Month: October 2016

Post-mortem Of CDW Holding Ltd Divestment

I have just recently divested my entire stake of 200,000 shares of CDW Holdings, at $0.265 and $0.235.

23) CDWlogo 21052016

This is a company where the business has deteriorated rapidly over the past couple of years, and I was genuinely relieved to see the last of my shares sold, despite having to recognize a relatively small loss from the divestment.

My initial investing hypothesis mainly involved a turnaround of the business after they have acquired Pengfu, a turnaround that never really arrived. Instead, the bad news just kept arriving, to the extent that the business has changed materially from when I first analyzed the company.

Here’s the initial investment thesis:

CDW Holding Limited

In this post, I’ll aim to reflect back on my initial thesis and the reasons for investing, discuss what has since transpired, and finally, my reasons for divesting (if it isn’t clear by then)

As mentioned in my investment thesis, the investment was done not solely based on valuations, but on the basis that it’s a “unique situation” with a visible catalyst.

In FY14, CDW said that their revenue was constricted by the lack of supply of light guide panels. As a result, management moved to solve this issue by acquiring a 25% stake in Pengfu in early 2015.

The deal seemed wise at that time: not only does it give CDW a stake of profits upstream, it also contained a provision that made sure Pengfu had to give CDW’s orders 1st priority.

On top of that, CDW had been getting these light guide panels from a competitor at a premium. Pengfu would supply these panels to CDW at a discount. What is there to not like?

With that in mind, CDW’s prospects looked good at the start of FY15. Many analysts came out with glowing reports, and I concurred. The “unique situation” was that the supply constriction in FY14 was solved, and with that, CDW’s production should not be constrained and they should be able to manufacture and deliver more backlight units (BLUs)

Here are some of the analyst reports then:

cdw-analyst-report

kgifraser_cdwholding17022015

kgifraser_cdwholding03032015

As far as I know, all analysts have since “ceased coverage” on CDW:

269) CDW cease coverage.jpg


The timing couldn’t have been worse. Literally, right after acquisition, the orders for BLUs dried up as the Chinese smartphone market blew up. CDW’s major client, believed to be SHARP, was also in talks to be acquired at that time.

When you’re about to be acquired, it is unlikely that new orders would be placed, for fear of committing to deals which the new management does not approve of.

In my investing thesis, I noted that CDW has a competitive moat as the approved BLU suppliers have to go through a stringent process, which at that time, can take up to a year or more. (I’m told it’s been shortened now)

That still holds true. Unfortunately, it is only a competitive moat if the client (SHARP in this case), actually places orders with you. SHARP had it’s own fair share of major problems, and what we are seeing with CDW is simply a reflection of the issues SHARP had.

You may have a moat in the sense that SHARP would continue to approach CDW for orders, but if SHARP themselves are squeezed or acquired, the moat is useless.

The much anticipated orders did not come through in 2015, despite CDW’s best efforts. They have designed and come up with a more efficient model, and this was supposedly “well received” by potential clients.

Management has repeatedly guided in the quarterly reports, that they are optimistic that orders will “soon” be received for this new generation light guide panels. I’ve read this for a few quarters now, and the latest said that the orders will start coming in in “2H2016”. We are well past the midway mark of 2H2016 and it’s quiet as a mouse in the orders front.

From my initial thesis:

“CDW has recently developed a new generation light guide panel, and given samples for potential clients to assess. This new light guide panel was co developed with a Taiwanese partner (rumored to be Foxconn), and if it is Foxconn, that can only be good news.

These samples have “passed the key customer’s product testing, and the key customer is currently in talks with the end customer“. CDW sits right at the top of the entire supply chain for smart phones. CDW supplies the light guide panels, which are used by smartphone manufacturers to actually assemble the smart phone, which are given to the smartphone companies to sell.

It is this new light guide panel that will determine in a large way, how well CDW does in the short to mid term, possibly the long term as well.

Which is why I describe this as a “unique situation” type of investment. Valuations wise, CDW is certainly on the radar of several value oriented investors.”


This is from my conclusion in my initial thesis:

“Here we have a company that’s very attractive valuation wise. But it is not the valuation that’s the key. Rather, it’s “qualitative” factors that’d determine the share price in the mid term. Without the contract win, CDW would likely remain in the doldrums. With a win though, that’d be the key catalyst for a huge jump in the share price.

Since the company has failed to garner the much anticipated contract win, the sole catalyst that I had in mind in my thesis did not materialise. Surely that calls for a divestment in itself.

But that’s not the only factor. As mentioned earlier, the company has simply deteriorated rapidly since then. What else has transpired?

CDW undertook a 2 for 1 share consolidation to meet SGX’s MTP rule.

To begin with, I think this is an extremely dumb rule. You don’t see a MTP rule for NASDAQ or NYSE. For God’s sake, just let the free markets work!

