacted recently due to their customer, the South Korea EPC, that has practically won almost all the contracts in Middle East with their competitive pricing and hence squeezing their subcontractors. Other than process heater, they are also involved in Waste Heat Recovery Unit for refineries. What the WHRU does is that it recycles the waste heat back into the system as a form of energy. This reduces energy cost and need to flare off gases which are important for refiners as they run on very tiny refinery margin. Every cost savings count. They also have a subsidiary Boustead Control & Electric that is involved in the upstream business providing process control system.

Other than the current 100,000 sqm DBL portfolio, Boustead Project is the market leader in design and building of industrial building in Singapore, with an added capability of Green Mark with strong execution and delivery record. Lastly, that will be the poorest performing segment of all, Salcon Water which Mr FF Wong has not fully turnaround though its losses are no longer what they used to be. However, Salcon Water does have the technological advantage and is a different specie from the other water treatment companies found on SGX. It is pre-qualified by the Japanese EPC and provide industrial water treatment where the purity and quality are of utmost importance for the manufacturer.

What I like about the business model is that it is involved in the high-margin, asset-light area in the design, project management and execution while not being involved in the asset-heavy and high capex manufacturing which is outsourced to their pool of subcontractors. The problem with such a model is often the lack of control on the quality of manufacturing, but I believe that Boustead Singapore has done a good job to achieve where it is today.

With its net cash of $180m (representing more than one-third of its market capitalisation), strong free cash flow generation with its business model, and high ROE despite its $180m cash hoard and a capable leader, Mr FF Wong, who has certainly delivered more hits than misses - this is a company that I will hope to increase my position in if the price is right. The intrinsic value is certainly far away from its current price. However, this is certainly not a stock where one can expect strong return within months. This is the type of company where one should hold on tightly and ride with the company to enjoy great compounded annual return. As such, this is a stock where I have a investment horizon of 3 years and more, and will be willing to look beyond some of the poorer results that come with its partial order-book driven lumpy revenue. While time is needed to fully realise its value, the ~5% dividend shall be an appetizer during the wait. However, this is certainly not a company for the impatient.

The Hour Glass

Purchased in early January 2012, this company has delivered my highest return to date. A luxury watch retailer based primarily in Singapore, it has been a key beneficiary of the rising wealth of South-East Asia as a whole over the past decade. Luxury watch retailer does not really enjoy strong competitive advantage as the RSP and cost of watches are determined by the respective watch manufacturers ranging from Rolex to Cartier. In addition, retailer also suffers from the rising rental cost that is a further hit to their tight profit margin. So what is it that draw me to this company?

Strong management capability and a tight focus are what I see in THG. In fact, it has delivered one of the best performance I have seen in a pure retailer. Net Profit Margin in 2012 is 9% despite the increase in expenses in preparation for 2 new stores opening in 2012. ROA is very impressive at 14.9% and ROE at 17.7% considering the type of business and industry they are in. This high return on asset and equity is achieved through a respectable profit margin coupled with high inventory turnover that's traditionally more than 2x. For this upcoming fiscal year, inventory turnover has dipped below 2 times, as a result of a dip in macroeconomic condition and the added inventory requirement for the 2 new stores. However, this does not worry me as this is merely a temporary issue and the business is still sound. In any case, the financial metrics make it one of the best luxury watch retailer to be found.

Other than the financial metrics we have seen, there are many other positive signs. Looking back to its history, this company has been fond of diversification to irrelevant industries like selling pizza. However, since the current management, the uncle-nephew team, has taken over, the company has regained their focus in being a pure luxury watch retailer. Of course, the Gems TV mistake has been a bad one and I believe this will be a reminder for the management.

In early 2008, luxury watch industry in Singapore is still enjoying very strong demand. However, THG made a decision to reduce their inventory level despite the healthy demand they still enjoyed. This has been an amazing decision made as the demand collapse and the other retailers are forced to sell their inventory at a discount to generate cash. What this show is not only that they have great foresight but that they dare to act differently from the crowd.

In addition, the change in location of their stores over the year is also a positive sign of their focus. Before Mr Henry Tay mentioned about the Orchard Quadrangle in the 2012 Annual Report, it has been clear that they have executed the strategy with a high level of focus 4 years before. The company closed down the shop in Lucky Plaza and Peninsula Plaza by 2011 and has now secured shops in all 4 corners of the Orchard Quadrangle. At the moment, it has 6 shops in Ngee Ann City, KnightsBridge, Ion Orchard, Tang Plaza, Paragon and Orchard Central. It is amazing that the management takes the step to close down 2 profitable shops where they have been there for decades. Someone that is only focused on short-term profit will obviously not have closed down 2 profitable shops to reinvest in better locations. This is even more important for watch retailer where their working capitals are often tied in the inventory. The company has also waited for years before they open a 2nd store in Hong Kong when they are able to secure a favourable rental rate. They have often taken advantage of recession to expand and open new stores where the costs are often much lower. In 2008 GFC, while many other retailers are suffering, they chose to open 8 new stores across various geographic location over the next 3 years.

I have purchased this company at an average price of $1.14 which was approximately 5x PER and slightly less than the book value at that point in time. While the company boasts a very high ROA, I feel that this should not be a company that should trade at higher than 10x PER. The reason lies in the business model of luxury watch retailer where huge amount of capital is tied in the inventory. When the business grows, inventory in the balance sheet will also grow which means that higher free cash flow that stems from higher profit will be partially pumped in to feed the inventory growth. During a downtime, when revenue is down, inventory will be reduced, and that's when the company enjoyed the strongest free cash flow yield. However, at the current price I believe that there's still a long way to grow when the economy recovers and with the 2 new stores (1 in Paragon and 1 in Hong Kong) enjoying a full year of operation in 2013. There's always reason behind why a company operating in the same industry can outperform its peers in terms of all the relevant metrics for a retailer. This will be another company where I have an investment horizon of 3 years and beyond. Should the price dip lower than its book value, I will certainly consider adding to my current position.

Silverlake Axis

Purchased in March 2012 where I also initiated a research report on the company at around the same time. Being a core banking software company, it enjoys wide moat and strong competitive advantage in the form of extreme high switching cost. Core banking system is equivalent to the central nervous system of a bank, where it is highly critical for a smooth operation. To change it comes with huge risk such that many are still using legacy system dating back to the 1980s. It is also certainly the market leader in the Southeast Asia region and in numerous countries like Singapore, Indonesia, Malaysia, Vietnam and Brunei.

Software company with a strong moat are often worth looking into as they have a high ROA, strong free cash flow generation, high margin and a huge portion of recurring income. These are characteristics that Silverlake Axis have with a 90% profit margin for licensing, and 65% profit margin for its recurring maintenance and enhancement services. While the profit margin for licensing is ridiculously high, it is not what that really matters for Silverlake. What that matters to me is that after they enjoy the one-time 90% profit margin, they get to enjoy the 65% profit margin maintenance recurring revenue for as long as the customers deployed their CBS. The maintenance income is approximately priced at 15% of the licensing fee which is much lower than many other competitors where their rate is around 18-20%. In addition, every 3-5 years, when the new version is created, there will also be additional revenue for the update. And for Silverlake Axis, all that's needed is to develop a one-time CBS which is a fixed cost that can be reduced as more banks chose their software.

To have an idea of the high switching cost involved, the management said that in their 20+ years of operations, only 2 customers have switched to another system. And in both instances, they came back to Silverlake Axis which means that they have never lost any maintenance customers. Such high switching cost allows Silverlake Axis to REPRICE their maintenance contract by around 2-3% per year whenever they expire. Of course, the management prides themselves on the ability to value-add in justifying the reprice of the maintenance contract. Such a business model is certainly a no-brainer and one of the best gems that's found on SGX though it is a Malaysian company.

When I purchase the company, it really seemed very expensive at a price of $0.350 and PER of 20X and that the licensing fee is a one-time. However, when I work out the profit to be derived from all the contracts that it has secured, this company certainly looks attractively valued given its immense growth potential and strong fundamental. This is a company where the sky is the limit subjected to the number of new contracts that they can secure and of which can change the valuation dramatically given its highly scalable business model. Of course, sky will obviously not be the limit given that high switching cost can also prevent them from stealing market share from their rivals.

They are also likely to be a key beneficiary of the trend where the banking system in the Southeast Asia is still highly fragmented and of which consolidation and M&A are likely to continue. When 2 banks operating 2 different systems merge, it is likely that the larger bank will preserve its systems. And in the customer profile of Silverlake Axis, their clients are of the largest in their respective market, namely OCBC, UOB, CIMB, Maybank, Hong Leong Bank, Bank Mandiri, Bank Rakyat, VietcomBank, BIDV, Bank Islam Brunei Darussalam and TAIB. Notably, 2 Malaysian Bank, CIMB and MayBank seemed to have been very aggressive in their regional expansion in the past few years. Merger contract comes with approximately 40% profit margin and the greater reward will be in the expanded customer base.

Another trend will be the outsourcing done by financial institution as they stick to their core operations. Obviously, the cost of developing the necessary software and maintenance is much higher for the banks themselves than vendor like Silverlake Axis. Of course, for large banks like Citibank, JP Morgan and HSBC, they might have the sufficient resources and the scale to develop their own CBS. However, for our banks in the SouthEast Asia, it is much cheaper to outsource it to Silverlake Axis. Given that many banks are still relying on the legacy system, it seemed like the potential revenue base is still huge.

Despite its spectacular rise, there still seemed room for further upside. Firstly, its associate Global InfoTech should be listing on the Shenzhen exchange in 2013. Secondly, the new RM 135 million contract add more visibility to its orderbook and comes at a time where there has been hardly any new contract of significant size announced. Thirdly, I believe that there's still quite a huge amount of maintenance income from its CIMB contract that has yet to be realised.

While valuation is rich, I do expect its intrinsic value to grow with the company. New contract will certainly be sparse due to the uncertainty that banks are undergoing, but when dust settles new contract win momentum should continue. In the meanwhile, as the maintenance and enhancement services continue to enjoy its slow steady growth, I shall continue to enjoy its quarterly dividend paid. Silverlake Axis simply has too much cash to spend. Mr Goh has also been forward-looking as he no longer view his company as a core banking software provider but rather delivering a Digital Economy Solution. This has been his direction for the company for this decade and reflects the changing dynamics of the banking IT industry.

VICOM

Purchased in September 2011, this company has been my first stock purchased and has delivered a remarkable return. I also did an initiation on this company on January 2012 over here. VICOM is in the Inspection, Testing and Certification industry with its 2 core business in VICOM (Vehicle Inspection) and SETSCO (Non-Vehicle Inspection).

Regulation is what that allows the industry to thrive. In Singapore, cars have to undergo inspection every 3,5,7,9 year while buses and taxis have to undergo inspection twice every year. This not only forms a very stable recurring revenue, but also one that will roughly grow with the slow overall growth in the total vehicle population in Singapore. The tightening of COE has been the key driver of growth for VICOM. In 2005, only 30% of the car population and 110% of the Goods & other Vehicle population undergoes inspection. In 2011, 45% of the car population and 132% of the Goods & other Vehicle population undergoes inspection. This is on top of the annual 3% increase in vehicle population in the past. Hence, what we see is a multi-bagger and one with revenue and profit growth for 9 straight years this coming fiscal year. In addition, it has a 75% market share in Singapore that has further expanded with the closure of Ayer Rajah Inspection Centre by STAI in August 2011.

Given its remarkable growth, it seemed like the time has arrived where VICOM is likely to enjoy slowing single-digit growth going forward. Growth will still be maintained by various policies like the Carbon Emissions-based Vehicle Scheme which will encourage take up of diesel vehicle as well as further tightening of vehicle population undergoing inspection. Vehicle population has also grown by around 1-2% this year. Looking at the chart below, one can see that in November 2012, the age distribution of car has reached what is roughly called a Normal Curve. This certainly means that further upside from increase in age distribution profile of vehicle population will be limited

As such, I do hope that its time that SETSCO will take over the growth momentum from VICOM. SETSCO is involved in the inspection, testing and certification of many products that range from chemical, biological, environmental, electrical and mechanical industry. There will be a portion that's highly resilient which include building inspection, food products while another portion will be depended on the economy like civil engineering and e.t.c. While not as attractive as the vehicle inspection business, the return on asset still beats many other businesses out there. Of course, they do have to face certain level of competition but I believe they will prevail with their wide range of services.

Valuation is rich and if we use Peter Lynch's PEG as a measurement, it seemed like it is certainly no longer a buy. This will be one in which I will consider selling should the price continue to rise and should there by a buying opportunity else where. In the meanwhile, I will collect its 4% dividend while awaiting a better switching opportunity.

Learning Journey

The best investment that any investor can make is always to invest in his personal education. In 2012, I have attended 7 AGMs (including 1 as an observer) and 17 seminars/events. This has been remarkable for me given that I have started school in August 2012 and that there has been numerous instances where I have to pull out of seminar due to school commitment. I believed that I have down at least 30 investment books in the year, including 6 books from the fisher investment series. Some of the more memorable books include Ken Fisher's Super Stocks, Pat Dorsey's The Five Rules for Successful Stock Investing, Bruce Greenwald's Value Investing: From Graham to Buffett and Beyond as well as local writers Dr Michael Leong's Your First Million - Making it in Stocks and Bobby Jayaraman's Building Wealth Through REITs. These are very insightful and offer varying perspectives to the game of investment.

I believed that I have grown quite significantly in terms of emotional stability and principles where it comes to investment. Not only am I now immune to the day-to-day and intraday changes in prices, I have now look towards 3 years as an appropriate investment horizon. Boustead Singapore and The Hour Glass are 2 such companies which I have convinced myself to give them 3 years to grow. Even in the daily life decision, I always remind myself to look at the long term and not the short term.

