King Wan Corporation – Part I

This has been incredibly difficult to write. King Wan holds the distinction of being one of my worst investments thus far. Probably the worst in fact. It is always easiest to reflect upon the successes, but the pain from the losses…

It is also the one company which I am least optimistic about in the short  -mid term. I currently hold 1,000,000 shares of KW bought at an average cost of $0.28 or so, after accounting for dividends.

Upon reflecting though, I thought that KW is a fine example of incompetent management + my own emotions having clouded my judgement. The emotion part is particularly frustrating as I have flagged up many concerns in my investing thesis prior to investing, these concerns have now been realised and yet, at that point in time, I went ahead to buy 1,000,000 shares, HAVING done the due diligence.

I have no explanation, or excuse, for doing that. I must’ve been possessed.

The entire process, from my initial investment, together with how things have played out, my correspondence with KW’s management, and my view on how things will develop from here, should be rather entertaining to read though, assuming one has no teeth in the game.

This is KW’s official corporate profile:

“Estab­lished in 1977, King Wan Cor­po­ra­tion Lim­ited is a Singapore-based inte­grated build­ing ser­vices com­pany with prin­ci­pal activ­i­ties in the pro­vi­sion of Mechan­i­cal and Elec­tri­cal (M&E) engi­neer­ing ser­vices for the build­ing and con­struc­tion industry.

Over the past three decades, King Wan has grown from strength to strength to expand beyond its core busi­ness, and suc­cess­fully ignited new growth engines to pro­pel the Group for greater share­hold­ers’ value. The Group oper­ates through its net­work of sub­sidiaries and asso­ciates in Sin­ga­pore, China and Thailand.”

Please read the 2nd paragraph again, so that you’d understand how ridiculous that sounds as we progress.

KW divides it’s businesses into a core business and an investment portfolio. The core business is where management has executive functions, overseeing the operations of the businesses on a daily basis.

Under their investment portfolio, KW mainly invests the cashflow generated from the core businesses in the form of loans to associates or joint ventures. They also act as the guarantor for bank loans that these associates/JVs get.

If this works out, it is a very powerful structure (Somewhat similar to Berkshire’s), where the core business is stable and FCF generative, and the FCF is invested into higher growth businesses or businesses that are undervalued temporarily by the markets.

Unfortunately, there’s no WB in KW. That is the main mistake I made: Judging that the management are investing gurus.

To simplify the above structure, I’d classify KW’s entire existing business into 5 categories:

The manufacturing segment (highlighted in red) has been divested and has since been IPO-ed and listed on the thai stock exchange.

As you can see, KW has invested it’s CF in many different industries. It’s core competency is in M&E for the construction industry.

Sure, one can make the case for the property segment and the worker’s dormitory segment to be related industries. But the vessel segment? and the manufacturing segment? KTIS is now a sugar company listed on the Thai stock exchange. KW has absolutely no business meddling in these 2 industries, yet they do.

I’ll breakdown and analyze each of these 6 segments later.

Here is the consolidated multi year income statement:

KW’s troubles started showing up in the later part of FY15 (the company has a March year end) when it has to recognise an impairment of $12mil due to soured loans to it’s associates. (Parked under “Allowance for amounts due from an associate”)

In FY15 though, due to the large 1 off gain from the sale and subsequent listing of the manufacturing segment (which became listed as KTIS), the company recognised a large $24mil gain on disposal, and this big fat gain masked the ugly impairment. (“Gain on disposal of available for sale assets)

Still, the 1 off gain was expected. The impairment loss, to begin with, was not 1 off, and it was certainly not expected by the markets. Guess you’d be able to guess what happened to the share price with that announcement.

Prior to FY15, KW’s valuations were actually rather compelling. Although earnings has dropped in FY13 and FY14, the one off gain alone would’ve added a massive 6.9 cents to the earnings!