Whoever at SGX thought of this damned rule, ostensibly to “protect” retail investors, for the sake of everyone, pls just retire. Why don’t these geniuses ever learn? All these interventions lead to more problems. Every “solution” tends to open up a new can of worms. You’re never solving anything, just transforming a problem to another.

SGX should just focus on educating the public to be more aware of their investments instead of trying such interventions which are ultimately destructive for everyone: the company suffers, the retail investors SGX purportedly is trying to protect suffers, and ironically, SGX themselves suffers!

Yes, I am aware of the Trinity saga (Blumont and the bunch). This MTP seems to be a direct response to that. My personal response is that true investors would’ve steered clear. Sure, many guys were burnt in the collapse, but short of sounding callous, I’d say that’s what makes a market.

Wanna protect the mom and pop investors? Educate them. If they still persist? Well, that’s just too bad for them. We know speeding leads to accidents. But we don’t put an auto speed cut off in the engines of motor vehicles here right? We educate drivers that you can’t speed and if you do and get into an accident, there are consequences.

But I’m digressing here. That’s another discussion altogether.

The 2 for 1 share consolidation has been value destructive. The share price after consolidation, is not 2x that before consolidation but much lower.

What do backlight units, a ramen restaurant in Japan, hair loss shampoo and hydroponics plantation have in common?

That’s right. Absolutely nothing.

As mentioned many times before in earlier posts, once I see a company expanding into COMPLETELY unrelated industries, it makes me sit up and recheck all my figures again.

Unless you are a Warren Buffett, it has almost never ended very well.

This year (2016), CDW started buying up the rights for some chemical compounds used in shampoos to combat hair loss. Before that, they acquired a ramen restaurant business. (CFO told a very skeptical TTI that the ramen business has been around for 70 years, it’s very “stable”) Then just very recently in end Sept, CDW’s subsidiary incorporated a company to expand into hydroponic plantation:

267) CDW hydroponic plantation.jpg

Now, all light guide panels are under pressure from the new OLED technology. I’ve done an in depth analysis of the industry (surprised that I didn’t write that up in my initial investing thesis). Basically, OLED produces clearer images, without the need for borders along the screen. This is because each light producing unit comes from the individual light diodes, you don’t need to have a light source at the back of the screen/film.

The downside of OLED is the cost, but as with all technology, cost is eventually brought down with more usage. OLED is in the midst of replacing the need for BLUs in many applications.

I’d actually be encouraged if CDW uses it’s cash hoard to expand and eventually develop OLED capabilities. Instead, hair loss shampoo, ramen restaurant and planting vegetables is what the management decided is the best for the precious cash hoard.

Tellingly, in one of my earlier correspondence with management, all my questions were answered except the one about whether the manufacturing plants can switch efficiently to producing OLED and if not, whether they’re considering expanding into that newer but related technology.

The question was simply ignored.

Dilution from share options

As of FY15, CDW had 19,000,000 share options granted to senior management, at an exercise price of $0.108, that could be exercised starting from May 2016.

1,000,000 options were lapsed as an employee left the company. This means at the start of 2016, there were 18,000,000 options outstanding.

After the 2 for 1 share consolidation, the 18,000,000 options should correspondingly be changed to 9,000,000 options. The exercise price though should also change accordingly to $0.216, isn’t it?

Recently, 500,000 options were exercised. There wasn’t much detail released except an announcement regarding the use of treasury shares:

268-cdw-use-of-treasury-shares-24102016

This means that currently, there are 8,500,000 options outstanding.

I have 2 questions regarding this:

  1. Is the exercise price now $0.216, instead of the original $0.108? It should be right? Afterall the options were granted before the 2 for 1 consolidation. I have asked management, this is a simple yes or no question, but have yet to receive a reply. Honestly, I’m not that interested in the reply, except for curiosity stake. For existing shareholders, I’d strongly suggest that you guys pressure management into clarifying this. In any case, both $0.216 and $0.108 are currently dilutive to existing shareholders. So it’s between a bad and a worse situation. Doesn’t look good. Having exercise prices below the current share price also means that the remaining 8.5mil options are going to get exercised between now to 29th May 2019 (when they expire).
  2. How is the value of treasury share transferred = $86,898.53? That works out to be $0.174/share. I simply cannot figure out how this $0.174 is derived. It’s neither exercise prices, nor is it a weighted average over a time period.

CONCLUSIONS

Since this has been an unsuccessful investment, what’s the lesson that I’ve learnt here?

Nothing much actually.

I’m also not overly bothered by this either.

In my initial investing thesis, I’ve already recognized that there’s a chance the catalyst (new orders) did not arrive. I did the due diligence, and in fact, the management themselves (if one assumes they were honest in their quarterly statement commentary) had no visibility on when the company can win new orders.

Which is why my position sizing on this investment was not high, and in fact, it was slightly below a moderate position.