Going forward, I will strive to make further progress on knowledge and skills. Knowledge will be to understand and gain more breadth and depth of industry. Attending AGM and seminars have been extremely helpful in this aspect. The more one gain the faster it is as one will realise how cross-industries knowledge can come in handy for companies in other industry. Skill will be on valuation as well as on financial statement analysis. While I was lucky to have been barely scarred by S-Chip, Olam has reminded us once again that any company can turn out to fraudulent regardless of their backing. Due diligence is of even higher importance for a highly concentrated portfolio like mine. Hence, I will hope to brush up on my skill on spotting financial shenanigans. Of course, I am highly confident of companies in my current portfolio as they are excellent business with strong cash balance and strong free cash flow generation.

As for the blog, post will be more sporadic as I have to juggle my studies, my investment and the blog. While the post might be less frequent, the quality will still be kept at a high standard. If there is nothing worthwhile to write, I will rather not write anything. Just like if there is nothing worth investing, I will rather not invest in any company.

2012 has been an awesome year and I hope 2013 will be another spectacular year not only in investment return but my growth as an investor. In addition, I will like to thank all my readers for allowing me to hit above 84000 visits in a year which equates to 230 visits a day.

Wish everybody the best regardless whether STI will move up or down :)

Sales of SIA Engineering

2012-12-25T19:58:00.002+08:00

SIA Engineering purchased at average price of $3.562 and sold at average price of $4.107 with total dividend received of $0.10 in early November 2012. Total gain is 18.1% in a timespan of 10 months.

Before we review the rationale for sale, it is important to look at the rationale of purchase. At that point in time (Dec 2011), it was 3 months into my investing journey and I had given up on speculation. At that time, SIA EC drops to $3.55 and it looks like one of the blue chips that I can rely on after drifting into the red. MRO is a growing business and SIA EC has quite a strong market share in MRO and line maintenance with its link to SIA. Both segment of the businesses are pretty resilient given the regulation in place for checks to be conducted. It has a very clean balance sheet and shows a respectable ROE. Strong free cash flow yield and dividend from associate results in a close to 6% dividend. In other words, safety was my key concern then.

Rationale for Sale

And in 2012, we witness a mild bull run among all the dividend stocks, be it in REITs or in the high-dividend paying blue chips. This yield compression is as a result of the uncertain gloomy economics condition, continued monetary easing and the low interest rate circumstances which investors are stuck in with no other place to go. Will interest rate continue to stay low forever? Perhaps for the next 2-3 years until US's unemployment rate falls below 6.5%. In any case, there seemed to be a limit to further yield compression though Mr Market can be really unpredictable at times. Hence, the upside seemed limited on the assumption of the same dividend paid.

While all along I have known the importance of the JVs and associates to SIA EC, it was only after attending the AGM that I realised the amount of cannibalisation going on during the past decade and that 3 particular associates account for a highly significant proportion of the results from associates and JV. And the problem is that I am unable to fully understand ESA and SAESL though their profitability seemed to be amazing. I hate it when I cannot get a good grasp of all there's to know about the company especially when these are significant contributors to the bottom line.

As for its growth potential, there's seemed to be some factors that might slow the growth. Slow is the word and not no growth. Firstly, almost all of its associates and JV's revenues are earned in USD. And as everybody knows, the USD has been depreciating against the Sing dollars and over the decade this has greatly reduced the absolute Sing dollar growth from its associate. If they reinvest all their profits, then this exchange rate problem will be just a mere accounting problem. However, since it is so highly reliant on its associate and JV to fund its dividend, those USD will have to be converted to SGD and hence growth will continue to be impacted by the movement in exchange rate. Margin will be impacted as labour cost is paid in SGD. For as long as USA still prefers to print money to resolve its debt and economic problem, USD will continue to weaken.

Another factor will be that new aircraft has much lower maintenance cost as compared to other aircraft. For e.g. Boeing 787 Dreamliner will only need to undergo a D check after 12 years as compared to the traditional 4-5 years for normal aircraft. In all, Boeing claims that it will reduce the maintenance cost by 30%. It seemed to be a trend that newer aircraft requires much lesser maintenance as compared to the previous generation.

Fundamentally, the overall growth of the MRO sector seemed intact but I believe that the 2 factors mentioned above will be a drag on its growth. And on a portfolio basis, as the STI continues to rise, it seemed like holding on to the cash option sounds much more attractive. As I have advanced in my investment journey, small cap and mid cap will be preferred over the blue chip unless great opportunities arrive. I believed that more opportunities will exist in the small cap and mid cap space where they are less covered and attract less attention from the institutional investor.

Genting Singapore - Part 2

2012-12-10T19:45:00.002+08:00

For this part, we shall have a look at the business of Genting Singapore. As everybody knows, the key attraction of Genting Singapore is that it is one of the only 2 IR operators in Singapore and many believe that casino and duopoly equate to a highly profitable business as seen from the prosperous Macau.

Understanding the business model of a casino

More than 80% of Genting Singapore's revenue come from its gaming revenue while the other 20% comes from hotel, USS and Marine Life Park. Hence, gaming is at the core of Genting Singapore and will be the focus of the post today. To operate a casino, one needs a license from the government and in the case of Singapore, the area of casino is capped at 15,000 sqm. Thus, within this limited 15,000 sqm area, a casino will have to optimize its area by placing the table and machine at the appropriate place to maximize its revenue per sqm. Next, for each table it has to maximize the turnover by having as much game played as possible. Finally, odds are calculated in such a way that the casino operator will always have an edge over the gambler. Win rate for the casino operator is often much lower at 1-8% as compared to much higher rate than Toto, 4D or lottery operator. Hence, volume is much more important for casino and the higher the volume, the higher their profit and the more likely the win rate tends to their edge due to the law of large numbers. Another reason why volume is important is that casino requires huge initial capital expenditure and outlay as seen from Genting's balance sheet where PPE accounts for 55% of their asset. There's also high fixed cost in the number of dealers, tables and cards which need to be paid for regardless whether there's only 1 gambler at the table or there're 10.

Industry Outlook

It is indeed true that the casino operators in Singapore enjoy a very healthy duopoly market structure which should theoretically bestow upon them high profit margin and ROE. However, many have not realized that for the casino in Singapore to prosper, they will need to rely much more on foreigner rather than the locals. Singapore certainly has a much lower population compared to other countries in the region which means that to generate higher volume of gamblers, Singapore will need to continue to attract tourist and foreigners to come to Singapore to gamble. What this means is while we can safely say that it is a duopoly in terms of capturing the local market, it seemed to be a regional competition for foreign gamblers that is much more important.

However, as a results of its initial success for its 2 IRs, there are now increasing competition in the region as we see numerous countries in the region opening new casinos from 2012 -2015. Vietnam, Philippines and Cambodia will be opening new casinos in 2012 and 2013. Russia and South Korea will also be building new casinos to attract the tourist while Taiwan has already legalized casinos. Both Japan and Thailand are also debating on the issue of legalization of casinos. As such, it seemed like competition is fierce within the region with better and newer casinos built over the next few years.

Given these various forms of competition, it seemed like Macau is still going to be the most thriving gaming countries in Asia. More casinos are going to open in the Cotai Strip and Macau easily outclassed the 2nd largest casino market, Las vegas, by 2-3x more in revenue. Despite supposed slowdown in China in lieu of the changeover of leadership, Macau is still expected to grow by 10-15% this year as compared to 5% for Singapore according to S&P. In the next 5 years, Macau's gaming industry is expected to grow by 15% as compared to 5-8% for Singapore. So what exactly is the secret to Macau's success that is hard for Singapore's 2 IRs to replicate? What is the reason to Macau's average ROA of 20% and ROE of 60% as compared to Genting Singapore's 10-15%.

The business model of Macau's casino

Essentially, Macau's casino runs on a junket model where the junket accounts for 75% of their revenue. Junkets are middleman who will bring in the high net worth individual (HNWI) to the casino and will take in a portion of the HNWI's total chips played. The casinos will also offer rebates and free chips to HNWI to attract these big whales to play in the casino. Hence, in such a model, the profit margin for the casino operators will be much lower. However, they will be able to attract the volume which is essential for the casino as the fixed cost of a casino is high.

In fact, junket has been the critical factor for the success of Macau's gambling industry that other countries are unable to replicate. These junkets are like the private bankers that establish the relationship with important clients and bring in the revenue. Many of the HNWI from China will prefer to go in a group lead by junket as they enjoys special rebate and networking opportunity. Coupled with its close proximity to China, Macau is the natural destination for the wealthy Chinese which takes on a more active attitude towards gambling as compared to the Westerner.

However, in the case of Singapore, the government does not allow and is very cautious of junket operation. Even for the 2 operators allowed for Genting Singapore, they are called as International Market Agent and they are very small players based in Malaysia and not Macau or Hong Kong. This is bad for RWS and MBS as the mass market often stagnate within 2-3 years and it is the junket that is needed to drive VIP's volume growth.

High DSO and impairment loss of receivables

In part 1, I have discussed about the high DSO of 5 months for Genting Singapore and the frequent impairment loss on receivables of 17% for Genting Singapore.This is in fact linked to the lack of junket operation in Singapore. In Macau, not only does the junket brings in the HNWI, they are also responsible for the collection of the debt. As such, Macau has very low receivables on its balance sheet and is able to enjoy higher ROA and better working capital management. Debts are often a problematic issue for VIP customers for casino as they are also afraid that being too aggressive in collection of debt will deter the clients from visiting their casinos again.

For Singapore, due to the lack of junket operation, the 2 operators have been slack on their credit policies in a bid to attract the VIP customers. They allow them higher credit, longer term of collection and these results in the high receivables amount as seen on its balance sheet. If we were to take into account that the mass market often produces no receivables as no credit is to be issued to them, the actual DSO from the VIP business is much higher. As seen, the implication of junket is not just a higher revenue but a better working capital management as well as higher quality of earning.

Given the huge differences in growth potential, ROE, DSO, it seemed like the 2 casino operators pale in comparison to the many Macau's casinos listed on the Hong Kong exchange who are also able to offer much higher dividend yield as compared to Singapore. Unless the government approves the junket operation in Singapore (which is very unlikely), it seemed like Genting Singapore is going to face a stagnant market where growth will at best be single digits and the fact that 16% of its receivables have to be impaired annually.

Genting Singapore - Part 1 (Financial Statement Analysis)

2012-09-11T20:25:00.002+08:00

This is likely to be one of the last New company that I will do an analysis on for the next 2-3 months as I intend to focus on my studies which has been a bit overloading at times. Nonetheless, I do hope to be able to resume research on new company when holiday is here. I will still continue coverage on VICOM and Silverlake Axis whenever possible.

This will be a 2-part analysis and as always I will start off with financial statement analysis. Genting Singapore operates one of two casinos in Singapore, owning 6 hotels with 1800 rooms as well as 2 key attractions of USS and Marine Life Park. While price might have fallen quite a bit from its peak, it may still have been overvalued at its current price. For the past few years, investors have been pricing in high teen growth rate for this company that seemed to have a long way to go. However, it seemed like RWS might have reached a stagnant market already.

Figure 1 - Income Statement

For the 1st half of 2012, Genting Singapore reported decline in gaming revenue of 19% and 4% for the first 2 quarter which seemed to imply that they have been affected by the decline in macroeconomic condition. Total revenue dropped by 14.2% and 2.9% in Q1 and Q2 2012 as 80% of Genting's revenue comes from gaming. And the decline was as a result of lower rolling chip volume and not lower hold rate (luck factor of casino). In Q2 2012, VIP rolling volume dropped by 14% and Mass volume contracted by 4% in spite of a slightly higher win rate of 3.1% than the theoretical win rate.

There has also been decline in the profit margin which the management has attributed to pre-opening expense of Marine Life Park. However, pre-opening expense increase is very insignificant and the fact is simply a lower gaming revenue. Despite 2 of its hotels, Equarius and Beach Villas, being opened in Feb 2012 which results in 8% increase in room inventory, non-gaming revenue only rises by 1%. RWS also recorded higher average room rent of $432 and occupancy rate of 92% as well as higher visitation rate. These did not lead to significant increase in non-gaming revenue which could imply the use of its non-gaming asset as complementary to attract the VIP players. If this trend continues, then we should not expect much from the non-gaming revenue as well.

Figure 2 - Balance Sheet

For the balance sheet, the right column of 2012 Q1 and Q2 is where I transferred the $2.3 billion worth of perpetual securities to the long-term debt. While it is being accounted as equity, it is clearly a form of debt of which the company will have to pay $118 million in interest tax per year, representing 9.6% of FY 11 net profit. While the company has the right not to pay out interest, it is cumulative and will hurt the company's reputation. Of course, debt level is still manageable as it can be cleared by Genting with 3-5 years of profits.

In any case, the company has not proven its need to raise cash through perpetual securities though the cost of debt is lower than its ROA of ~8%. Instead, "the Group invested in a portfolio of quoted securities, unquoted equity investment and compounded financial instruments amounting to S$1,148.9 million" in Q2 2012. This amounts to 9% of its total asset and yet there is a lack of transparency as to what sort of equity investment and financial instrument did Genting Singapore decide to play with. In any case, equity investment is definitely not a core competency of Genting Singapore.

Figure 3 - Receivables

Figure 4 - DSO Not Accounting the Mass Market Revenue

Figure 3 is something that I don't find very comfortable with, which is that Days' Sale Outstanding of Genting Singapore is as high as around 3 months and have been rising ever since RWS commenced operation in 2010. And if we take into account the fact that casino is not supposed to grant any Singaporeans and PRs credit unless they are Premium Player (deposited $100k as credit balance), the actual DSO is much higher as seen in Figure 4. In fact, it has gone up as high as 150 days in 2012 1H which is equals to 5 months of receivables. This is just the tip of the iceberg...

