THESIS

My original target price for OSIM based on the comps as well as the potential EBITDA per store was S$1.80, updating that for recent earnings and comps, my updated price target is S$2.05. OSIM has surpassed that target and could potentially continue the trend however, there are two things that concern me:

1. He run up in the price has been relatively quick and isn’t supported by a corresponding run up in the EBITDA. OSIM is now trading in line with the regional comps on an EV/EBITDA basis for the TTM and is above on based on the FY2013 estimates.
2. The 7^th item on the Notice of AGM was to pass a resolution allowing the Directors to issue up to 50 per centum (50%) of the issued shares in the capital of the Company. This is a significant amount of shares and could be seriously dilutive to the existing shareholders. This leads me to believe that the Directors might be eyeing up another acquisition or corporate action and considering their previous track record with acquisitions and convertible bond offerings I’d rather not wait around to see what happens.

130515 – OSIM CompCo Valuation

I still like the management and the margins but the multiples make me want to take a breather for a while. I’m currently evaluating Kruez Subsea (KRZ SP Equity) to take OSIM’s position in the portfolio and would be interested in any comments readers have regarding management and the company.

As at writing I don’t have a position in OSIM but may make other transactions within the next 30 days. If you’re considering investing or selling, please do your own due diligence. 

The post OSIM – Sell appeared first on argutori.

The customs lines can get quite long when you’re heading in and out of the country, so it pays to be at the front of the plane on arrival and to leave yourself more than an hour to make it from the check-in counter to the boarding gate.

As could be expected in any developing country, the scene outside the airport is organised chaos, cabbies gesturing and yelling to win a fare but never crossing the guarded barriers.

The traffic is a mix between India and Thailand; cars compete with scooters, horns are used as the primary form of communication, and road markings play a decorative part in the ensemble.

I’ve been travelling there for work for nine months and each time, I see this one “new” highway that’s in the process of being built. I haven’t noticed any additional progress on the road since I first laid eyes on it and am unsure when it’ll be completed if at all.

The above traffic issues are endemic of the fiscal problems that face the Indonesian economy at the moment. In FY2012, the Indonesian Government spent US$32bn (S$40bn) or 3.6 per cent of GDP on energy subsidies, double the amount that they spent on infrastructure investment.

The fuel subsidy covers premium-brand gasoline, solar-brand diesel, kerosene and LNG. The subsidy price is set each year by the Ministry of Energy and Mineral Resources but may be adjusted throughout the year to account for rising oil prices or fluctuating currency rates.

Instead of taxing people for being on the roads (ah-lah-Singapore), the Indonesian Government encourages people to get on the already congested roads.

Instead of spending money fixing the roads and creating new ones, the piggy bank is already bare because all of the funds are being spent on subsidies to keep the populace happy. This is merely a short-term solution that increases the ever-present congestion and is creating an even longer-term problem for the growing nation.

What would people do if they were unable to afford gasoline anymore? In an experiment, the Swedish Government introduced a congestion charge for vehicles going into high congestion areas.

Initially the population was against the measure, but after seeing it in action, over 70 per cent of the population felt strongly for it. It successfully removed 20 per cent of the cars from the road, which dramatically reduced the congestion.

What happened to the other drivers? They didn’t disappear – they just made other arrangements. No-one suffered, people did what they always do and adapted to the new situation. Therefore, there are other solutions that would benefit the populace as a whole over the long term but they just need to be made aware of the possibilities.

The arguments against removing the fuel subsidy are largely political. With the election coming up in 2014, no-one wants an uprising similar to the last time the Indonesian Government tried to remove the fuel subsidy.

I’ll get into the technical details of why the subsidy is so destructive to the potential of the economy in another post. To solve their current predicament, the Government could remove the subsidy, introduce a tax in the highly congested areas, and put the surplus funds towards building a better infrastructure. This would in turn lead to reduced transport times as well as an increased movement of goods and people around the country, increasing the productivity of the country as a whole.

Presently, with the lack of savvy fiscal leadership, insufficient public infrastructure and high levels of corruption, I wouldn’t recommend looking to invest in Indonesian for the near or medium term. However, could be a good place to look long term, but you’ll likely have a better opportunity to enter the market as the current dynamics play out.

The post Indonesia appeared first on argutori.

