S i2i Investing Thesis

This post is going to be different.

For the 1st time, I’m going to post an investing thesis… that’s not mine. This comes from a reader of SG TTI.

I have had many readers who have emailed me, many have shared their own personal investing thesis. Thank you for all the ideas. Whether I agree with them or not is not important, I enjoy understanding the thought process of others. I greatly appreciate them.

I enjoy discussing any ideas, particularly if I have some knowledge of the company and/or industry.

This investing thesis is one such example. It intrigued me enough to drop everything else, and dive deep to analyze this company.

For those of you whom I’ve promised to write an investing thesis on a particular company, I’ll get down to it. I apologize for the delay.

This investing thesis is written by Alain T.

Reproduced here, of course, with permission.

Executive Summary
Si2i is a Singapore-based telecommunications company. The company operates in three business segments, two of which are loss-making, but a third (sale of prepaid mobile cards in Indonesia) has consistently generated ~S$4-6m/year in EBITDA.

In aggregate, Si2i was profitable in 2015, and management is aggressively cutting costs and divesting/shrinking non-profitable businesses.

The company has S$2.11 per share in net cash vs the company’s last traded price of S$1.32. As such, there is an opportunity to purchase cash at 62 cents on the dollar and receive Si2i’s profitable operations for free, with the free call option that management continues to shrink Si2i to profitability and return excess capital (as it did recently, distributing S$0.729 in cash vs a pre-announcement market price of S$0.87).

Lastly, the SGX’s listing rules provide a hard catalyst to this idea as Si2i is currently on the SGX’s watch-list and thus has until March 2018 to double its market cap and remain profitable or face delisting.

Even in a delisting scenario, Si2i’’s intrinsic value could be unlocked as non-controlling shareholders should receive an exit offer per the SGX’s listing rules.

Business Description
Si2i is a Singapore-based telecommunications company. The company operates in three business segments: 1) Sale of prepaid mobile cards in Indonesia, 2) IT services, and 3) sale of mobile phone.

Si2i’s recent history began in 2009 when the Spice Group, a conglomerate controlled by telecommunications mogul Dr Bhupendra Modi, bought a controlling stake. Si2i was to be the vehicle for Dr Modi’s vision of building a low-price phone manufacturer to compete in the developing world.

Consequently, the company raised S$288m in capital via rights issues in 2010 and 2011, and snapped up domestic champions in the region, culminating in its US$175m purchase of “Nexian”, Indonesia’s 2nd most popular mobile phone brand with over 20% market share.

However, Si2i was slow to adapt to the feature phone to smart phone transition, ultimately ending up a casualty of the commoditization of smart phones. The subsequent destruction of value as the company discounted inventory and shuttered most of its mobile phone business has left the company a shell of its former self, having once boasted ~US$1bn in sales and a market cap of over S$350m.

Investment Thesis
Recent capital reduction exercise is the latest and most emphatic of a series of shareholder friendly events.

Si2i recently completed a capital reduction exercise whereby shareholders received a S$10m cash distribution. The rationale for the exercise was that Si2i had capital in excess of its immediate needs. This is a huge positive because: 1) it evinces a shareholder friendly board, and 2) alleviates concerns that Si2i may be a “cash box” value trap. This is but a continuation in 2016 of a series of positive developments in 2015, including: 1) The company’s continued shrinking to profitability bearing fruit as Si2i has posted three consecutive profitable quarters after years of losses, 2) Dr Modi’s return to the chairmanship, and 3) Management and the Board de facto forgoing pay in 2015 until losses were stemmed.

Non-profitable businesses hide a consistently profitable prepaid mobile card business.

Si2i’s non-prepaid mobile card businesses lost a cumulative S$2.1m in 2015, obscuring a prepaid mobile card business that consistently earns ~S$4-6m per year in EBITDA. As management continues to shrink or sell off unprofitable businesses, the strength of this segment should begin to emerge. Even accounting for the loss of clusters in Indonesia (see key risks section), the unit should be able to throw off ~S$3m in EBITDA, and at a conservative 4x multiple would alone be worth 68% of Si2i’s market cap.

Controlling shareholder has been purchasing shares in the open market.

Dr Modi purchased S$98.4k worth of shares over the last three weeks at an average of S$1.88/share. Whilst small relative to his net worth and stake, it is significant when one considers the stock’s illiquidity as these trades accounted for 22% of total trading volume during the period.

Threat of delisting presents a hard catalyst for value creation.

On March 2015, Si2i was placed on the SGX’s watch-list for having recorded pre-tax losses for three consecutive years and having an average market cap of less than S$40m.

The company has until March 2018 to exit the watch-list by recording a pre-tax profit and having a trailing 6-month market cap of S$40m, failing which the Exchange may either delist Si2i or suspend it with a view to delist. As per Rules 1306 and 1309, if the Exchange exercises its power to delist Si2i, the company or its controlling shareholder “should” make a “reasonable” exit offer, “normally … in cash” to its shareholders which “may include … liquidation of … assets and distribution of cash”.

Si2i’s entry into the watch-list may thus be a blessing in disguise as it creates a hard catalyst, ensuring Si2i does not end up a value trap. Furthermore, in either of two scenarios, the stock is a potential double within ~2.5 years.