Figure 5 - Impairment Loss of Receivables

In actual fact, Genting Singapore has been taking significant amount of impairment loss ever since RWS started. It has ranged at an average of 17% of total receivables and 4% of total revenue which is not a small amount. This figure is not shown explicitly in the Income Statement as it is hidden in the "PROFIT/ (LOSS) BEFORE TAXATION – CONTINUING OPERATIONS" under rows of figures. Alternatively, it can also be found in the cash flow statement. Performing impairment losses every quarter is something that's worth noting about and I will elaborate on the reasons for the receivables in Part 2.

Figure 6 - Profitability Ratio

Figure 7 - Profitability Ratio of Macau Peers

I have always thought that being one of two casinos in Singapore should have made it very profitable, but it seemed otherwise with its average ROA of 7-8%, ROE of 12-13% and ROIC of 12-13%. While some might have thought that the $2.3 billion perpetual securities have dragged the profitability, ROA and ROE are at 7% and 12% after taking away the perpetual securities. Such profitability ratio seemed to imply an average company and not one with sustainable competitive advantage.

Now, compare to Macau Peers with an average ROA of 20% and ROE of 60%, it seemed like RWS really pale in comparison especially as an Integrated Resort company operating in a duopoly structure. Given that Genting Singapore has a high profit margin of 23% to 31%, it means that its asset turnover ratio is very low. Not forgetting that Macau's casino are subjected to a 40% tax on gross gaming revenue as compared to 12% in Singapore. Looking back at Figure 2, PPE accounted for 45% of total asset, which means that volume is much more important than profit margin in order to drive operating leverage. Macau's peers does have a lower profit margin, but they are able to make it up with high asset turnover. This will be explained in Part 2.

Figure 8- Cash Flow Statement

Figure 9 - Cash Flow Analysis

Free cash flow has been unstable as the company is still at an investment phase as the West Zone and Marine Life Park is not yet opened. Until the investment phase is over, we will not be able to see a clear picture of the maintenance capex and derive a stable state FCF. However, as a guide, PPE as a percentage of revenue has been around 20-40% of revenue during this phase and I expect the maintenance figure to be around 5% -8% of total revenue when it is done with the initial investment.

In conclusion, we can see from its financial statement that it is certainly not a company with a very strong business model. In that case, it seemed to have been overpriced at PER of 16x and 18X based on FY 11 results and forecast FY 12 result. Part 2 will be on the industry and Genting's business model.

VICOM - 2012 1H Update

2012-08-20T18:07:00.001+08:00

With the release of 2012 1H results, VICOM has hit an all-time high of $4.70 after PAT increased by 10.7% in 2012 1H.

Figure 1 - Income Statement

The 1st quarter has been the most spectacular with profit growing by 13.2%. Comparatively, Q2 2012 has not been as fantastic, delivering a 8.1% growth on profit after taxation. Revenue for both period grows at an average of 7.9%. Unfortunately, VICOM no longer discloses the segmental result after the change of CEO. Personally, I believe that both segments should be delivering similar growth at 7-8% and not that one particular segment has been driving the growth.

Back to operating expense, total operating expense increases by 8.6% in 2Q 2012 and 3.1% in 1Q 2012. Staff cost increases by only 0.4% in 1Q 2012 due to write-back of provisional bonus while in 2Q2012 it is in line with total revenue growth. Depreciation expenses increase as a result of higher depreciation coming from the new building at teban garden. All other operating expenses continue to increase above the increase in revenue which makes me wonder if cost-saving is indeed achieved from shifting the HQ to teban garden.

With the help of lower taxation in 2Q 2012, VICOM managed to achieve a 8.1% growth in profit. Lower taxation comes from "enhanced capital allowances on qualifying expenditure under the Productivity and Innovation". http://iras.gov.sg/irasHome/page04.aspx?id=13838

Figure 2 - Balance Sheet

After the distribution of $9.4m in final dividend, cash and bank balances manage to increase by $600k despite a $3.5m reduction in trade and other payables. Nothing else worth mentioning about the balance sheet other than that compared to FY2011, vehicles, premises and equipment decreases from $55.5m to $54.7m which shows that depreciation is more than total capital expenditure.

For cash flow statement, VICOM generated 81% operating cash on net profit after taxation. It is supposed to be higher as trade receivables increased by $1m and trade payables decreased by $3.5m. Total capital expenditure is only $1.9m for 1H 2012 which is about 15% of net profit. Personally, I do expect a 100% and above FCF/Net Profit Yield for FY 2012. As capex has been significantly reduced with the completion of new HQ at SETSCO, the interim dividend declared increases from 6.9 cents to 7.5 cents. This is still a very comfortable payout ratio for VICOM and there's certainly room for another 10-20% more. Total dividend paid for the interim will be $6.6m which is approximately net profit for a single quarter.

Prospect

Just last month, Minister Lui has announced a few measures to ease the spike in prices of COE which are marginally beneficial to VICOM. Initially, car population growth rate is supposed to be cut from the current 1.5% to 0.5% by August this year and continued until 2014 where the growth rate will be subjected to change. The authority has since delayed the cut to 0.5% to February 2013 while maintaining a 1% growth rate from August 2012. According to LTA, an additional 390 COE will be made available per month which works out to an extra 2340 vehicles in total.

The clawback of oversupply of COEs will also be delayed by a year to July 2013, making available 266 more COE per month, which is 3192 in total. In another move, LTA has set the taxi fleet growth rate at 2% pa from Aug 2012 to December 2013 and they will not be bidding for COE. While the 2% growth rate will come at the expense of Cat E COE, a taxi contributes 7x the revenue of a civilian car in a 3 years period.

These measures are temporary moves that will only defer the cut so as to alleviate the spiking COE prices which played an important role in our CPI. Most importantly, they signal the will of the government to resolve the problem of overcrowding vehicle population.

Figure 3 - Age Distribution Data

The age distribution data has been one of the most important data that I monitored monthly from the LTA site as it determines the proportion of the population undergoing inspection. The continued ageing profile of vehicle population has continued to amaze me. As seen from Figure 3, the proportion of vehicle aged 6 years and above has increased by 9.7% in July 2012 as compared to December 2011. When this ageing will start to peak is beyond my ability though I do expect the trend to continue at least until the end of this year. For as long as the price of COE remains at the current level, I do not foresee any significant reversal in the age profile.

As for SETSCO, I am not aware of any new service that they have been accredited in FY 2012. As for inspection of central alarm monitoring station (CAMS), they are currently still the only one with the appropriate accreditation.

Should the earning growth continues, we should expect a minimum of 8-10% profit growth in FY 2012. Assuming a 10% growth, total dividend to be paid out for FY 2012 will be $0.194 based on similar payout ratio of 60%. At the current price of $4.56, it will give us a 4.25% dividend yield, PER of 15.4x or Forward PER of 14.3. Many will definitely ask me whether it is the right price to buy or not and my answer will be that the margin of safety at the current price will be limited. However, I will still be holding on to my shareholding as I believe that the growth story of VICOM is not yet over and will be able to prove its resilience during this period of economic uncertainty.

Healthway Medical Corp Ltd - Turnaround probably not in the short term

2012-08-14T09:32:00.001+08:00

Healthway Medical Corp is one of the few companies in the healthcare sector listed on the SGX, operating the biggest clinic network in Singapore. Other than operating GP clinics and dental services, they are also involved in specialist & wellness healthcare division which is involved in Paediatrics, Orthopaedics and Aesthetic Medicine.

Figure 1 - Income Statement

FYI, 2005 to 2007 results are PRO FORMA results found from the IPO prospectus and hence might differ from the actual figure that you see from the FY 2008 annual report. In fact, the pro forma result in 2007 is the highest level of profit that the group has ever recorded in its operating history. The trouble in Healthway occured in 2010 when a group of specialists decided to leave en mass which created a vacuum and losses of customers. What happened is the start of a drop in profitability which accumulated till 2011 where a $58m of intangible asset is being written off. In 2010, they should have also been in the red if not for gain from acquisition of Crane Medical and disposal of Healthway Medical Enterprises.

2012 1H looks like a pretty good set of result that shows some turnaround occurring with Healthway recording a 10% margin for 2 straight quarters. The question is then has it really turned around? In actual fact, it seemed like the company has largely relied on its other income to boost its profitability. Looking back into the annual report 2011, the company has deferred booking $7.1m in income due to prudent reason of which it has booked approximately $1.6m in 2012 Q2 and perhaps another $1.2m in 2012 Q1 under other income. For more details regarding the deferred income, please refer to http://info.sgx.com/webcoranncatth.nsf/VwAttachments/Att_6AF4D9F6C8EC525F482579E10075BE16/$file/HMCMaterialVariances.pdf?openelement
Now, I shall present the pro forma income statement for 2012 Q1 and Q2 after stripping out these deferred income from 2011.

Figure 2 - Pro Forma Income Statement for 2012 1H

What we see is that nothing much has changed for 2012 1H after taking away the deferred income from 2011, and the company is obviously still struggling to maintain its profitability. Since these deferred income is non-recurrent in nature, it seemed like the company is still stuck in the limbo.

Figure 3 - Operating expense ratio

Figure 3 will allow us to understand the loss in profitability of the company since 2010. From figure 3, we can easily see that the main cause of the losses has been staff cost which has risen from around 44% in 2008 and 2009 to approximately 56% of revenue ever since 2010. In 2012 Q1 and Q2, this has also been held true which goes to show that the level of profitability is similar to that in 2010 and 2011. Do take note that actual percentage for 2011 should also be around 55% as the company chose to "derecognised staff cost recharges of $4.5 million to a 3rd party which remained unpaid" (part of the $7.1 million in deferred income).

However, it is not all bleak from the above figure. The cost of medical supplies and other operating expense as a percentage of revenue have held pretty steady which means that the company has been able to pass on increase in medicine cost and rental to its customers. Another positive point to note lies in its staff cost which in fact provide huge potential for operating leverage given that this is largely a fix cost. If Healthway can focus on increasing its revenue per clinic per doctor, it will definitely be able to return to its profitability in 2009. However, it seemed like the company's main focus is still on further expanding their services be it in specialist, aesthetic or in China.

Figure 4 - Balance Sheet

This is definitely not the ideal balance sheet that any company should have and the biggest problem will be in the intangible asset which stands at $119m compared to $198m in total asset and $160m in total equity. I will discuss about the intangible asset later on. The new management has done a pretty good job in reducing the total debt from a high of $68m in 2008 to the current debt level of $17m. Cash has unfortunately dwindled down to a worryingly level of $5m which raise the prospect of some form of financing option in the short term. However, the group has a loan receivables of $15m which are supposed to be returned to them in the current financial year and this will hopefully strengthen their balance sheet.

Intangible Asset

Let's explore the intangible asset which is worth $179m at its high in 2007. When company A uses $10m to acquire company B with net tangible asset of $5m, the excess $5m over the NTA will be booked under intangible asset. Therefore, we have to trace back the history of HMC to understand how did such a huge amount of intangible asset appears in the first place.

Founded by Dr Wong Weng Hong in 1990, HMG expanded its network of clinic to 15 by 1997 and 31 in 2002 before it went on to acquire 4 clinics under "Singapore Family Clinic and Surgery". A management buyout was carried out in 2006 by the founder together with Fan Kow Hin, Dr Jong Hee Sen and a few other investors. By the end of 2006, the group only has a total of 38 clinics, which paled far in comparison to the 80+ they had by the time they were listed in 2008. In the mere span of 1 year, the group went on a massive acquisition spree paying $72.32 million for "Silver Cross" and "Peace" group of family clinic, "Aaron" and "Universal" groups of dental clinics, "Paediatric Centre", "BCNG Laser and Medical Aesthetics". They also went into agreement to acquire IOC, IOCH, SBCC Clinic and SBCC S&T for $107.9m. Therefore, by spending $180m the group managed to expand from a sole family medicine clinic chain into specialist and wellness healthcare services before they got themselves listed on the exchange. Given that they do not have that much cash at that point in time, the acquisition was done through offering of share which lead to its specialist leaving en mass in 2010.

Figure 5 - Intangible Asset

Figure 5 shows us the breakdown of intangible asset as well as the impairment loss carried out in 2011. We can see that the bulk of the write down are for Paediatrics and Orthopaedics which falls under the specialist segment. Family medicine is probably their strongest division as no write-down has been carried out so far. It seemed like it has been a huge mistake for the firm to acquire IOCC, Paediatrics Centre and SBCC in 2007.

The greater concern currently will then be is the write-down in 2011 the last of impairment loss? Unfortunately, what I see is that another $60m in intangible asset needs to be written down. The calculation of impairment is based on DCF calculation using a discount rate of 8.5% and projecting a terminal value based on the EBIT "from the 6th year at annual growth rate of 1% to 3% to perpetuity." This is definitely acceptable to me. The devil is in the detail where the cash flow growth is projected for the first 5 years. For Family Medicine, Dentistry and Wellness and aesthetics, expected annual revenue growth is approximately 4% from 2012 to 2016.

However, for the Paediatrics and Orthopaedics division, the anticipated annual revenue growth is 9% from 2012 to 2016! Remember that these 2 divisions were the ones that have to be written off in 2011, then why does it have so much higher projected revenue growth than the family medicine? Specialist and Wellness segment produced a loss of $3.7m on revenue of $25.6m before the impairment loss. What's more, the anticipated annual revenue growth in FY 2010 for Paediatrics and Orthopaedics was at 4% and after 1 year of poor performance, they are now expected to deliver double the revenue growth in FY 2011. I believe that the increase in anticipated annual revenue growth from 4% to 9% is done so as to reduce the amount of impairment loss being recognised in 2011 for both Paediatrics and Orthopaedics division. In any case, I believe that it is pretty reasonable to expect a complete write-off of total intangible asset of $59.5 m for these 2 particular divisions. Garbage In, Garbage Out, but not unexpected from a firm that seemed to love performing financial engineering since they are listed.