Thesis

Prestariang is selling at half the price of other Malaysian education providers. While a majority of the earnings are currently coming from the software sales and licensing, the development of more educational services will bolster margins and profits in the business. It looks cheap now and even cheaper when the recently opened boutique university is fully online.

Variant View / Issues

Given that Government-related entities accounted for nearly 90% of total revenues, a deterioration of relationship could adversely impact Prestariang’s performance, however with a Ministry of Finance-owned entity owning >7% of the company, this risk is smaller than it would otherwise be.

Conclusion

After reviewing this company, I feel as if I’m missing something, I’m unable to find a good justification for the company to be trading at the current multiples considering the asset base and earnings potential of the business. While there are risks around the earnings streams, with >90% of the revenue coming from Government contracts, there’s no reason to believe that these contracts are going to come to a halt at any point in the near future. Therefore, it’s a BUY based on my screening criteria and valuation metrics.

Introduction

Prestariang was established in 2003, and was listed in July 2011 with a total market capitalisation of RM198m (RM0.9 per share).  The company provides Information and Communication Technology (ICT) training and certification services, as well as software licence distribution and management. Prestariang offers over 40 certification courses in partnership with major technology and software vendors, such as Microsoft, Oracle, IBM, CompTIA, Autodesk, Sun Microsystems and others. The main customers are government-related entities, comprising nearly 90% of total revenues for the past several years. Since inception, the company trained and certified over 120 thousand participants, and distributed over 2m software licenses.

Prestariang Group Structure

 Long-term plans

Prestariang is pursuing several long-term goals to expand its business in the next 4 years, targeting revenues of RM400 million (from 111m in 2011), including:

• launching a boutique university;
• developing more in-house programmes;
• diversifying its existing programmes and bringing in new partners;
• securing new contracts with government entities; and
• marketing in-house programmes regionally.

Boutique University

With the support of Ministry of Higher Education (MOHE), Prestariang has opened a “boutique university” known as University of Computing in Cyberjaya. The company plans to initially establish a temporary campus with a capacity of 2,000 students, before moving to a permanent site by 2016. Prestariang has partnered with the University Of Melbourne School Of Engineering, to provide enhanced courses and additional vocational opportunities for students.

Based on initial guidance of the average fee per student being roughly about RM30k per year, the new development should add around MYR1.3m to NPAT for FY2013. Once the operations stabilise, the University could provide an additional RM20-25m of earnings for the group.

Operating Metrics

Over the last 3 years the software license distribution segment was the main driver of revenue growth, accounting for more than three quarters of total revenues in 2011.

Prestariang Revenue Breakdown

However, the first 9 months of 2012 saw revenues boosted by a surge in the ICT training and certification segment, increasing its proportion of sales to 34% driving an improvement in margins.

Key Shareholders

Dr. Abu Hasan Ismail, CEO, is effectively the largest shareholder with a total stake of 41.2% through his interest in Ekohati, Sigma Dedikasi and Anjakan Evolusi companies. The MOF Inc, a body monitored by Ministry of Finance, holds 7.18%, therefore it’s in the Government’s interest to retain the contracts with Prestariang. The free float represents nearly 49% of total shares outstanding.

Prestariang Shareholders

Management

The management team seems to be a considerable asset for the company, having Dr. Abu Hasan Ismail (Ph.D) as the CEO and Executive Director since inception, with more than 28 years of experience in the training and educational areas. He also participates actively in numerous academic organizations. Abdul Hamid Abdul Rahman, Chief Knowledge Officer, brings over 31 years of experience in teaching and ICT training, having also worked extensively with the Ministry of Education.

Valuation

The company is currently in a net cash position with RM0.25 of net current assets per share, half of which is cash. EBITDA for 2011 was RM36m, which should almost double over the next 3-4 years as the new campus gears up. Taking into consideration the growth from the new students (excluding any inflation increases in tuition or software licenses) would yield a RM1.58/share valuation based on the current EV/EBITDA multiple.

Prestariang BotE Valuation

I also looked at a CompCo valuation, to ascertain the relative valuation. It’s currently trading at about ½ of the Malaysian comps EV/EBITDA, implying a RM2.46/share relative valuation.

Prestariang CompCo Valuation

I believe that Prestariang is worth between RM1.58-2.46 so have taken the average (RM1.84) as the intrinsic price. At this level, there’s a potential >50% return (my hurdle rate), making it a BUY.