In the first scenario, management successfully achieves its 2017 target of exiting the watch-list, resulting in a double from today’s prices. This assumes minimal dilution in the interim, a not unreasonable assumption given that management has actually been returning excess capital. Dilution would also hamper such efforts as investors would penalize the company’s valuation. Exiting the watch-list could also lift a big overhang for the stock.

In the second scenario, Si2i fails to exit the watch-list and is delisted. This triggers a potential exit offer to minority shareholders. In this scenario, based on past transactions, a 0.85x P/NTA offer would not be unreasonable, resulting in 135% upside.

Si2i is likely to remain profitable going forward, which is key to a valuation rerating.

Si2i has lost money over the last three years and burnt through S$288m raised via rights issues. As a result, investors have soured on the company’s stock as evident by its 38% discount to net cash as investors discount the value of cash in a) the hands of management with a history of destroying value, and b) a company that as recently as 2014 was loss making.

Thus, establishing a track record of profitability is key to Si2i rerating over time. There are three main reasons to believe that Si2i can achieve sustained profitability. Firstly, management intends to exit the SGX watch-list, which requires a full year of pre-tax profit.

Secondly, Si2i’s CEO and Board voluntarily reduced their annual salary and fees respectively to S$1 in 2015 following years of losses. These remunerations have since been restored following Si2i’s return to profitability.

This is prescient of future profitability as slashing compensation was a line-in-the-sand statement about the intolerance for further losses. It would also be a public relations disaster to restore such compensation, only for Si2i to slip back into the red.

Lastly, management is in the process of aggressive cost cuts and has been shrinking, restructuring or selling unprofitable businesses. Such initiatives have thus far yielded a promising three straight profitable quarters.

Valuation

SOTP valuation yields ~S$3.00/share intrinsic value. A conservative SOTP valuation ascribing $0 value to Si2i’s two unprofitable business units and a 4x EBITDA multiple to the prepaid mobile cards business still suggests 128% upside.

Net cash valuation yields S$2.11/share price target. Si2i currently trades at 62 cents on the dollar of its net cash alone.

Mandatory delisting scenario yields S$3.10/share price target. A study of exit offers for past mandatory delistings show that the most commonly used valuation methods to justify an exit offer price are P/NTA and premium to last traded price and VWAP. Based on a sample of precedent transactions, shareholders could receive a 0.85x P/NTA exit offer.

Key Investment Risks/Bear Case Arguments

Business risk of the company cash cow.

The prepaid mobile card business is currently Si2i’s only profitable segment, and is thus key to the investment thesis. In October 2015, it was announced that Telkomsel – with its 60% market share, and of which Si2i was one of its three largest distributors – had completed a consolidation exercise of its exclusive distribution clusters, reducing its clusters from 204 to 130, and the number of its distributors from 155 to 100.

Si2i’s allocation of clusters was reduced from 12 to 4, a net decrease even factoring in the effects of consolidation. Segment revenues have been down 27% YoY since. While management intends to reduce associated costs and plans to grow the company’s share of clusters with other operators, investors should be alive to such renewal risks.

Potential for mismanagement of cash pile via further value destroying ventures.

One of management’s stated initiatives going forward is to “plan for new areas of growth to reenergize the company”. Whilst sub-optimal given management’s past history of poor capital allocation, any new venture should be judged on its own merits and the investment thesis may change depending on the nature of any new business, price paid, and source of capital.

Nano cap risks.

Firstly, as an S$18m market cap company, Si2i suffers from extreme illiquidity and has an average daily volume of ~10k shares.

Secondly, there is outsized potential for minority shareholder abuse. However, Si2i is in the rare position (for a nano cap) of having a high profile chairman and major shareholder. Dr Modi is Singapore’s 39th richest person, worth an estimated US$615m, and is thus unlikely to risk his business reputation over a 32% stake in Si2i.

Dr Modi’s current tenure as Chairman also only dates back to September 2015, having handed the role to his son in 2013. The younger Modi resigned in March 2015, citing tax reasons.

The recency of Dr Modi’s second go-round helming Si2i is key as he would not have returned to the role if there was an expectation of future mispractices.

Lastly, an investor may be concerned about the reporting reliability and tangibility of cash in a nano cap company, especially when the thesis so heavily hinges on the value of net cash.

However, Si2i’s recent capital reduction exercise is strong evidence of the materiality of its cash pile as 25% of reported net cash was distributed. The company’s 1.3% effective yield on cash also passes the eyeball test and appears in line with its disclosed mix of cash investments and their range of interest rates

270) S i2i trading statistics.jpg

271) S i2i thesis.jpg

272) S i2i presentations.jpg

273) S i2i SOTP valuation.jpg

274) S i2i Mandatory delisting scenario.jpg

275) S i2i delisting rules.jpg

276) Enforceability of Exit Offers for S i2i.jpg

277) S i2i valuation summary.jpg


I currently do not own any position in S i2i, although I may take up a position anytime. If I do, it’d likely be a small position sizing. I have my own thoughts on S i2i and may add to this in a subsequent post.

I will say that I mostly concur with Alain in his investment thesis.

There have been new developments in the company, that is not mentioned in this thesis as the thesis is dated June 2016. I am not privy to the author’s position or entry price into the company, but it is safe to say that if one bought in June 2016, the returns would’ve been sizable right now.

Many thanks to Alain for allowing this to be shared, it’s been fun having this discussion.

Happy Deepavali!

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