Figure 6 - Profitability Ratio

Many might have pointed out that its ROA even in its most profitable year is unimpressive at 7.7% based on the Pro Forma statement. However, if we were to strip out the intangible asset, it seemed like we have a highly profitable business at least before what happened in 2010. As for free cash flow, it seemed like has the ability to generate good cashflow in the long run should profitability stay or improve. Total capex for 5 years are only at $8.5 million of which majority occurred in 2010 where multiple specialist clinics are opened especially the ones at Tripleone Somerset.

From a valuation point of view, despite the fact that price has tumbled since IPO, the company does not look attractive. With a PSR of 2.0, even if the company manages to return to a 10% profit margin, it will be a PER of 20 which is just slightly lower than the well-run Raffles Medical Group which has a much better track record and balance sheet.

To conclude, an actual turnaround has not really occurred despite the return to profitability in 2012 1H. Discounting the deferred income from 2011, profitability probably remains the same as the past 2 years. For as long as the intangible asset stays in the balance sheet, I believe it will be a time bomb that will not be welcomed by investor. While it is reasonable to say that some gestation period is needed for new clinics to turn in profits, it seemed like there remains numerous loss-making clinics around.

Without doubt, things have definitely changed for the better with the new CEO, Mr Lam Pin Woon in Jan 2011 as we see debt being pared down and a much lower staff turnover rate. Discounting the intangible asset, it is likely that they do have a crown jewel in family medicine clinic and management of clinic and asset. However, it seemed like the company has yet to internalise the importance of focus in operation as they embark on their expansion plan in China and specialist division in Singapore at a point where their balance sheet is weak and certain operations are bleeding. Whether the strategy will work out remains to be seen though it is likely that any turnaround will be visible only in the middle to long term, especially when their clientèle base for specialist and wellness builds up.

SIA Engineering - 3rd Core Business in Engine Overhaul

2012-08-05T17:22:00.001+08:00

Many that have attended the AGM for SIA Engineering on 20th July 2012 will have agreed that it has been a great session that provides important insights into the SIAEC's business model during the past decade. One of the most important will have been the fact that the management has been very willing to cannibalise their business to support the growth of their JVs and associate companies.

The first reason is that OEMs are increasingly going into the MRO space and it is either you compete or collaborate. However, as with all collaborations, there must be something which you can offer before the other party will be willing to do so (SIA's business). The second reason is that this is one of the best way for SIAEC to reach out to global clients. Without a JV, the management explained that other airlines might not be willing to engage the service of SIAEC due to certain sensitive data. By forming a JV with credible partners, competing airlines will be less guarded and SIAEC will also be able to tap onto the network of its partner.

The question that pops up now is obviously to what extent has the cannibalisation taken place? However, upon digging deeper into the past years annual report, initial prospectus, analyst presentation, I found a shocking truth with regards to its network of 26 JVs and associate companies. In actual fact, of the 26 joint ventures, there were only 3 that are really important - Eagle Services Asia, Singapore Aero Engine Service Limited and International Engine Component Overhaul Private Limited. What is even more surprising is that the share of profit of these 3 companies are very close to the total operating profit of SIAEC's core business of Line Maintenance and Repair and Overhaul. Coincidently, these 3 companies can in fact be grouped under the Engine Overhaul business and they are with 2 of the top 3 aero engine manufacturers Rolls Royce and Eagle Services Asia.

Figure 1 - Associates

Now, I will take you through the accounting of its associates and JV before I delve deeper into its Engine Overhaul Business. This part might be slightly complicated as it involves accounting for associates and joint venture. Note that Eagle Services Asia is being accounted as part of the Associated Companies as it is 49% owned by SIAEC. "Unquoted shares, at cost" is the initial outlay of capital by SIAEC in forming the associate. Under normal balance sheet term, it is also known as share capital under the Equity portion. "Share of post-acquisition profit" is SIAEC's share of the accumulated profit or retained earning by the companies. Translation adjustment is there as these associate companies don;t report their financial statement in SGD, instead most of them are reporting in terms of USD.

Figure 2 - Share of Profits of Associates Companies

For 2005 and 2006, 100% of revenue, asset and profits are reported before the accounting is changed in 2007 onwards, where only SIAEC's share of the profit and equity of the company is being reported. Luckily, sufficient information has been divulged for us to understand the profitability of its associated companies.

Starting with the balance sheet, there is supposedly very little off-balance sheet financing done as the non-current liabilities are only around 3% of net asset. The best measure of profitability are always profit margin as well as ROA and ROE. These figures have been very impressive for its associated companies as we see a profit margin of 8-15%, ROA of 15-25% and ROE of 19-28%. Just by its ROA of 15-25%, we can easily conclude that this business is definitely worth something.

Something that your might have noticed is that, the performance of its associated companies seemed to have peaked in 2009 with share of profit as well as the profitability ratios dropping. Asking the CEO, he told me that as all its associated companies are being accounted in USD, it has suffered the effect of depreciating USD. Notice that I have sought to account for the translational effect in Figure 1. I applied this to the revenue and net profit and what we see is that revenue has increased but profits have dropped which means that certain business have been dragging the profitability. Given that 3 new ventures have been set up in the past 3 years namely Safran Electronics Asia, Southern Airports Aircraft Maintenance and Panasonic Avionics Services, it could be likely that some of it has not reached its point of break even and hence incurred some losses.
Joint Venture

Joint Venture

Share of Profit of Joint Venture

There is a very interest fact about its JV, which is that it comprises of only 2 companies, Singapore Aero Engine Services Pte Ltd and International Engine Component Overhaul Pte Ltd which are formed with Rolls Royce. Therefore, we can safely conclude that all of SIAEC's share of profit of joint venture, comes from these 2 JVs which are in the business of engine overhaul.

Over the years, this division has been very successful in growing the top and bottom line ever since it started full operation in 2002. Given that the share of profit from JV companies is $74.7 million, it means that total revenue and profit from these 2 companies amount to $1.5 billion and $148m which is more than total revenue and operating profit of SIAEC in 2012! Compared to the associate companies, the balance sheet for JV is not as clean as there is a $58 million of long-term liabilities which is likely to be debt. Comparable margin with the associate companies, though it seemed to be a super profitable business with a ROA of 28.76% and ROE of 64.94%. It is very rare to have such a high ROA, which is usually reserved for companies involved in technology or business services. Since 2010 onwards, dividend payout ratio has been close to 100%, which might mean that the business is in a rather auto-pilot mode already.

Figure 5 - SIA contribution and Engine Overhaul Business

Figure 5 is made up of data derived from the analyst presentation done by SIAEC after release of its full year result. The first row is basically the contribution coming from different segment of its associates and JVs. Initially, it was just Engine Overhaul which comprises of Eagle Service Asia and Singapore Aero Engine Service, as well as all others. As we can see ESA and SAESL easily contribute around 60% of the total profit for share of profit of associate and JV for SIAEC. After FY08/09, the format has changed from Engine Overhaul to Engine Overhaul and Component.

The first table can also help us to pinpoint the weak division that has been dragging down the share of profit of associate. Ever since 2009, both division has taken some hit though the "others" have not yet recovered. What we can deduce is it is likely that the multiple new start-up in Safran, Panasonic and Southern Airport have created some losses, coupled with perhaps a slight drop in profitability of certain associate. As for engine and overhaul, we can easily deduced that ESA might be the culprit as we see that the result from JV has been improving over the years.

Moving on to the 2nd table which is SIA's contribution of JV & associate revenue, and which will reveal the extent of cannibalisation done by SIA to support the JV and associate. For "Others", SIA's contribution has been increasing hitting a peak in FY1112 with $55m in revenue contribution. This does confirm that the Panasonic Avionics is likely to account for the $14m increase in revenue contribution and the reason which the CEO attributed for dragging down the profitability of line maintenance.

For Engine Overhaul and Component, what we see is fluctuating numbers with the lowest point being in FY1011. And this coincides with the decrease in profitability of the division in FY 0910 and 1011. What actually happened? Checking through the Singapore Registered Aircraft Information from CAAS, I realised that it is because SIA has been reducing its number of B747 which runs on P&W engines from 33 in Jan 2008 to 20 in Jan 2011. With the addition of A330 and A380, 80% of the aircraft of SIA are now running on Rolls Royce Engine. This certainly explains why profit from its JV has been increasing over the years while the ESA has been suffering. Some might ask then if SIA switches from P&W engine to Rolls Royce engine, should not the overall contribution by SIA for Engine and Overhaul remains the same? The answer is simply that the new aircraft probably does not need to do an engine overhaul, and hence we starts to see SIA's revenue contribution return to the peak in FY 1112 as these aircraft reaches the stage where repair and overhaul needs to be done.

Now to the 3rd and 4th table, Non-SIA's contribution of JV & associate revenue, we can see that demand for Engine Overhaul and Component has a pretty strong demand. As for others, revenue drops by 60% since FY1011 and I wonder if this is due to an allocation of some revenue from Others to Engine Overhaul and Component. In any case, we can see that total revenue from Non-SIA has been increasing from $1.265 billion in FY0506 to $2.67 billion in FY1112. They have achieved success in growing the Non-SIA business to more than 80% for the last 3 years.

Eagle Service Asia and Singapore Aero Engine Service Pte Ltd

Without much doubt, these 2 forms the core of SIAEC's associate and JV and they are in the business of engine overhaul and repair for P&W and Rolls Royce. Usually, when engines are purchased from the OEM, a package is purchased that includes repair and overhaul for a period of time. These aftercare services are often more profitable than the actual selling of the engine and also provides future source of income for the OEM.

Figure 6 - P&W

Eagle Service Asia is an important arm of Pratts & Whitney handling the engine overhaul business in South East Asia. P&W also provides engine overhaul services in New Zealand, North America, China and Turkey. From a cost point of view, airlines will send their plane to the nearest service centre, giving ESA a monopoly status over the SEA region for repairing of planes running on P&W engine. And in 2012, ESA has been the first engine center designated to service the PW1500G engine, which has been selected as the exclusive engine for Bombardier CSeries aircraft. The PW1000G engine series will be in production by 2013.

Singapore Aero Engine Service Pte Ltd is Rolls Royce's Centre of Excellence that specialises in the repair and overhaul of the successful family of Rolls-Royce Trent aero engines. It is also the only one currently that is able to service all variants of "in-service" Trent Engine. As a reference, the Trent Engine has commonly been used in popular aircraft like B777, A340 and A380 which forms the bulk of SIA's fleet. SilkAir, Tiger Airways and JetStar Airways are all using 2 type of aircraft which are A319 and A320 which are all running on Rolls Royce V2500 engines. Currently, the facility is able to service up to 250 Trent Engines every years. While I am not sure how many other engine overhaul centres are in service around the world, it is likely that the OEM will want to minimize the number of such centres to reduce cost.

In conclusion, SIAEC has a 3rd core business in Engine Overhaul business, just that this has been done through partnering with P&W and Rolls Royce. It has also been a good thing that it has partnered with both OEMs in case any of the 2 loses to each other in competition to be the engine of choice. For this segment, growth will be directly linked to the total number of aircraft in service. As for its other 23 associates, it seemed like they are minor contributors though there is a serious lack of information on them. Feel free to comment on the data above.

Lessons Learnt From My First 3 Months

2012-07-22T18:06:00.001+08:00

Not too long ago, I was introduced to this portfolio tracking tool on Excel called the XIRR. I give up on using it as it don't seemed very accurate or perhaps I made some error because I don't fully understand it. Since I have compiled my trade history, I think it will be useful to share my wonderful experience with the market during my first 3 months. It was a really good experience and without with I think I will not have improved much especially when it comes to emotional balance.

Figure 1 - Trade History

So this is my trade history when I just started out in the market. The decision to take the plunge at the onset of the current Euro Zone crisis last September is a wise move as I started to get used to market gyration. So on 22nd September 2011, I got my trading account and bought my first 2 stocks - VICOM and Eratat. VICOM was a great choice and I bought it for I think it is a great piece of business.

For Eratat, I thought it was being deeply undervalued and I was drawn into its story of going up the value chain to price itself as a premium brand. Profit margin is growing and profit and revenue have been jumping higher each year. Coupled with its high cash position and low P/E of less than 2, it looks like an ideal value stock. I sold 2/3 of it in 10th November 2011 at a loss of 9.7%. Lesson Learnt - Accounting skill is extremely important when doing fundamental analysis.

3 days later, I flew to Australia as part of military exercise and thus I did not do any trading until I came back at the end of October. I bought into this stock called Sunvic Chemical as it has some share buyback programme and I think it is going to deliver a good quarterly result as price of the ester commodity seemed to be doing fine. Subsequently, I can no longer stand the price fluctuation and decide to sold it at a loss. Lucky, I sold it as it subsequently reported a 40% drop in quarterly profit. Lesson Learnt - Do not buy a stock if you cannot stand the price fluctuation.

While the loss was only 2.97% and maybe a few hundred, I cannot take the losses and was determined to get back into the black. Not long after, I got to know about this stock called Mewah through some investment website and blog. Basically, there was insider buying and speculation that it will have be a turnaround for the next quarter. I was hoping to be able to recoup my losses but I ended up losing money yet again though I was quick to cut my losses. Lesson Learnt - Don't buy on rumours.

As I continue to slump into the losses, I was even more determined to get out of it. So I went into Sunvic again, hoping to make some quick bucks. Luck was not on my side and I sold it off 4 days later at 4.94% losses. Lesson Learnt - Things get worse when you are speculating aka gambling...

Subsequently, I bought into UOL($4.26) since it seemed to be undervalued though I did not really do much analysis. 2 days later, ASSD was announced and all the property counter starts to crash heavily and I sold it at a 5% loss once again. Of course, if I have done my homework I might not have sold UOL given that it holds hotels, offices and retail malls. Lesson Learnt - Always do your homework.

I also bought into SIA Engineering as I want to reduce my "gambling" chips as I am quite scared about the losses coming from speculation. However, I did make a mistake in buying again the next day at $3.53, thinking that I was averaging down. Lesson Learnt - Averaging down target should at least be 10-20% lower.