What should’ve been a red flag to me, is the “interest income” and the “Fee income from financial guarantees to associates” (Highlighted in red)

To be fair, I did notice it and it made me sufficiently uncomfortable enough to contact KW’s management to enquire. KW’s IR is rather responsible. Their CFO, Mr Francis Chew, did reply promptly and rather clearly. This is my exact email to KW, completely unedited except to take out my name.

Pls see the 2nd question. This correspondence took place sometime in end 2015.

Here is the exact reply:

Basically what he is saying is that this is “required by financial reporting standards”. I am no accountant but being a skeptic, I did verify this FRS39 rule and sure, he’s right. I totally do not understand the logic behind this but that’s how the high powers decide financial reporting should be done.

Now at this point in time, what I should have done is to eliminate these earnings. Take is as 0. But I didn’t. That’s a dumb mistake.

These earnings are earnings only because the FRS rules say so. KW has not collected any $$$ on these loans, and by their own admission, would not be collecting any $$$ anytime soon. In fact, the loans kept increasing and increasing and increasing and increasing EVERY QUARTER.

KW just kept sending $$$ to their associates without any collection. Not the principal, not the interests, nothing.

I kept monitoring the CF statement every quarter, hoping against hope to see some $$$ collection. Nothing. To date, nothing has been collected.

Now to draw an analogy, imagine we are friends. You loaned me $10,000 and I said ok, I’d owe you an additional $1k every quarter for this. So after every quarter my debt becomes $11k, then $12k then $13k etc. But not once would you see a single cent repaid by me.

Would you be concerned after a few quarters?

Which was what I brought up. (Read question 1. above)

“These loans have increased rapidly from $17.4mil in FY12 to the current figure. KW has increasingly taken on bank loans or guarantees the bank loans of associates, this has increased the debt to equity ratio to 0.49, and current asset:current liabilities is now 0.54. Is management comfortable with the current balance sheet, and are we likely to see this “non current receivables” balloon further in the coming year?“

His reply:

“As you have correctly pointed out, the increase in debt equity ratio was due mainly to the Group’s extension of loans to associates, in particular, associates which are property developers and where the funding requirement is usually higher. The balance sheet will improve upon the completion of the respective ongoing development projects in the next few years.”

As we will see as I continue, this is an outright lie. The balance sheet did NOT improve in the “next few years”, and instead, the bulk of these loans kept getting written off. (ok yes, technically it improved because it’s been written off but I don’t think that’s what he meant!)

Manufacturing segment

When KTIS was divested and subsequently listed on the Thai stock exchange, it generated a lot of hype for KW. Many analysts were scrambling to cover the company (none of them are still covering the company right now. See a pattern here?)

For a sugar (commodity) company, I thought the valuations were rather rich. The PER at IPO was around 24. KW’s MD, Chua Eng Eng gave many interviews, suggesting that KW could slowly divest its KTIS stake for cashflow. Many ridiculous extraordinary dividends were suggested, and Ms Chua did not refute them either.

Here, judge it for yourself:

http://www.nextinsight.net/index.php/story-archive-mainmenu-60/919-2013/7171–king-wans-agm-greater-clarity-on-ipo-of-ktis-and-special-dividend

I’ll quote:

“Asked to comment on analyst reports by SIAS Research and OSK-DMG about King Wan being able to pay special dividends for several years, management said the analysts had studied King Wan’s cashflows and track record of rewarding shareholders with special dividends.

“We don’t think their assumptions are wrong.”

OSK-DMG analyst Lee Yue Jer has noted in a report that the M&E business currently contributes S$5m-7m of cash, which easily pays for the 1.5 cent ordinary dividend totaling S$5.2m.

The analyst said if King Wan wanted to, it could sell the KTIS shares gradually and be able to pay 1.5 cent a share as special dividend annually over 10 years — assuming the sale price is S$48 million in aggregate.

“This doubles the dividend to a juicy 9.7% yield sustainable for the next 10 years,” according to the analyst.”

Unfortunately, their assumptions are wrong. Very wrong.

KW has distributed dividends of 1.5 cents annually from FY12 – FY14, and with the listing of KTIS, the dividend increased (very slightly!) to 1.7 cents in FY15. In FY16, the dividend was completely eliminated.