As at writing, I don’t have a position in Prestariang, I may initiate a position within the next 30 days. If you’re considering investing, please do your own due diligence. 

The post Prestariang – Buy appeared first on argutori.

My partner and I try to explore as much of the region as possible and being an investor by trade, I’m always looking at the cultural differences between countries, how quickly they’re developing, and if there’s any potential for a profitable investment. While these posts are intended to cast some light on the various pieces to the puzzle of investing in the orient so you can begin to put it together.

Recently we went to Japan to get our powder fix for the year. Being from NZ we used to enjoy getting down to Ruapehu in the weekends and have the odd trip further South to Queenstown and Wanaka. We flew into Narita and spent a couple of days walking around Tokyo, it was amazing to see how much the city had rebuilt itself, compared to the state that Christchurch is still in, in such a short time. The city had been completely cleaned up and any construction that was still underway appeared to be progressive rather than remedial. Japan has had a long history of earthquakes because of its geological position and because of this there are authorities and systems in place to deal with the consequences. New Zealand could learn a lot from the way that Japan deals with the earthquakes.

After a couple of days in Tokyo we made our way out to Nagano and then on to Myoko Kogen. It was truly incredible how easy it was to cross such a large distance with public transport. The current bullet train network consists of 2,387.7km of lines and the trains are able to reach speeds of 240-200km/h. This makes it possible to cover the same amount of distance that you would on a short-haul flight in half the time (no check in, processing, or taxing time required). We had 5 epic days in Myoko, with some of the best snow that we could have ever imagined. We enjoyed the food, the culture, the hot chocolates from the vending machines at the lift stations and then a comfortable ride back to Tokyo on the bullet train.

Anyone who has traveled on the trains across Japan will have noticed the old developments, that look like they were created in the 1980s, and the lack of new developments. Japan is a country of contrasts, billed as the country of the future with gadgets and gizmos to solve problems you never knew you had. At the same time the country appears to be stuck in the past, with no new private developments in the past 2 decades and it’s a cash based economy, with few merchants accepting credit and debit cards. It was as if Japan got stuck in some vending machine induced time-warp but why and what’s going to happen from here?

Following the Second World War, the Japanese picked themselves up, dusted themselves off and banded together to rebuild the country. While they might have lost the war, they won the economic war that followed with growth rates of 10% in the 1960, 5% in the 1970s and 4% in the 1980s according to the Ministry of Economy, Trade and Industry. The growth combined with record low interest rates imposed by the Bank of Japan lead to asset bubbles (similar to the situation that’s happening in the US presently). To describe how far reaching the bubble had got, the Nikkei had a Golf Club Membership Index and people who didn’t even play golf were buying memberships as an investment. At one point a membership at one of the more expensive clubs was going for JPY350bn (equivalent to S$4.5bn at today’s exchange rate), well more than enough to build a golf club for yourself if you were so inclined.

The bubble began to burst in 1990 and the “lost decade” followed, where Japanese GDP floundered at 1.5% annually.  Not wanting to admit defeat in an economic battle, the Japanese companies banded together again and started to rebuild. Japanese companies formed keiretsus, or interlocking relationships where they would lend to and invest in each other. Companies that were in the same industries got involved as did the banks. This meant that when the going got tough the banks continued to lend to companies, who had no way of paying back the loans. Capitalism works like a forest, as the old plants die and fall to the ground, they provide the nourishment for new stronger, more profitable companies to emerge. Having the network of relationships supporting zombie companies meant that new businesses couldn’t emerge and banks were effectively forced to issue non-performing loans instead of refocusing on the loans that could have grown new and stronger companies.

Any international saver shunned Japan, you might have heard the term “Asia ex-Japan” when referring to global share market indices. What does Asia ex-Japan mean? Since poor companies were being propped up, it meant that these companies were trading at over 60 times earnings and ridiculous multiples. The situation that Japan had created meant that when investors wanted to know what was going on in Asia, they were only interested in the growing economies, the tigers of the region, that were progressing forward and not the country that was stuck in stagflation.