After that, I bought OUE at $2.05 and sold it at $2.05 incurring brokerage losses. Once again, I was trying to recoup my ballooning losses but I cannot take it and sold it. Lesson Learnt - Even if you manage to sell away your stock at the original price, you will still be incurring brokerage losses.

Then I bought into SMB United as a arbitrage play given that the original offer from Boer is a bit too cheap. I was thinking that even if the offer fails, the company is still worth more. Finally, Lady Luck smiled on me and I got away with a 13.2% gain though I am still quite in the red.

Getting away lucky, I venture into CD/XD play with UtdOAus which was trading in SGD but declared the dividend in Aussie. I got away with a 2.68% gain though I am sure I am still speculating.

At the end of the year, I bought into San Teh upon the declaration of dividend distribution the previous night. Not only was i speculating, I keyed in twice the amount as I was not aware that I failed to cancel the previous trade. Needless to say, I made ~8% losses again as I sold it within 3 days as I know I do not have enough money to pay for it. Lesson Learnt - Always check the trade that you have entered especially if you are doing online trading on your own.

In all, I made 11% in realised losses using NAV within 3 months and I told myself that I am going to stop speculating once and for all. I have read The Intelligent Investor before I have started, but I simply cannot control the very powerful feeling of greed and fear within me.

However, I am glad that I have paid for the lesson and become determined to follow the proper path. I restructure my portfolio and sold the loss-making Eratat. I bought companies like HR Glass ($1.06) and additional stake in VICOM before the minor bull returned in 2012.

Summary of Lessons Learnt –

Accounting skill is extremely important when doing fundamental analysis.
Do not buy a stock if you cannot stand the price fluctuation.
Don't buy on rumours.
Things get worse when you are speculating aka gambling...
Always do your homework.
Averaging down target should at least be 10-20% lower.
Even if you manage to sell away your stock at the original price, you will still be incurring brokerage losses.
Always check the trade that you have entered especially if you are doing online trading on your own.

That's why I have always said that I am blessed to have started on September 2011 in the midst of the trial and tribulation ongoing in the market. The bear is where you learnt the most as it is akin to putting yourself on a survival mode out in the open sea. If I have started in a bull market, I supposed I will have made much better gain before my portfolio will get wiped out when the bear returns. I am happily waiting for the giant bear to come though it will probably not be any time soon. That will be where I can get to understand my character and emotional balance best.

SIA Engineering Company (Operation)

2012-07-14T10:09:00.001+08:00

Fig 1 - Operating Segments

SIAEC has 2 core operations in repair and overhaul as well as in Line Maintenance. Line management makes up around 35% of total revenue while repair and overhaul makes up the other 65%. However, if we were to look at the results, line management makes up 65% as compared to 35% for repair and overhaul. This implies that line management is a much more profitable business for SIAEC as compared to repair and overhaul.

Repair and Overhaul

Under the rules of aviation authority worldwide, planes have to undergo periodic inspection before they are allowed to fly off (being deemed airworthiness). This rule is implemented to ensure the safety of passenger as a faulty plane is fatal in the air. Other than the scheduled routine maintenance, SIA also provides other services like aircraft modification, paint stripping, conversion of aircraft cabin interiors and e.t.c. Fees are typically being charged based on a fixed fee per man-hour as well as cost of all the materials used.

Commonly, there are 4 checks which a plane has to undergo throughout its lifespan in order for it to be approved for flying off. These are known as the "A", "B", "C" and "D" check. "A" check is the most basic level of check and will be done every 500 flight hours. "B" check is an expanded form of "A" check and is done every 4-6 months. "C" check involves the whole aircraft and is performed every 15 months or 5000 flight hours. The aircraft will have to be put out of service for around 1-2 weeks when performing a "C" check. Last but not least, "D" check is performed every 25,000 flight hours or 5 years, whichever is earlier. This is the most comprehensive and expensive check and will take around 1-2 months to complete. For the reason of cost, some airline might choose to scrape off the plane before it reaches its next "D" check.

Theoretically, we can hence view this part as fairly resilient as an airline has to continue its scheduled maintenance unless they choose to ground it or scrap it. Decision to ground an aircraft may not be the most cost-efficient move. Planes are not cheap and with a lifespan of 15 years (for SIA's plane), grounding it for a year or 2 will represent a waste of capacity. Other planes will also has to bear with heavier load and should the airline decides to de-ground it all the previous check missed will have to be carried out. For your information, "Aircraft maintenance and overhaul costs" represent 3% of total revenue for SIA.

Figure 2 - Number of Registered Aircraft

Given that SIA and its subsidiaries and associates account for a huge percentage of total revenue, let's have a look at their number of registered aircraft throughout the past 5 years. As seen from the table, there has only been a slow increasing trend for SIA, Silkair and Tiger Airway (30+% owned by SIA). During the difficult time of 2008 to 2009, we hardly see any contraction in the numbers. For 31-Mar-12, 2 planes has been transferred to Scoot. From 31-Jan-2007 to the latest data as of 30-Jun-2012, there has been an increase in total number of aircraft from 128 to 156, representing a 20% increase.

Figure 3 - Number of Checks Performed by SIAEC

Digging into the 11 years data, I have compiled the number of checks performed by SIAEC as well as its maintenance and overhaul revenue. I have also highlighted recessionary year in orange - namely 2001 9/11, 2003 SARS and 2008 GFC. For FY 2007/2008, there is a revised maintenance schedule that extend the interval between each check, creating a drop in A check for 2007/2008. From the table, we can easily deduce that a normal financial crisis is not enough a dampener for SIAEC as revenue manages to hold on well. However, a greater aviation crisis like SARS is able to reduce its revenue by 20%. One point to note is that as customers are charged based on man-hour, an "A" check revenue is not equal to that of a "C" check or "D" check. Depending on the extent of check, an "A" check requires 500-1000 man-hours as compared to 1000-8000 for "C" check and 20,000-50,000 for a "D" check.

Line Maintenance and Technical Ground Handling

For line maintenance, its job is to "release certification, such as aircraft transit checks, night-stop checks and rectification of defects as well as maintenance and repair of aircraft radio systems, navigation and

communication systems, radar and cabin management interactive video systems". SIAEC's main task is to ensure that the aircraft has done all relevant checks before they are issued with the airworthiness certification.

For technical ground handling, they provide services "such as push-back and towing of aircraft, water and lavatory servicing and the provision of aircraft ground support equipment". To sum up, this division is highly correlated with the number of flights received by Changi Airport as the higher the number of flight, the higher the revenue is. SIAEC has approximately 80% market share in Changi Airport Singapore.

This division also enjoys a high profit margin of 20% as noted earlier as a result of the low expenses involved. For Repair and Overhaul, material cost and equipment depreciation are involved resulting in a much lower profit margin. However, for line maintenance, it is relatively asset-light and fees are charged based on a flat fee per flight handled basis with the bulk of the cost being manpower.

Figure 4 - Flights handled by SIAEC at Changi Airport

Just as how the number of departure flights have increased over the years, number of flights handled by SIAEC has also shown a similar trend. Revenue is also correlated with the number of flights being handled. Hence, this division will be in sync with future growth in air traffic at Changi Airport, especially with the ASEAN Open Skies agreement in 2015 where traffic is expected to expand by at least 5% per year. Air traffic is relatively stable apart from the 2003 SARS where there is a 25% drop in revenue as a result of a drop in number of flights handled.

To conclude, both of SIAEC's core operations are relatively stable even during a normal recession. Should a crisis like SARS occur once again, we can then expect some significant drop in revenue at a range of 20-30%. The line maintenance business also have a chance to grow in line with the air traffic at Changi Airport. However, SIAEC has a huge proportion of earnings coming from its investment, associates and JV, which we cannot overlook.

Investments, Associates and Joint Ventures

Not willing to be solely dependent on Singapore's air traffic for growth, SIAEC has been constantly seeking growth through external partnership. Its external partnership strategy is a two-pronged approach where it partners with well-known high-tech OEM to build its expertise as well as seeking overseas partner to start line maintenance business to grow its revenue base.

Figure 5 - Joint Venture with OEM

It has always been part of the strategy to invest in a joint venture with established OEM to expand the breadth and depth of their services. Not only will they get an increase in revenue, SIAEC will also be able to provide better technical expertise for its MRO customers. Partners can also benefit from the customer base of SIAEC in Singapore.

Some of the major partners involved are like Rolls-Royce and Pratt & Whitney which are 2 of the 3 largest aero-engine manufacturers. A wide range of repair services are also provided like hydraulic pump, thermal coating, engines, fuel accessory, turbine, aircraft cabin, landing gear, compressor and avionics. These services help SIAEC to market itself as a one-stop service contractor that can take care of all needs.

Figure 6 - Line Maintenance Joint Venture

While SIAEC have joint venture in Pan Asia Pacific Aviation Services and PT JAS Aero-Engineering Services, they seemed to have adopted a new strategy ever since the joint venture of Aviation Partnership (Philippines) Corporation was formed in 2005. The strategy has been to make use of line maintenance activities which require lower capital expenditure and start-up time to expand into repair and overhaul services at a later stage. The line maintenance partnership will allow them to forge a critical mass of customer base and business volume.

After the partnership with Cebu Pacific Air in Philippines, SIA Engineering (Philippines) commences operation in 2009 becoming their first overseas based heavy maintenance facility. In 2007, SIAEC acquired Aircraft Maintenance Services Australia (AMSA) which offers line maintenance services in Sydney, Brisbane, Coolangatta, Melbourne, Adelaide and Perth. After the success in Philippines, SIAEC went on to establish Southern Airports Aircraft Maintenance Services (SAAM) with Southern Airports Corporation. Having commenced operation in late 2010, there has been plan to expand to other airports in Vietnam and to scale up operations to provide heavy maintenance.

To conclude, SIA Engineering will be a better way to take advantage of growing air traffic rather than SIA which is subjected to fuel cost, higher capex and more intense competition. While its resilience is respectable, expect some decline in both top-line and bottom-line during a global epidemic on the scale of SARS. There has also been signs that they are seeking to expand beyond their stronghold in Singapore to countries like Philippines, Vietnam, USA and Indonesia. Meanwhile, shareholders can benefit from the slow and steady growth in air travel industry in Singapore with our 2 IRs, F1 and other events.

SIA Engineering Company (Financial Statement)

2012-07-10T21:30:00.001+08:00

SIA Engineering Company (SIAEC) is a leading provider of maintenance, repair and overhaul (MRO) services of aircraft as well as providing line maintenance services and technical ground handling in Changi Airport as well as in airports in USA, Hong Kong, Indonesia, Philippines and Vietnam. Without further ado, let's look at the financial statement of SIAEC.

Figure 1 - Income Statement

Revenue has been on a slowly increasing uptrend from $878m in 2002 to $1.17 bn in 2011 which is an increase of 33% in 10 years. Other than in 2003 where there is a huge dip in revenue of 25%, the business is fairly recession proof with a 5% drop in 2009. This has to do with its business model which I will explain later. For expenditure wise, Staff cost is the highest contributor as the business is essentially reliant on a skilled labour force to perform MRO. 2nd biggest cost is material costs which is all the spare parts and repair material used in MRO of the aircraft. Together, they make up 58.9% of the total revenue.

Something not commonly seen is that the net profit is always higher than the operating profit. This is due to the fact that it has 25 joint ventures and subsidiary which contributed a significant amount of profit. This has been part of its expansion strategy as it sees a limit to its organic growth. Since 2006, contribution coming from investment, associates and JV have exceeded 50% of net profit, and this will be discussed in greater detail later on.

Figure 2 - SIA contribution to revenue

With the support of its parent company, SIA accounts for a huge portion of SIAEC's revenue. The figure is derived from SIA's annual report using inter-segment revenue under its engineering arm. I have also pro-rated the figure to account for the distribution of SATS by SIA in 2008. SIAEC provides technical support to Beijing Aviation Ground Services Company which is a JV by SATS. From the above table, we can infer that SIA contribution has been very stable over the decade and it is contribution from other airlines that have been driving growth in the top line.

Figure 3 - Balance Sheet

There's also something very interesting about its balance sheet which is that it does not have any Non-current liability in the annual report. I have decided to classify the "deferred taxation" found under equity as long-term liability in line with the usual form of presentation. The company is very cash-rich with insignificant debt such that cash + short term deposit is around 40% of total equity. Receivables is insignificant being at around 8% of total revenue, which means they are collected every 28.56 days. PPE comprises another $300m and it is made up of $165m in leasehold land and building, $90m in Aircraft Rotable Spares and $37m in plant, equipment and tooling. Aircraft Rotable Spares are anything that requires routine replacement like enginer, pumps and tires. We can see that equipment needed for MRO is not very capital intensive. For its liability, it is pretty impressive that it is more than twice the amount of receivables at $263m. At a day payable outstanding of 82 days, it shows that SIAEC has significant leverage over its supplier. In all, this is a very clean balance sheet.

Figure 4 - Cash Flow Statement

For the net cash flow from operating activities, profits coming in from investment, JV and associates are being taken out and only the dividends are accounted under cash flow from investing activities. In calculating the FCF, I have taken into account purchase of intangible asset, dividend received from long-term investment, associate and JV. FCF/Net Profit ranged from 50% to 94% usually, and is susceptible to some fluctuation as they may not received 100% of profit from associate as dividend. There is a noticeable dip in 2007 and 2008 and this is due to much higher capex by the company in ensuring that its maintenance facility is A-380 ready. As such, get ready for a slight drop in dividend the next time there is another mega jumbo plane coming out. Under normal circumstance, the company should be able to maintain a FCF/Net Profit of around 85%.

Figure 5 - Financial Ratio

SIAEC has managed to maintain an operating profit margin of above 10% for the decade. While this might not be the net profit margin, the only negative item to deriving the net profit is taxation. Net profit margin might not be an accurate representation as they are being falsely inflated by the huge amount of share of profit of associate, JV and dividend from investment which are not accounted for in the revenue.