That’s right. 0 cents in FY16.

Now, I understand that it is hard to give long term projections. Nobody knows how the business environment will be like in the next 2 years. But how the heck would an analyst (who is supposed to provide an expert opinion), conclude that there’d be a 1.5 cent special dividend annually over the next 10 years is beyond my understanding.

Mind you, he is talking about a SPECIAL DIVIDEND. This means he thought it’d be 1.5 cents (ordinary dividend) + 1.5 cents (special dividend) = 3 cents every year for the next decade.

Even for a company that I have thoroughly analyzed, I don’t have much visibility over how the company would perform in the next 3 years, much less over 10 years. I’d never dare to give a 10 year projection to such detail.

What is most disappointing to me, is that the MD Chua did not refute this. She did not temper expectations. “We don’t think their assumptions are wrong.”

I’m not saying all this due to hindsight bias. To be fair, I too, did not predict the subsequent crash (obviously, or I wouldn’t have invested), but when I read the report then, I was very skeptical of it’s conclusions. For the record, this is what I wrote in my personal investing thesis then (reproduced exactly without any editing):

“osk dmg analyst reported a likely increase of dividend to $0.03 from FY15. He’s expecting the KTIS stake to be divested gradually and a special dividend to be given out every year. UNLIKELY. PROB CASH RETENTION FOR MORE DEALS. EXPECT DIVIDEND TO INCREASE TO $0.02 INSTEAD.”

Looks like I’m wrong too.

Since it’s IPO, KTIS share price looks like this:

Outright ugly.

Again, to be fair, KW did divest some KTIS shares at a higher valuation when it continued rising for about 6 mths after its IPO. Currently, the KTIS stake is carried in the balance sheet at 7.30 THB.

This KTIS stake is carried in the balance sheet at market value. This means that every quarter, KW would recognise a profit/loss depending on whether the value of this stake has increased or decreased. I don’t think it’s important to look at it in the short term, but unfortunately it does affect earnings and the markets do react according to the earnings news.

In this case though, my personal take is that there wont be too much write offs regarding KTIS anymore. I have analyzed KTIS financials and I am confident now, the valuations are ok. (not fantastic. I wouldn’t buy it individually from the thai exchange, but I wouldn’t sell it now either)

I won’t be analyzing KTIS here because the analysis is not as thorough and because that’d really divert into another 2-3 posts.

Now, just to be clear, I’m not faulting the analysts for getting this call wrong. Nobody gets it right all the time. Not even WB. Not Munger, not Icahn, not Soros, not Ackman and certainly not some analysts.

My beef is where are they now? Don’t run away! Stand up and say it’s wrong, update your analysis, issue a new call or simply say you have no idea. Put the spotlight on management. Pressure them to be accountable for their actions.

Wouldn’t your track record as an investor be fantastic if one can just forget about your mistakes, while hyping up your wins?

Honestly, I have no idea why I seem to be the only one who’s frustrated with this. This is an issue with only the local investing scene. In the US markets, a lot more spotlight is on the management and no management can quietly slink away after making a public statement.

That’s why they’re paid an obscene amount. If you say something, you better work your ass off to make sure it comes true. Otherwise, expect some heat from analysts and shareholders.

Unfortunately, in SG, the analysts will run away, and the shareholders are only interested in the buffet. Nobody questions the management. Nobody (except me) seems to be upset.

A reader who has emailed me recently shared these concerns with me too. In fact, he said that’s why he mainly invests in the US markets instead of SG. (you know who you are). This is perhaps one of the better examples justifying his opinion.

Let me end this segment regarding KTIS, the analysts coverage and the “loans to associates” with this self explanatory image:

Alright, I’m stopping here as I’m supposed to be on holiday, and writing about failures doesn’t make one feel relaxed.

In the 2nd part, I’ll continue with how the investment has regressed from a bad one to a terrible one.

I promise it’s just as entertaining, or even more so than this one.