You might have heard of the term Abenomics, referring to the recently elected Prime Minister of Japan, Sinzo Abe. Abe appointed Haruhiko Kuroda as the new Bank of Japan governor, who takes the position with a mandate to get Japan out of the current economic predicament through introducing new monetary and fiscal policies that aim to encourage private investment. Some of the measures include targeting inflation at 2% and setting negative interest rates amongst others. These are important because they will force investors to take their money out of the bank and look for returns better than the 2% inflation rate; otherwise their purchasing power is going to be decreasing. Put another way, if savers aren’t earning more than 2% on their investments then they will in effect be losing money because something that cost $1 this year will cost $1.02 next year and so on. It’s a risky policy because the fiscal spending will increase by 2% of GDP to reach 11.5% of GDP for 2013. This is still within a reasonable level but if the policy fails to work it could cause uncontrollable inflation and debt levels to increase without any discernible improvements in the livelihoods of the population.

When we were in Tokyo we were lucky enough to make it along to a sumo tournament, while there we sat next to some yanks who weren’t as interested in the wrestling as they were about impressing their world views on us. The mother lectured us on how it was incredibly difficult for her to open a bank account in Japan because the culture was xenophobic, the children then proceeded to tell us that they refused to learn Japanese because the culture was going to be extinct within the next decade. All I could think was the US is taking a similar, albeit more extreme approach, with the regulations they’re putting in place (FATCA) and the economic policies seem very similar to Japan in the early 1990s. If any country is going to become less relevant on the geo-political stage it’s most likely going to be the one with the protectionist polices and ballooning Government debt and not the Asian nations.

Japan still has a lot of economic issues to work through, including those mentioned above and the aging demographic. However, as the policy initiatives are put into place Japan could rise from the rubble once again, although hopefully they don’t over-cook it this time. Personally, it’s easier for me to see the growth opportunities in the developing ASEAN countries so for the time being my portfolio is going to remain focused on Asia ex-Japan.

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While this is marginally dilutive, it doesn’t change my original hypothesis. I still believe that China Minzhong is a good investment at these levels.

Fair Value -> S$2.35, currently trading at S$1.14 (revised because of dilution)

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I’ve had a couple of readers request that I look at China Minzhong. It appeared on my original Singapore screen but I passed it up because of the S-Chip link. I subsequently decided to have another look at the company and since it’s had a bit of a run lately, I thought I’d see if it’s justified on valuation grounds or just a victim of the January effect.

Thesis
China Minzhong is a leading vertically integrated vegetable processor in China currently trading at 4.0x 2013F earnings. As the free cashflows continue to grow with earnings and market begins to understand and appreciate the business China Minzhong has the potential to see a rerating and failing that the growing earnings will mean an investor will still be compensated for the risk taken.

As the current farmland matures and begins reach its potential yield, China Minzhong would be worth almost 3x the current price. In an optimal scenario China Minzhong could be worth 10.0x FY2013F earnings, in line with other small caps trading in Singapore. This isn’t a huge ask for a business that has been showing a 42% CAGR in revenue and fairly stable margins over the past 4 years.

Variant View / Issue
The margins are too good to be true (GM = 38.4%, NM = 26.5%), suggesting that the earnings themselves are also an accounting manipulation.

Realistically, you could expect these margins from a vegetable grower and the RoE of 19%, isn’t exceptionally above what you’d expect from a stable business.

Introduction

China Minzhong was established in 1971, which was named as the “National Leading Dragon Head Enterprise” by the Chinese government in 2002. China Minzhong has two key business segments; Processed Vegetables and Fresh Vegetables. The Processed Vegetables segment produces over 100 types of processed vegetables that are air-dried, freeze-dried, brined and freshpacked. The products are distributed across 26 different countries and regions including the Americas, Asia and Europe.

China Minzhong – Business

Key Shareholders

China Minzhong was listed at S$1.20 in April of 2010 and has had a tumultuous journey since then because of an overhang and accounting scandals reducing the credibility of S-Chips. 2 out of 3 of the funds that were shareholders at the IPO needed to sell their combined 16% position in 2012 because of mandate requirements. The substantial increase in supply weighed on the price until recently.

The third fund that remains in the fray is GIC, under the alias of Tetrad Ventures, which currently holds slightly under 17% and is under no mandate obligation to sell the position. GIC’s involvement increases the confidence in the credibility of the numbers because of GIC’s track record and Singapore’s views on corporate governance and accounting credibility.