For a more accurate picture, we will then have to look at the ROA, ROE and ROIC. The figures are strong with ROA and ROE staying above 15% and 18% (other than the 2003 SARS) and ROIC above 14%. Discounting the effect of JV and associates, I have also did an adjusted ROA and ROE to look at SIAEC's organic operation. Adjusted ROA managed to stay above 11% while ROE is 13% which goes to show that its organic operation provides respectable return as well.

By all counts of financial leverage ratios, SIAEC has a very clean balance sheet as explained earlier. It has excellent working capital management as it has a negative cash conversion cycle of at least 30 days and more. Basically, this means that SIAEC can afford to distribute all its cash and short-term deposit without affecting its ability to continue operation. Not many firm has a negative cash conversion cycle.

The next part will be on the operation aspect.

SATS

2012-06-27T13:11:00.000+08:00

SATS, Singapore Airport Terminal Service, "is the leading provider of gateway services and food solutions in the region". As stated by the description, SATS's 2 core businesses are in the Gateway and Food industry contributing 31.9% and 67.5% respectively. As majority of the food solution are meant for air passenger, aviation accounted for 59.8% of total revenue which means it is highly correlated with the travel and tourism industry in Singapore.

Figure 1 - Segmental Revenue

Figure 2 - 5-Years Result Summary

I have compiled the more important numbers in figure 2 and we can see that revenue has nearly doubled over the past 5 years. However, do take note that it has also been driven by acquisition of new business. They acquired SFI in 2009 which contributed 2 months of revenue worth $110m in 2009 before making a full contribution in 2010. In 2011, they acquired 50.7% of TFK which contributed $73m in revenue for 3 months.

Despite the increase in revenue, it has been noticed that net profit attributable to shareholder has not increased much since 2008. If you take in account that there is a $17m in exceptional item in 2008, then we will have seen a 10% increase in profit over the years as compared to 75% increase in revenue,

Profit margin has dropped sharply since 2009 from a high of 20% to 9.1% currently as a result of the acquisition of SFI. So is the acquisition of SFI a bad move given that profit margin drops by such a huge amount? Looking at SFI's profit margin before it is being acquired, it is at a figure of around 4-5%. However, this certainly does not imply that it is a bad acquisition. If you were to look at the ROA and ROE, you will have only noticed a slight dip which goes to show that SFI have a high turnover and hence ROE.

In fact, things will have been much better without the consolidation of TFK in 2011 which contributed $73 m in revenue but $74.2m in operating expense, implying an operating loss of $1.2m. Paying $122m for operating loss of $1.2m, it is again not necessarily a bad investment. TFK has been unduly affected by the disaster in March 2011 which resulted in 11 of its airline customers suspending or diverting flight as well as a disruption to raw materials supply. When TFK starts to turnaround, we are going to see significant improvement to the bottom line. In 2010, TFK recorded a revenue of $353m and $27m in EBITDA on total equity of around $180m.

With regard to the cashflow statement, FCF/Net Profit is at an average of around 90% ranging from 70% to 105%. SATS is not as capital intensive as 60% of the PPE are in leasehold building and land. However, capex has increased rather significantly after the acquisition of SFI though it is still able to generate a pretty healthy FCF.

Figure 3 - Segmental Result

The segmental result shows that the Gateway services is much more profitable as compared to Food solution. Of course, we have to make some adjustment here as the share of profit from associated/ joint venture companies does not contribute to the revenue. ROA for Food Solution is around 7.4% and 10% for Gateway Services. It seemed like the company has been doing while with its investment in associate as we see a ROI of 20%. Gateway Services has a higher profitability as it is more of a service provider unlike the Food Solution where cost of food is involved. Should there be a rapid rise in food prices, expect profitability to be hit.

Competition

For its Gateway and Aviation food services in Singapore, SATS is the clear market leader with DNATA being the only competitor. DNATA is owned by Emirate (wholly owned by the Government of Dubai) which helps it to secure contract with Emirate and other airlines. For Gateway, operators need to secure a license from the Changi Airport Group which has currently issued 3 licenses. SATS has a market share of 74% in this area with DNATA having the other 26% of the pie. ASIG, the 3rd licensee, has not been able to secure any business after 1 year of securing the license. In 2004, Swissport got a license to operate but exited within 3.5 years with $15m losses. As such, SATS has a rather strong grip in its market share and is poised to benefit from growth in traffic of Changi Airport Group. One possible risk is that as it is no longer linked to SIA, its chance of losing SIA's contract is slightly higher now.

In terms of aviation food solution, SATS has a market share of 86% as compared to 14% for DNATA. In this area, SATS get to benefit from its economies of scale as it delivers up to 80,000 meals a day through its central kitchen. SIA requires an average of 30-45m meals a day which there is no one in the market with the equipment and expertise to deliver presently.

For its non-aviation related food solution in SFI, around 30% of the revenue comes from military cook-house contract. It is not a monopoly though as NTUC FoodFare is also involved in the catering of food. However, I am pretty sure it is a monopoly in terms of the outfield ration as I always see the same green pack and accessory pack when I went outfield. SFi is also involved in the food distribution business with brands like Farmpride and Singourmet.

SFI has an excellent segment in Abattoir operation as it is the only one in Singapore licensed to provide pig slaughtering services. To understand its profitability, look at similar business in Elite KSB's chicken slaughtering business. They also conduct the Hog Auction market which conducts daily auction of live pigs. As a result, the revenue is highly correlated with the number of pigs imported into Singapore. ROA for this segment is as high as 30% though it only accounts for 15-20% of SFI's net profit.

Cyclical or Recession Proof?

Figure 4 - Operating Statistics

Figure 5 - Passenger Traffic

As shown earlier in Figure 1 that 40% of revenue are non-aviation, this part is likely to be a recession-proof business since a huge portion are from 5-years military contract as well as abattoir operation. As for the other 60% of the revenue, we will need to take a look at figure 4 and figure 5.

Changi Airport Group has shown strong growth in passenger traffic over the past 6 years and has proven its resilience in 2009. Do note that International Visitor accounts for around 50-60% of the total traffic which means that Singaporean accounts for the other 40-50% of it. Theoretically, for every international visitor that arrive, they will also have to leave which means by doubling the international visitor figure you will get their contribution to passenger traffic. Local passenger traffic seemed rather stable with most of the growth coming from international visitor. This has spiked up since 2010 with Formula 1 and our 2 Integrated Resorts.

If we look at figure 4, we can see similar growth and stability in most of the operating metrics other than in Cargo & Mail Handled as well as Inflight Meals Produced which shows an estimated 10% decrease in FY 2010. This does prove that the business of SATS is fairly resilient in a recession. The drop in Inflight Meal though Flights handled increases seemed to imply that that it has undertaken more budget airline business. However, I believe a similar crisis like SARS will still be able to hurt its top and bottom line greatly.

Figure 6 - Share of Result of Associate

While SATS has performed rather well, its associate seemed to get hurt much more during a recession, dropping by nearly 60% in 2009 from its high in 2007. SGD 30 million will be equivalent to around 15% of its net profit. Do take into account that this will also be negatively affected if Sing dollar continues to strengthen.

Therefore, it is likely to be hit by the greatest extent from its associate companies in a recession. Other than a SARS-like event occurring, profit should drop by around 20% (5% from themselves and 15% from associate) during the downturn. With free cash flow/ net profit at a decent percentage, it will not be hard for SATS to maintain a 70% dividend payout ratio throughout the business cycle.

Berjaya Sports Toto Berhad and Sports Toto Malaysia Trust (Toto Business)

2012-06-14T13:54:00.000+08:00

As the name of the company suggests, Berjaya Sports Toto's core business is in selling 4D and Toto just like the Singapore Pool. The only difference is that Berjaya does not do sports betting as it does not have the necessary license. Here's all the games available:
http://www.sportstoto.com.my/m_how/6_52.htm

The business is pretty straightforward and simple in that they basically collect bets to form a pool of money. For digit games, the prize money is fixed and you will be awarded if you win a 1st, 2nd, 3rd, consolation or special prize. For lotto, the jackpot involves a fixed guaranteed sum + a percentage of the total pool money. After deducting all the prize payout and expenses incurred, the remainder will be their share of profit.

As with all in the gaming industry, the hold percentage is one of the most important ratio to look at. This is basically the statistically calculated odds that the house is expected to win in the long run. If the 4D has a hold percentage of 60%, it means that in the long run, the house is going to win $60 for every $100 of bets collected. We shall now take a look at the hold percentage of the respective games owned by Berjaya Toto.

Figure 1 - Toto 4D

All the payout and hold ratio are calculated using the probability of striking multiplied by the amount paid out. For the sake of simplicity, I will not show the calculation here. For Toto 4D, you can choose to buy big or small at RM1 per bet. The difference is that in Small, you are entitled to a higher 1st, 2nd, 3rd prize in exchange for not being able to win the special and consolation prize. To summarize, the gross margin (revenue - total payout) for the Toto 4D is 36% and 35% for Big and Small respectively.

Figure 2 - 5D

Figure 3 - 6D

Toto 5D is an extended version of 4D where you will be playing with 5 digits instead of 4 digits. Similarly for 6D, it is 6 digits. In this case the gross margin for 5D and 6D are much higher as compared to 4D at 66.2% and 66.6% respectively.

Figure 4 - 6/52 Jackpot

Figure 5 - 6/55 Jackpot

Figure 6 - 6/58 Jackpot

Berjaya's lottery games comprise of 6/52, 6/55, 6/58 jackpot game where you choose 6 numbers out of 52,55 and 58 numbers in total. The jackpot is earned when the 6 numbers you have chosen matched the 6 winning numbers. Do take note that the minimum guaranteed amount and prize pool differs for all the 3 games. The gross margin for the 3 games are 55.92, 52.93 and 52.42% which is higher than 4D but slightly lower than 5D and 6D. The odd of striking Toto for the 6/52, 6/55 and 6/58 games are 1 in 20.35 million, 1 in 28.99 million and 1 in 80.95 million.

Out of the total revenue collected from the pool betting business, 75% are from 4D alone while the other 25% are from 5D, 6D and lotteries (6/52, 6/55, 6/58). 4D is the most popular game in both Singapore and Malaysia and it is a unique game that is hardly played elsewhere. While 4D has one of the lowest margin, it is good to have it as a large proportion of revenue as it helps to stabilise the profit margin. All gambling and casino games make their fortune on the basis of the "Law of Large Number" where given a large number of trials, the results will be very close to the expected probability. 4D is more popular than the other games because it boasts a higher chance of winning though the size of the win is much smaller as compared to Toto. The revenue collected is also more stable as gamblers usually buy the same set of numbers for every draw days for fear of losing the chance to win.

Lottery is more popular among the youngster who wants to be a overnight millionaire. However, as a result of the very low probability of striking Toto, profit margin can fluctuate as a result of lack of sufficiently large number. Revenue collected also tends to fluctuate more as a high accumulated amount of jackpot is required to attract more people to buy. If the Toto strikes more often, the accumulated Jackpot will be reduced and hence the buying interest reduced. Therefore, this is the portion of business where luck is very important. Like casino, while the VIP often brings with them huge amount of chips, they are also the one that tends to create a larger fluctuation in profit margin.

Toto and Gaming Industry in Malaysia

Malaysia (50% are Muslim) is a highly regulated and taxed gaming market as compared to the world due to the fact that Gharar is prohibited in the Muslim culture. Other than the operator's license, factors like the number of draw days, prize payout ratio, type of games allowed are all being tightly regulated. The operators need to seek permission to reduce payout ratio or to introduce new games. Taxes are high with the following charges: 8% pool betting duty on net gaming revenue, 8% gaming tax on gross gaming revenue, 25% casino tax, 10% NSC contribution on gaming pretax profit and 10% royalty on gaming pretax profit. In the case of Berjaya Toto, it needs to pay gaming tax, NSC contribution and pool betting duty on top of the corporate tax.

As it is a highly regulated industry, Berjaya Toto only has 2 other similar competitors in 4D - Magnum and Tanjong. Berjaya Toto is the market leader with the largest network of 680 outlets in Malaysia and an estimated market share of 40%. Currently, Berjaya Toto has a monopoly on the Toto segment of 6/52, 6/55 and 6/58 as well as 5D and 6D because the other 2 competitors do not have the lottery license. Basically, the government does not wish to grant too many license to avoid backlash from the Muslim community of encouraging Haram activities. This is also part of the reason why Berjaya has not been successful in vying for a sport betting license.

Other than the usual "luck" factor that will affect the total revenue and another factor that can create some fluctuation will be the number of draw days allocated. Berjaya Toto conducts its draw 3 times a week on Wednesday, Saturday and Sunday. 365*7/3 will give us 156.429 days, which means total number of draw days a year is likely to be 156 or 157. This will have a marginal impact on the revenue. Each of the 3 NFOs are also allocated extra draw days called special draw. The number of special draw days differs from year to year according to the mood of the government and usually ranges from 5 to 12. In 2010, Berjaya Sports Toto was allocated with 20 days, but revenue does not actually increase. The reason is that instead of a special draw, all 3 NFOs are allocated common special draw day as compared to the exclusive specival draw days in the past which will generate higher revenue.

With regard to illegal betting, which is a common sign around the world, Berjaya Toto is not as impacted as compared to its competitor. The reason again lies in the type of games they have over their competitors. 4D, 5D are games that bookies can easily take the bets as the payout is not substantial to the extent that they will suffer a huge loss due to "luck". However, for games like Toto 6/52 and e.t.c, the payout is extremely high and one needs to reach a certain scale to be assured of profitability.

In conclusion, we can expect to see up to 10% fluctuation in revenue and profit depending on numerous factors including total prize payout (luck), number of draw days, size of jackpot as well as possible changes in taxation. Generally, revenue and profit will still be relatively stable as 75% of revenue comes from 4D which enjoys the law of large number theory to the largest extent. As compared to a casino business, capital outlay is also much lower. However, between Berjaya Sports Toto and Sports Toto Malaysia, it seemed like Berjaya Sports Toto might be a better bet as it is selling off a mature business at a PE of 17. That aside, Berjaya Sports Toto will still control Philippines Gaming Management which is in the business of managing lotteries business and has a very high profit margin.

Berjaya Sports Toto Berhad and Sports Toto Malaysia Trust (Financial Statement)

2012-06-10T17:26:00.002+08:00

Berjaya Sports Toto Bhd has proposed to spin off Sports Toto Malaysia (STM) into a Sports Toto Malaysia Business Trust. This has prompted me to look into BST and I will share my findings in a 2 parts analysis. This is my first time going into an analysis of foreign share and I have realised the additional difficulty of securing information. Under the deal, Berjaya Sports Toto will hold on to 79.5% of the shareholding of STM and they will get RM 670m in cash and RM 527.4m in promissory note. As always, we will start off with the financial statement analysis.

Figure 1 Income Statement

Looking at figure 1, we can see revenue increasing slowly over the year, peaking in 2009. Subsequently, revenue has dropped by 8.2% in 2010 before a 1.2% increase in 2011. The 2010 drop in revenue is as a result of lower 4D sales (due to a new 4D Jackpot by competitor) as well as lower jackpot which in turn attracted less buying interest. One reason for a lack of strong topline growth has been due to a maturing of market in Malaysia and that Number Forecast Operators (NFO) are not allowed to introduce new games and drawing days without seeking permission.

For profit wise, it seemed to have stayed range-bound from 2006 onwards. One point to note is that there is a write-back on over-provision of RM 50m in tax in 2006 which created a RM 50m boost in profit. The drop in profit in 2010 is in line with the drop in revenue in 2010. For 2011, profit margin has been affected as a result of a hike in pool betting duty from 6% to 8% for all Number Forecast Operator.

The reason for fluctuating profit margin over the year is as a result of the "luck" factor often involved in gaming operation. A higher number of Jackpot and 1st prize paid out in lottery and 4D will affect the profit margin. This will be discussed in more depth in part 2. Profit margin has traditionally been 10-15% over the years. Do take note of the high corporate tax rate of 25% in Malaysia as the EBT has always been more than 15%.

Figure 2 Balance Sheet

For the Balance Sheet, there is a huge amount of cash and deposit of RM 450m and a RM600m intangible asset. The intangible asset is as a result of goodwill arising from consolidation dating way back before 1992. So long as Sports Toto remain profitable, a write-down on intangible asset is unlikely. For the liability, there will be a concern on the borrowing for the past few years as well as the RM 550m Medium Term Note in 2011. The MTN was taken up in 2011 with the main aim of refinancing its bank borrowing. The question will then be why should such a profitable company be having such borrowing in the first place?

Basically, Berjaya land owns 43.5% of Berjaya Toto and they require huge amount of capital to settle their loan as well as for their property development project. If you have noticed the yellow, blue and red highlight, they stand for share buyback, distribution of treasury share and capital reduction respectively. Not only has Berjaya engaged in share buyback activities and paying special dividend, they have also engaged in huge capital reduction activity. From 2005 to 2007, total equity goes down from RM 1.57 billion to RM 418m as a result of capital reduction and share buyback. With its high minimum dividend payout ratio, Berjaya will then go into some debt for working capital requirement. A year of EBIT can easily cover this seemingly huge amount of debt.

Figure 3 - Cash Flow Statement

The cash flow statement is unlike many other companies. The receipts from customers is actually around 8% higher than the revenue reported. This is as a result of a deduction of 8% gaming tax of total receipts from customer before it is reported as revenue. A huge amount of the cost is the prize payout as well as to supplier and other expenses. Another interesting statement is "Payments for pool betting duties, gaming tax and other government contributions" which is actually the sum of the Pool Betting Duties as well as Gaming Tax which will be explained in Part 2. They have managed to generate around 10-15% of cash from total receipt from customer.

Looking at acquisition of PPE, we can see that this is an asset light business as purchase of PPE is only around 5% of net cash generated from operation. Net cash used in investing activities hardly have a negative impact on cash flow other when they are acquiring additional interest in their subsidiary in 2009 and 2010. For financing activities, debt recycling can be seen from 2006 onwards with constant repayment and drawdown of borrowing. We can also see that dividend payout and capital distribution has been really good to shareholders.

Figure 4 - Key Performance Metrics

The operating profit margin of 15%-20% and net profit margin of 10%-15% have been discussed earlier on. The key reason for such profit margin has been due to prize payout ratio of around 60% as well as government taxes. Adding on all the taxes and dividing by total revenue, we can see that of every $100 earned in revenue, $20 will be paid out to the government in the form of taxes over the past 8 years.

Despite the average profit margin, the company has been enjoying a high ROA figures of more than 20% on average. Return on Equity has been inflated as a result of debt undertaken since 2006. This high ROA ratio arises from its high asset turnover as the business is essentially very scalable. The company FCF/ Net Profit yield has been really fantastic, maintaining at an average of 105% since 2007. The ratio for 2006 should also be more than 100% as a RM 50m over-provision for tax has been reversed but this does not represent any cash inflow.

Figure 5 - Historical Chart

From the historical chart, it seemed like shareholder does not have much capital gain to speak of if they have bought at the start of 2004. However, the company has actually rewarded their long term shareholder immensely as shown below.

Figure 6 - Return to Shareholder

With hindsight, if you have bought the shares in 2003, you will have been awarded with $2.70 of ordinary dividend, $1.35 of special dividend, $1.00 in Capital Distribution which sums up to be a total return of $5.05 over 10 years. On top of that, you will have been awarded with 1 more share for every 14 shares that you own and that the company has bought back approximately 8% of the total share. While the stock price has lingered over the years, long term shareholder of the company will have been very happy with their return. Fluctuating dividend comes not only from fluctuating profit but that the company does not have a fixed dividend payout ratio as the guidance is only a minimum of 75% payout ratio.

Regarding the spin off of Sports Toto Malaysia into a business trust in Singapore, it is likely to be yet another move to reward their shareholder (Berjaya Land owns 43.5%). Should the proposed listing be completed, Berjaya Sports Toto will hold on to 79.5% of the total shareholding of Sports Toto Malaysia. They will be entitled to an annual ~RM 20m in trust manager fee as well as a total of RM 670m for divesting their remaining stake. Other than the entitlement, Berjaya Sports Toto will also enjoy a RM 527.4m worth of promissory note owned by Sports Toto Malaysia. After the spin off, the only remaining asset should be Philippine Gaming Management Corp which enjoys management fee for managing BPI which is a subsidiary owned by Berjaya Sports Toto and leases out on-line lottery equipment in Philippine.

To conclude, Berjaya Sports Toto will get a total of RM 1197.4m in cash and promissory note in return for divesting 20.5% of stake in a business that generates RM 345m in 2011 which work out to a PE of 17. While Sports Toto Berhad will not be a bad deal considering the estimated dividend yield of 5-6%, it is obvious that Berjaya Sports Toto will get the better deal at the end of the day. Part 2 will be on the business of Toto and lottery as well as the gaming industry in Malaysia.

Characteristics of stocks that I look for

2012-05-26T17:58:00.003+08:00

One important lesson that many have learnt from the ongoing Euro Zone turmoil is the importance of owning high quality stocks in their portfolio at all time. Macroeconomics condition is ever-changing and no one has the ability to predict the future accurately. However, a good stock is one that will continue to prosper through the ebb and flow of the business cycle. This is not exactly what we called defensive stock, but these are companies that are able to survive a hit or two and yet able to grow fast during period of growth. The following are the characteristics that I always look for in my target:

Business
Recurring and Predictable Income
Favourable Long-term Business Economics
Sustainable Competitive Advantage

Accounting
High ROA and ROE
Clean and Strong Balance Sheet
High FCF/Net Profit Yield
Dividend Yield

Recurring and Predictable Income - Recurring income exists in many forms, with some being more explicit than others. Things like licensing fee, rental income, regulation and toll road are pretty straightforward. For other less obvious form, this involves your bread which you eat for breakfast everyday, the printer cartridge you need or the cable TV subscription. It is always good that the business has some form of recurring income as this is the portion that will keep the business afloat during a recession or unforeseeable Black Swan. So long as the business does not make a net loss, shareholder's equity will continue to grow.

Favourable Long-term Business Environment - As with all stocks that we buy, we are expecting that the business and net profit will grow. Having favourable environment allows a company to grow its business much easier as compared to one that is going against it. For e.g. ageing population and healthcare tourism are inevitable trends that will benefit those in the healthcare sector. Growing population will favour those in the FMCG and transport sector(if they have sufficient capacity). Demographics is just one of the more obvious and inevitable trend out there in the world. Kodak, print media and non-smartphone are the few that are destined to collapse in the long term (definitely not immediate as they will just die a slow death).

Sustainable Competitive Advantage - This is a term that has been repeated throughout the book Buffettology and has been seen as a key criteria of Warren Buffett. Why is sustainable competitive advantage so important? A business with this characteristic is like a castle with a wide and deep moat to fend off competition. Any good business that can deliver high returns will always be assaulted from all direction as a result of capitalism. As in the classic bubble tea case, new competitors seeking lower return will just lower the return of the existing business. A moat is one that allows the company its high return over a long period of time, be it through market share, mind share, monopoly, or monopsony. Example of moats include network effect, government regulation, strong brand name, patent, high switching cost and lowest cost structure.

High ROA and ROE - I have always viewed Return on Asset and Equity as one of the most important financial ratio. ROE is basically dividing net profit by total shareholder equity, while ROA is changing the denominator with total asset. High ROE and ROA is highly favourable as a company with the higher ratio will be able to grow its equity faster assuming the same dividend payout ratio. To illustrate, company A has a ROE of 20% while company B has a ROE of 10%. Assuming they are not listed company, every $100 pump into company A will yield a return of $20 annually as compared to $10 for company B. As such, it is very logical why this is important.

One reason why ROA is also being used here is that ROE= ROA x equity multiplier ((Total Equity+ Total Liabilities)/ Total Equity ). Therefore, a company can easily boost its ROE by taking on extra debt. To illustrate once again, we have company A and B earning $100 in Net Profit with Total Asset of $1000. However, company A has equity of $1000 with $0 liability while company B has equity of $100 with $900 of debt. Both companies will have ROA of 10% but company B will have a ROE of 100% as compared to 10% for company A. Company B will be an obvious choice if we were to choose solely based on ROE. However, does not it make sense that company A should be worth more than company B given that the only difference they have is that company B has extra $900 in debt? Though there is an exception to this which is when the liabilities are interest-free non-debt that are offered to the company.

Clean and Strong Balance Sheet - A balance sheet of this kind is one where there is very little debt, especially those bank loans. Debt can be a useful leverage for company seeking to expand their business beyond the ability of their equity. However, the problem comes where too much debt is undertaken beyond the company's ability to service them in the worst case scenario, typically a recession. A company with strong cash buffer and no debt can easily remain a going concern even if it were to face perhaps 5 consecutive years of losses.

High FCF/Net Profit Yield - Free cash flow is basically the amount of cash a company get after deducting all working capital needs as well as capital expenditure. It is a important factor to look out for as cash and not profit is what that keeps a company going. FCF represents the amount of cash a company has to invest, payout as dividend, pay debt or to add on to its cash holding after it has used up whatever is necessary to keep the business ongoing. FCF/Net Profit represents the amount of FCF that a company can generate from its net profit. These are often idle cash that can be used to grow the company or the shareholder's wealth. A company with very low FCF/Net Profit will find it hard to invest or to payout dividend

Dividend Yield - this is basically the amount of cash that the company returns to shareholder annually as a percentage of the price the stock is purchased. While I am not always looking for very high dividend yield of more than 6%, I find it more comfortable to purchase stocks that offer a decent dividend yield of around 4-5%. I viewed dividend as a form of margin of safety should the business not grow in the way that I have thought it will be. Dividend also provides important cash flow for your personal finance especially since undervalued stocks can usually stay undervalued for long. One reason why I am not preferring a company with dividend yield of more than 6% is that such company will not be able to grow their business much as equity injection is lower. However, there's company that recognises that they will not be able to grow their business much and choose a close to 100% dividend payout. These will be the kind of stocks that you should be going for if the main goal of your portfolio is to earn steady dividend.

One last part to add, many of these factors are in fact inter-linked together. A company with sustainable competitive advantage will in most cases has high ROE figures. High ROE can be sustained easier by a company with a high dividend payout ratio. FCF/Net Profit Yield will determine the dividend payout ratio that shareholders get. A company with strong business model can afford to take on a more debt-fuelled balance sheet, though in most cases the company will have a clean balance sheet as its high ROE is sufficient to grow the business. With a recurring and predictable revenue base, a company will also be more willing to pay higher dividend to its shareholders. Therefore, when you find a company that shows a few of these symptoms, it is good to dig out more about it as you will be likely in for pleasant surprise.

AmFraser Day - Nam Cheong, OSIM and MIIF

2012-05-20T10:33:00.001+08:00

Nam Cheong

At the peak of the oil prices, many OSV builders built the more sophisticated deep water OSVs. However, Nam Cheong's focus is more on the shallow water OSV which are continuously needed for production. Production for the shallow water will normally continue until oil prices really hit to the low of USD 30 per barrel.
Nam Cheong's built-to-stock model takes around 21-24 months to complete building the ships.
The China's shipbuilder that Nam Cheong outsourced to are state-owned enterprise and are what that has been recommended by the officials there. Their chairman has a close relationship with the officials since the 1980s.
Some of their major clients and number of ships ordered include Bumi Armada Berhad (13), Perdana Petroleum Berhad (8), Vroon B.V (7), Topaz Energy (6) and Tidewater (3).
Under the Petronas's bidding system, bidders are split into 2 tiers between "Malaysian Flagged Builder" and "Non-Malaysian Flagged Builder". As such, through the LOA by Nam Cheong, bidder will have an advantage over those without the LOA.
As for ship financing during a recession, it was said that so long as their customers secured a contract with Petronas and e.t.c, banks will be willing to lend to them to buy a ship from Nam Cheong.
Going forward, Nam Cheong will improve their build-to-stock model by allowing more flexibility such that they hope to be able to cater to 90% of demand.
They will also be building more PSV as there's a low supply of Asian sea truck.