China Minzhong – Shareholders

Combined, Management hold 13.6% of China Minzhong and used the placements last year to increase their positions. Franklin Templeton also hold >13% of the company so any prospective investors would be in good company.

Management

Management appears to be very experienced with Lin Guo Rong, CEO and Executive Chairman, having been with the company for >37 years. He was named as one of the “Top One Hundred Entrepreneurs” by the China Media Development Institute as well as having received numerous other awards. Wang Dazhang, CFO, has also spent >37 years with the company and had previous experience in the vegetable growing industry before joining.

Valuation

I’ve tackled the valuation using a back of the envelope approach to determine what the revenue and profitability would look like if all of China Minzhong’s land used for Cultivation was mature and cross checked this with the current multiples for peers.

China Minzhong – Valuation

China Minzhong – Valuation 2

Peers Sino Grandness and Yamada are trading at 4.6x and 2.4x earnings respectively, so a 3x multiple for MINZ doesn’t appear demanding. I believe that if China Minzhong doesn’t invest in any more farmland, as their existing farmland matures the business is worth at least S$2.70/share.

Conclusion

Overall, I believe that China Minzhong still has some room to run and as it continues to grow the valuation will continue to play catch up. This could be a great opportunity to pick up a high quality small cap before the institutions learn hear about the story.

As at writing I have a position in MINZ and may make other transactions within the next 30 days. If you’re considering investing, please do your own due diligence.

The post China Minzhong – Buy appeared first on argutori.

When looking at Malaysia, I’ve tried to stay away from any agricultural companies that are purely focused on palm oil for ESG reasons. A quick scan of the companies on the list revealed that JCY has been struggling (although management is confident their situation will improve mid-2013). Puncak Niaga looks interesting prima facie but the profitability has been volatile over the past couple of years and the business model is based on receiving contracts to repair and operate dams making it difficult to value. I’ve also shied away from holding companies that have a menagerie of businesses in their portfolio.

That said, I’ve decided to focus on:

• Prestariang – Provides ICT training and certification as well as distributing software licenses. The Government has recently increased their focus on tertiary training centres with the goal of improving the skilled workforce in Malaysia to catch up with the fast developing ASEAN peers.

Malaysia

If you have any opinions on the companies I’m looking at or avoid, let me know.

I don’t currently have any active positions in the companies mentioned but may initiate positions within the next 30 days.

The post Malaysia Screen appeared first on argutori.

Fair Value -> 1,780 – 2,280IDR, currently trading at 800IDR

Thesis

As the Indonesian middle class  and discretionary incomes continue to grow, retailers will benefit as they nibble on pieces of an ever-expanding pie. The premium retailers who occupy a niche market and have developed sustainable competitive advantages will significantly outperform. Ace Hardware stands to be one of those players with no long-term debt and an expanding store footprint.

Looking at the traditional relative valuation metrics it appears that Ace is overvalued. The level of development and amount of growth ahead of Ace mean that it’s worth looking at the total potential market for Ace to determine the intrinsic value. I believe that considering the total market for home improvement in Indonesia, Ace will still be undervalued, albeit expensive on near term metrics.

Introduction

The first Ace Hardware store was opened in 1996 in Karawaci, Tangerand, West Java. The company has since developed into a chain of over 50 stores throughout Indonesia. There are two parts to the chain, Ace Hardware, a home improvement chain that supplies hardware, home appliances, cleaning aids, lawn and gardening supplies, lighting, outdoor living furniture, paint, plumbing supplies and fixtures, electrical supplies, tools as well as other home improvement essentials. The second part of Ace relates to Toys Kingdom, which specialises in “creating smiles” through offering a variety of world-class branded toys.

Issues

Ace is currently priced for perfection (at 23.8x EV/TTM EBITDA and 35.5x 2011 P/E) and looks to be expensive on simple relative valuation metrics.

Key Shareholders

PT Kawan Lama Sejahtera, a commercial and industrial supply company that provides tools, industrial equipment, and machinery in Indonesia, currently owns 60.0% of Ace. The remaining shareholder list is composed of a range of other major institutional holders, including Aberdeen and GMO amongst others. There are some pretty savvy shareholders on the register, so it looks like anyone considering investing in Ace Hardware would be in good company.

Ace Hardware – Shareholders

Valuation

Taking a simple relative valuation approach, Ace looks fairly expensive compared to peers. It’s trading on 23.8x EV/TTM EBITDA and 35.5x P/E vs peers on 9.6x EV/TTM EBITDA and 20.7x P/E. However, I don’t believe this is the best way to look Ace Hardware because it has no long-term debt and a lot of growth opportunities, albeit these should be tempered by the potential for more aggressive competition entering the space. I believe It would be better to use a Back of the Envelope approach to determine the intrinsic value of Ace.

Ace Hardware – Compco Valuation

I used two methods to determine the intrinsic value of Ace. Firstly, I attempted to determine the intrinsic value by looking at what the total market in Indonesia could be for Ace by:

• Determining the size of a similar market (Thailand) in Sales / Capita;
• Multiplying the result by the current Indonesian population, giving the total potential market for home improvement sales in Indonesia;
• Adjusting the size of the total market for differences in geography and culture (the population in Indonesia is spread over a greater land mass so it would be difficult to reach all of the customers vs Thailand) and the introduction of competition (HomePro has ~10% market share in Thailand, assuming the Ace’s brand is strong and there isn’t a lot of competition could allow it to double HomePro’s position);
• Multiplying by the Sales for Ace by the average EBITDA margin for the industry; and
• Multiplying the result by the median EV/EBITDA multiple I’ve derived for the comps to get the overall EV and subsequently Equity value.

Ace Hardware – BotE Metrics

Ace Hardware – Back of the Envelope Valuation

I believe that Ace would be worth >2.5x the current EV using a relatively modest 10% assumption for Ace’s market share.

Secondly, I attempted to determine what Ace’s slice of the pie would be if it was able to reach a similar size as the listed Thailand comparisons. This is a more conservative approach because it assumes that Ace’s Sales / Capita level is the same as the sum of the Thailand comparisons as they sit presently. There are two ways to view this:

• Ace could capture a larger market share than both Siam Global and HomePro because it has a dominant market position; or
• There isn’t presently a lot of competition in Indonesia and as the competition increases Ace will struggle to hold the same Sales / Sqft or EBITDA margins that it currently achieves.

It’s also worth noting that as Thailand continues to develop the Sales / Capita will also continue to increase closer to levels of developed countries. Considering the second bullet-point, I’ve only assumed a 10% EBITDA margin for Ace (from the 15% average EBITDA margin that it’s able to generate at present).

Ace Hardware – Back of the Envelope Valuation 2

The resulting value is adjusted  down for geographic differences. Although, there could be currents that cut in the opposite direction. Namely, Indonesians might feel inclined to spend more on their homes than their Thai counterparts i.e. Indonesia home improvement stores receive higher Sales / Capita. This gives a resulting valuation of IDR2,280 per share, above that of the first calculation.

Ace Hardware – Sensitivity

Conclusion

Ace Hardware has some really good long-term prospects in Indonesia and, failing a turbulent entrance from additional competition Ace should continue to reward shareholders with outperformance. I believe that the intrinsic value of Ace Hardware is between 1,780-2,280IDR vs the current price of 800IDR. While I could see a place for Ace Hardware in the portfolio, there is a market timing element to the portfolio strategy. To be consistent with the strategy  I’ve decided that I’ll continue to follow the company and if there’s price weakness then I’ll reconsider it for the Argutori’s portfolio. However, that’s not to say that there isn’t potential for this holding to make it into other portfolios that have a different strategy.

At present I do not have a position in Ace Hardware (ACES IJ Equity) but may initiate a position within the next 30 days. If you’re considering investing, please do your own due diligence.

The post Ace Hardware – Review appeared first on argutori.

Thesis

STX OSV (STX) is currently stuck in the mud because of pending rumours of a fire-sale to an Italian Ship Builder (Fincantieri). While the EV/EBITDA multiples and high ROE suggest that STX is worth significantly more than its current price (>S$4.00), rumors circulating surrounding the sale are suggesting that the sale could go ahead for 900bn KRW, which would only represent ~S$1.60 vs the current price of S$1.35.

While a fire-sale is unlikely because of the improving financial condition of the parent company (STX Offshore Shipbuilding) and presence of Och-Ziff Asset Management (OZAM), the overhang from the potential transaction prevents this investment from having a large enough margin of safety for me to recommend it to readers.