OSIM

OSIM itself contributed more than 80% of their profit and 75% of their revenue.
China is the number 1 market contributing 28% of the business's revenue. Other major market contributors are Hong Kong and Taiwan (16% each).
uDivine has been sold out during Mother's day and they have a waiting list of 1 month.
As for GNC, it has been said the the Singapore and Malaysia operations are one of the most profitable and the CFO describes it as cash cow. However, I am sure profit margin is not as high since they have to pay a 5% franchisee fee on their revenue.
For Richlife, OSIM owns the brand which I feel is a good thing since they need not pay franchisee fee. It has not yet been profitable as they say health supplement shops are usually lose-making in the first few years.
For TWG, they have been warmly welcomed by malls and hotels as they bring about one of the highest profitability among the shops in the mall. Their franchisee in Dubai is Dubai Mall itself which is the mall with the tallest tower in the world.
For Brookstone, they have learnt some key lessons. One of them is to make sure that they have a controlling interest. For Brookstone, while they have a majority share, they are unable to control the company as permission is needed from the other 2 private-equity funds shareholder. It's said that these PE funds are more interested in the short-term interest while OSIM is looking it from a long-term business point of view.
Brookstone will still have a chance at IPO in 3-4 years time if the recovery continues.
They have also learnt not to depend on bankers though I still don't like their issuance of convertible bond.
Private bankers have looked for Ron Sim to privatise the company since it is extremely cheap at 5-6 cents during the 2008 GFC. However, Ron Sim chose not to do so as he wants to protect and maintain their established reputation.
The company has also started changing their made-in-Japan model to made-in-China model as they understand that the made-in-Japan model is unsustainable. By shifting production of uDivine in Nov 2010 to their JV factory in China, they have managed to reduce its ASP from $9000 to $5000+. The lower ASP has provided a more consistent revenue with higher volume without impacting the margin.
Replacement cycle of the product is around 3-5 years and they say 25% of their revenue comes from recurring customers.
They also have their house brand health supplement under the brand "LAC" and its LAC Activated Liver Protection is their top seller now with sale of 200 bottles a day.

MIIF

Characteristic of infrastructure fund - High barrier of entry, Long operational life, stable predictable cash flow, low demand elasticity
Most of the debt in its various infrastructure are project-financed, which means that there is no recourse to MIIF.
For TBC, Taiwan is split into 51 regions, TBC has a monopoly over 5 of the regions.
Owning all the cables infrastructure, their license is renewed every 9 years. However, MIIF believes this to be not of any issue.
They aim to grow through 3 areas namely Broadband, Digital and Cable TV. Cable TV is really cheap in Taiwan as it cost USD 15 to have access to 100 channels.
For HNE, detolling of Xin Guang has lead to a slight drop in total revenue. However, it has also lead to congestion of Xin Guang and they are starting to see lost toll coming back.
2012 opening of Guang He expressway is likely to bring about 6 to 8 % growth in traffic.
As the current road has a high capacity, there is no need to have additional capex to widen it.
A key risk highlighted is that China is planning to standardize the toll rate in Guangzhou and this will impact HNE earning. The background is that tollroad built after 2003 is standardized at 60 cents per km. However, part of HNE's road toll is negotiated before 2003 of which the toll rate is negotiable.
The impact will only be for the phase 1 whose current toll rate is 75 cents per km. As such, even if MIIF fails to negotiate in maintaining the toll, maximum impact will be around 10 percent.
For CSP, MIIF has managed to grow the revenue by diversifying the cargo.
As Chinese steel is cheaper than international steel, there has been a lot of exporting of steel from China recently.
40% of all paper and pulp import into China goes through CXP.
Previously, the 5.5 cents dividend is partially paid from cash balance as they are not fully covered by OCF. This is because they have invested additional equity in TBC. For 2012, they expect dividend to be fully covered by OCF.

OSIM

2012-05-14T23:05:00.001+08:00

Once a market darling until the notorious leveraged buyout of Brookstone in 2005, OSIM has regained its past fame being the renowned super multi-bagger company in recent years. Founded by Ron Sim in 1979, the company underwent a revamp to bring in healthcare product in 1989 and continue positioning itself as the market leader in home health-care product in its major market in Asia today. Having fully written down its flawed $144m investment in Brookstone, OSIM became a great turnaround story increasing its net profit from $99m losses in 2008 to $69m profit in 2011.

Figure 1 - 2001-2011 Financial Statement

OSIM has always been able to deliver more than 20% in return on equity before the investment in 2005 as well as from 2009 onwards after the write-down on Brookstone. Using the Du Pont financial ratio, ROE is the multiplication of net profit margin x asset turnover x equity multiplier. With this in mind, I shall delve further into the business model of OSIM.

Figure 2 10 Years Profit Margin Figure

For most of the 10 years period, OSIM has been able to maintain a net profit margin of 10% other than in 2007-2009. For 2006, it is as a result of finance expense as well as Brookstone losses, else its net profit margin will be around 10% too. How has OSIM been able to maintain a 10% profit margin despite its high advertising expenses as well as aggressive expansion?

Branding. This has been the key word to OSIM's success to date as mentioned here:

"I had to shift from being a trader to being a builder. I thought the best way was really to create your own brand, create your own products, designs,concepts and services because if you can't differentiate, over time, you will lose control. As a Singapore company, we have a very small domestic market. So how can you grow if you do not build on your brand? Since 1989, when we embarked on brand building, we have grown 20 to 30 per cent."

Source : http://www.scribd.com/doc/80778051/OSIM-Research-Info

Figure 3 - Price Comparison

Brand has not only been the key factor that has allowed OSIM to secure a very strong market share such that when we talk about massage chair the name of OSIM naturally comes to our mind. It has also allowed OSIM to price its product above its competitor without losing significant market share as the price comparison chart shown above. Of course, to be able to continue holding on to this mind share requires significant advertising expenditure which will naturally eat into the profit margin.

Between 2007 to 2009, net profit margin even after excluding Brookstone drops tremendously as a result of recession to 5% and below. This drop in net profit margin is accompanied by a drop in revenue which hints that either gross profit margin is affected or fixed cost accounts for a huge percentage of revenue.

Figure 4 - Gross Margin

From figure 4, we can infer how OSIM has been able to grow its net profit so fast during the past 2 years. COGS as a percentage of total revenue drops rapidly from 37% during 2007-2009 to 34.6% in 2010 and 31% in 2011. It is more than likely that OSIM has priced their goods higher than that they have managed to reduce their COGS as this is a period of economic recovery and strong growth. However, this is still unable to explain their 50% profit growth in 2009 where revenue only increases by 5%.

Figure 5 - Financial Statement for 2007

Figure 6 - Financial Statement for 2009

Figure 7 - Financial Statement for 2011

From figure 6, we can also easily understand how profit expanded by 50% in 2009 without an increase in gross profit margin. Ignoring "Changes in Inventories of Finished Goods" as well as "Finished goods purchased" since they stand for Cost of Goods Sold, its pretty obvious that the rest of the cost hardly changes. Something surprising is that despite all the revenue fluctuation from 2006 to 2011, employee benefits expense, other operating expenses (this was much higher in 2006 as OSIM had undergone a restructuring exercise in 2007) and depreciation expenses hardly changes throughout the 6 years. Therefore, we can conclude that OSIM has a high fixed cost business that cannot be easily sized down even during recession. This fixed cost as whole is around $250m to $300m annually which comes to around 50% of the total revenue.

What the above 2 paragraphs serve to show is that should a recession comes, OSIM will be hit badly as a result of higher fixed cost % (due to drop in revenue) as well as shrinking of gross margin coming from pricing down of goods. This is not totally unexpected as OSIM's product is not really a luxury good and it is something that is not necessary especially during a recession. As such, OSIM can be viewed as a cyclical stock though its core business did not create losses during 2007-2009. Another point to note is that as OSIM is a franchisee of GNC, it has to pay 5% royalty fee on its total revenue which can easily be a matter of profit or losses.

Figure 8 - Summarised 5 years Balance Sheet

For asset turnover ratio wise, it has ranged from 1.5 time to 2x (total asset is current asset + the non-curren asset reflected right above the current asset). However, I feel that the 2 x asset turnover ratio from 2008-2010 is not a very good ratio to use though there is nothing wrong theoretically. As seen above, the huge write-off of $90m off the shareholders equity (more than 50% of the equity in 2007) sort of falsely inflated the asset turnover ratio for the next 3 years. If you are thinking in terms of ROIC, there seemed to be no mistake as the leftover equity is the capital that they are really using to fund their core business. However, OSIM has previously been using those 166m equity to fund most of OSIM's expansion before that, which I feel should be accounted for when calculating the actual ROE of the business from 2008-2010. For 2011, expansion has been using funds generated during the past year, as such using 168 million as the equity is acceptable.

As for equity multiplier, the figure has been at around 2x -3x even after the write off of Brookstone. With such high equity multiplier, question must then be asked regarding the strength of the balance sheet as well as the type of liabilities that it holds. Since 2009 onwards, OSIM has learned from its LBO mistakes and has quickly paid all its term loan as we seen from Figure 8 where term loan has been fully paid by 2009. However, in 2011, OSIM has once again issued a $120 million convertible bond at an interest rate of 2.75%. Next, we shall look at the current liabilities.

Figure 9 - Current Liabilities

Figure 10 - Current Asset

Looking at Figure 9, interest loan only takes up 10% of the total current liabilities which means OSIM has a relatively strong balance sheet currently. This is taking into account that it has not spent much of the $120 million from issuing of convertible bond as seen in the fixed deposit. Should they decide to spend it in a huge acquisition, OSIM will then have a weak balance sheet.

As for the other 90% current liabilities, these are supposed to be treated as interest-free loan that OSIM has earned through its own ability. Owning a 30% stake in the OSIM-Daito subsidiary as well as a 20 years relationship with key contractor Oriental Export & Import Co has allowed OSIM to have a low working capital requirement. Owning $100 million in payables, OSIM only has a receivables of $50 million, which means OSIM enjoys a $50 million free short-term working capital. This is a definitely a key advantage of OSIM as it has definitely helped to mitigate its huge debt in the past. Therefore, before 2011 OSIM has a healthy equity multiplier which rightly boosted its ROE. However, taking on a $120m convertible bond, the ROA might now be a better ratio to use over ROE when analysing OSIM.

In conclusion, OSIM's key competitive advantage lies in its brand, premium pricing, relationship with suppliers as well as its negative working capital. However, it is subjected to recessionary pressure which will not only erode gross margin but also increases its fixed cost per unit sold. Another key risk will be that OSIM returns to its Brookstone path through aggressive acquisition and expansion through debt as seen from its issuing of $120m convertible bond. At the current price, I will not dare to touch it not only because that I might be catching it at the peak earning but that its expansion might drag it down should recession comes. As in 2008, this is a stock worth catching perhaps after the balance sheet is cleared and net profit falls drastically.

Silverlake Axis - FY 2011 9M Result Review

2012-05-09T22:42:00.001+08:00

Silverlake Axis delivered an outstanding quarter once again, not very surprising given that an estimated RM 5650 million worth of projects are to be recognised from 2012 to 2014.

For Q3 2012, revenue increases by 21% while net profit increases by 63% compared to Q3 2011. Surprisingly, there's a 50% fall in Selling and Distribution costs as well as Administrative Expenses. This was as a result of "the RM8.4 million charge on grant of shares awards pursuant to the Silverlake Axis Ltd Performance Share Plan ("PSP") in Q3 FY2011." not occurring in Q3 2012. Therefore, net profit margin excluding extraordinary item remains the same at around 43% for the quarter as revenue mix did not change much.

From the above figure, we can also see that quite a sizeable portion of the profit from the MYR 390m licensing contract for HNA Group and CIMB Group has not been recognised yet. To date, a total of MYR90m has been recognised for Software Licensing, while MYR 40m has been recognised for sales of hardware product from FY 2011 and FY 2012. Therefore, conservatively there's still at least another MYR 180m for software licensing to be recognised. Assuming 90% profit margin, that will be a MYR 162m profit coming solely from Software Licensing over 2 years and 1 quarter.

For the balance sheet, trade and other receivables decreased from RM121m to RM107m. Amounts due from customers for contract work-in-progress increases from RM 10m to RM 57m, this segment is what that has been recognised as revenue in the financial statement but that they have not yet billed the customer for it. Cash balance drops from RM 73.4m to RM 65.7m as a result of RM 33.5m used for acquisition of ISIS as well as RM 52m being paid out as dividend so far.

Other than the release of result, Silverlake Axis has also released the news that it has won a new licensing contract with Malaysia Building Society Berhad (MBSB). This is going to be very significant as licensing contract has the highest profit margin at 90%. In term of asset size, MBSB' total asset is 1/6 that of the sixth largest bank of Malaysia, AmBank. While this contract size should be worth at least 10m SGD, the best thing is that Silverlake Axis has finally secured a contract for the financial year. This contract will be fully realized by FY 2013 and let's hope it marks the start of new contract win for Silverlake Axis. The more important contract is still Touch N Go by CIMB of which there is no new yet.

For this quarter, a dividend of SGD 0.5 cents has been announced to be paid on 20th June 2012, which makes the total dividend yield so far at 3% for the first 9 months. Outlook is very positive for Silverlake in terms of profit as there's still quite some bit of licensing fee that's not yet recognised. Finally, it is of great significance that they have finally secured 1 contract for the financial year, lest they go into FY 2013 without any new contract secured the previous year.