Introduction

STX is a global shipbuilder, operating in Norway, Romania, Brazil and Vietnam. It constructs vessels used in the offshore oil and gas exploration and production as well as other specialised vessels. Find out more about the business here and on the investor relations page.

Issues

To save time and space, the details and time line surrounding the potential transaction have been summarised here. The main issue facing STX OSV is the extent of the financial distress that the Korean parent (STX Offshore Shipbuilding) is facing, a dire situation could likely result in pricing that will reflect a fire-sale. If the situation is bad but manageable then shareholders who sit and wait could be handsomely rewarded. Presently, OZAM is sitting in there with a 21% shareholding, which could further alleviate the potential of a fire-sale being affected without a bit of a furore.

STX Offshore Shipbuilding, which has a majority 51% stake, is the entity that has been experiencing cash flow and debt management problems – see the group structure below.

STX OSV – Group Structure

The debt ratios and servicing ability of the parent, STX Offshore Shipbuilding, are getting down to more manageable levels following a capital raising and some tighter working capital initiatives in the past few years. However, with global shipping in a rut it’s unlikely that things are going to get much better in the near future for shipbuilders.

STX OSV – Debt to Equity

STX OSV – Debt Servicing

Overall, the level of leverage and recent improvements in the financial condition suggest that a fire-sale won’t be as likely as it was at the beginning of the year, when it the rumours of a sale were first mentioned in the media in May 2012.

Key Shareholders

OZAM received an 18.3% stake at S$1.33 in placement in July 2011 and subsequently topped the position up to 21.0% with on-market transactions. It’s claimed that the placement was made to “improve trading liquidity” but in all likelihood the placement was made so OZAM could block any potential takeover approaches.

STX OSV – Shareholders

OZAM saw value in STX, when it purchased the stake at similar levels to where it’s currently trading, so it’s unlikely that it’ll let the stake go for a similar amount (even after considering the 21 cents in dividends that have been paid out over the past year).

Valuation

Based on takeover multiples and current market multiples STX is worth >S$4.00. STX continues to have a strong and growing pipeline of ship orders for the next few years. There’s always the issue of large buyers delaying purchases or payments now that funding and business conditions are tighter. However, the management team has been capable of handling the business cycle so far. I believe that STX will be able to continue generating earnings at similar or growing levels in the future, which makes the current multiples look really low vs peers.

The recent acquisitions in the Asian shipbuilding space suggest that STX should trade on an EV/EBITDA multiple of 11x vs the current multiple of <3x.

STX OSV – Transaction Valuation

Using a market multiple approach, STX is again trading at ½ of the peers.

STX OSV – CompCo Valuation

Combining the two methods together I come to my price target of S$4.12, which is >2x the current market price.

STX OSV – Combined Valuation

Since the P/BV looks high compared to the peers, it’s worth taking into consideration the company’s ability generate returns from those assets. The P/BV vs ROE chart below shows that, while STX is more expensive on a P/BV basis this is justified by the returns it’s able to create.

STX OSV – PBV Valuation

Conclusion

If the sale doesn’t materialise then it’s possible that STX could re-rate and trade in line with its peers. In the meanwhile any investors would be paid a 5% dividend, which could be considered princely when compared against the current interest rate environment in Singapore and the quality of the company. At current levels, if the M&A does materialise within the next 12 months then the returns would still outweigh what an investor could get by parking money on the sidelines.

Overall, there are offsetting factors at play and significant uncertainty around whether a deal will materialise. The point of this blog is to find and discuss investments in solid companies and not speculate on potential M&A activity. While this investment could be better than sitting in the sidelines, the potential M&A activity could limit the potential upside which skews the risk / return consideration.

As at writing I have a position in STX OSV and may make other transactions within the next 30 days. If you’re considering investing, please do your own due diligence.

n.b. I decided to take a position for 2 reasons -1) to follow my proprietary system with skin in the game so I could see how things play out, and 2) to give the portfolio some added market exposure while I search for other investments that are more suitable.

Subsequent Events 21/12/2012

Fincantieri has offered to buy 51% of STX OSV from STX Europe for S$1.22 (vs last close of S$1.40, at a 13% discount). The deal will help STX Group (based in Korea) meet their goal of raising US$2.3bn to repay debts.

OZAM now holds 12% of STX OSV. Since Fincantieri has made an offer for >30% of STX OSV, it has made an offer for the remaining shares to the minority shareholders, as required under Singapore regulations.

Additional information:

Official press release

Offer information

Bloomberg article

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Thesis

OSIM is a high margin business that is producing lifestyle products targeted at the increasing upper-middle income demographic. OSIM is currently expanding existing store footprint, while deploying cash that was raised via a bond offering in other strategic investments and share buy-backs. As the current cash hoard is used the business will return to previous RoE levels, which at ~50% beats the competition.

OSIM – Return on Equity

OSIM is focused on “enhancing total well-being” or retailing lifestyle brands, such as in-home massage products. The Company’s products include massage chairs, foot massagers, neck massagers, head massagers, fitness equipment, diagnostic equipment, vitamin & supplements (GNC Holdings in Singapore, Malaysia, Taiwan and Australia) and luxury tea (TWG Tea Co in Singapore).

Issues

In the middle of 2011 the company raised S$120m for acquisitions and working capital through issuing convertible bonds. This caused the price to drop off a cliff because 1) the issue was dilutive and 2) past acquisition experience wasn’t great with Brookstone not delivering to expectations. The convertible bonds are paying 2.75% interest semi-annually and can be redeemed until the 25^th of June 2016 at S$2.025 per share. If all of the notes are exercised it would represent an 8% dilution to the existing equity holders. I can’t fathom why management wiped 8% of value out of the hands of the equity holders unless they had something up their sleeve that was going to be substantially value accretive and they had no other way to generate the cash.

Prior to the issuance the company was generating ~S$100m in operating cashflows and had negligible levels of debt. This was more than enough to cover the relatively small acquisitions made, which makes me seriously question why this issuance was necessary but for the obvious fact that there was an overzealous banker sitting in the background. Over the past 2 years OSIM has been buying back shares with the excess cash.

All 9 analysts who cover the stock are currently rating it as a buy, limiting the potential for further marginal buyers.

Margins

The company only reports segment information for the retail and distribution businesses, this doesn’t provide a lot of insight into the operations of the subsidiaries. However, the overall EBITDA margin was 21.4%, ranking up there with the other international luxury brands (see the table below) and has been improving each year, with the exception being the year following the acquisition of Brookstone.

The improvement in the EBITDA margin has been driven through mix changes and cost reductions. It’s difficult to tell how much improvement has come from better sourcing and improvements because of limited transparency in the segmental reporting. Regardless, the GP margin has improved from 57.8% in 2005 to 68.9% in 2011 and appear that it has more room for improvement now OSIM is achieving economies of scale.

OSIM – EBITDA Margin

Key Shareholders

There are some high profile names on the OSIM register, including; Franklin Templeton, Blackrock, and Fidelity among others.

OSIM – Shareholders

The Founder and Chairman, Ron Sim, was named Best CEO in the mid-cap category at the Singapore Corporate Awards in July this year (2012).  COO, Teo Chay Lee, has been with OSIM for over 20 years now and is responsible for Malaysia, Thailand, Indonesian and Singaporean operations.

Valuation

Currently 5% of households in Singapore and Hong Kong own massage chairs compared with 30% in Japan. There is a lot of room for OSIM to grow its flagship brand in the current markets, when combined with the potential of the other brands currently in the OSIM stable it looks like there is a lot of potential for OSIM as a whole as long as it doesn’t bite off more than it can chew.

The global peers trade at 11x EBITDA but don’t produce the same amount of FCF that OSIM does at the moment because of the under ambitious current capital structure. Not only is there room for OSIM to grow earnings from its current platform but there’s also potential for a rerating if capital initiatives are executed effectively. It would be preferred if OSIM management stuck to their knitting and focused on growing the existing stable of brands, without the help of zealots encouraging flights of fancy into unknown realms.

The potential for ~20% upside from current prices, with stable and growing streams of FCF mean that OSIM will make the cut it into the Singapore portion of the portfolio. On a relative multiple basis, lacking any near-term catalysts, I’d value OSIM at S$1.80.

OSIM – Valuation

As at writing I have a position in OSIM and may make other transactions within the next 30 days. If you’re considering investing, please do your own due diligence.

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