The key then, is to cut losses when the data has changed materially, and as I have explained above, it sure has changed materially! I bought a BLU manufacturer, not a shampoo/ramen/hydroponic vegetable company!

Even if the company suddenly announces orders right after I have divested, it still wouldn’t change my mind about divesting. The expansion into all kinds of weird stuff really killed any potential longer term investing thesis one can come up with for CDW. Unless you believe CDW is an infant Berkshire.

I’m not sticking around to find out if they are getting any new orders.

I actually really like CDW’s CFO, he has been as honest as he can be IMO. But the facts are facts. I have only well wishes for the company, even after divesting.

When divesting, I’m reminded of this comment from Druckenmiller:

I’ve learned many things from [George Soros], but perhaps the most significant is that it’s not whether you’re right or wrong, but how much money you make when you’re right and how much you lose when you’re wrong.”

Stanley Druckenmiller, 1994


Addendum on 06/11/2016:

Reply from CFO Mr Philip Dymo:

  1. Exercise price post-consolidated is confirmed to be $0.216
  2. The value of treasury shares transferred was the average cost we paid for shares bought back under the Share Purchase Mandate.”

Info That I Have Gleaned From LTC Corporation’s AR 2016

This post was republished on NextInsight:

https://www.nextinsight.net/story-archive-mainmenu-60/938-2016/11103-ltc-corp

I spent the past couple of days dissecting LTC Corporation’s recently released Annual Report 2016. This post is about what additional information I have gleaned from the report. Since this is an update, I won’t be spending any time on the basic characteristics of the company. I reckon unvested readers who have not previously looked at the company, will probably find this irrelevant and very dry. Anyhow, here goes.

4) ltc-logo 13052016

To put some context in place, here are related earlier posts about LTC:

LTC Corporation (Part I)

LTC Corporation (Part II)

LTC Corporation & Asia Enterprises Holdings – What Are Investors Missing?

1. Strong start to CF generation in FY17

Under “Current Assets”, within the “completed properties held for sale”, the company’s balance sheet recorded $27.9mil. This $27.9mil includes properties in malacca, JB and the 7 Crescent bungalows. The 7 Crescent bungalows had 4 unsold units recorded.

Details of this are found in page 65 of the AR:

259) LTC completed properties held for sale 23102016.jpg

BTW, the company has a June year end.

Since the AR was compiled though, LTC has successfully sold off the remaining 4 units of the 7 Crescent project. In fact, they were sold right after the AR was compiled.

Here are the relevant, lodged transactions caveats:

260) LTC 7 crescent property caveats lodged.jpg

The remaining 4 units were sold at the end of June and July 2016, at a price of $3.6mil each.

This means that the project is fully old, and we should be seeing the effects of this in the upcoming FY17Q1 results to be released, probably in a couple of weeks from now.

While I do not know with certainty if the company is making $$$ from selling at $3.6mil, I do know that this is a great start in terms of CF generation, to FY17.

In my earlier report, I surmised that LTC has been using it’s FCF generated to pay off debt, and that starting FY17, the FCF will truly… be free. It’d be interesting to see how the management utilizes it.

LTC Corporation & Asia Enterprises Holdings – What Are Investors Missing?

The CF from this ($3.6mil x 4), is thus, a nice start and reaffirms the points I made in the earlier report.

Again, I’d emphasize that I do not know how profitable or unprofitable this whole project is to the company. In my earlier guesstimate done 2 years ago, I’ve worked out the  total developmental costs to be in the range of $50mil or so. This would be excluding transactional costs such as legal fees, taxes and agent fees. If so, the sale of these 4 units would be done at almost cost price, not sure if it’d contribute much to earnings.

2. Poor returns from USP acquisition

Again, in an earlier post, I’ve explained why I was disappointed with the… I believed I used the word “asinine” deal.

USP is the holding company for a 90% stake in the SOGO departmental stores in Malaysia. As I’ve explained, with corresponding figures, it seems the management over paid for the acquisition.

On top of that, it hardly seems wise to use CF from a very tough steel industry now, to jump both feet into another, probably even tougher industry. (Retail)

The figures basically confirm my fears.

Under “Share of results of a joint venture” in the income statement, USP contributed $506k.

To be fair, USP has contributed only 3 quarters of earnings, and it’s hard to gauge how it’d perform without longer term data.

Also, as of Q3 results, USP recorded -$171k, hence, in the 4th quarter, they actually earned (506k + 171k).

Still, the ROE figures are not great. Let me be generous and assume that in FY17, USP contributes 2x what it did for 9M16. That’s about $1.01mil.

The 50% stake is carried in the BS at $24.07mil.

This means that USP generates an annualised ROE of 4.2%

Hardly something to be proud of eh.

Well, LTC’s ROE figures were equally as shabby: 3.52% in FY14, 4.04% in FY15 and 2.75% in FY16. But if you’re going to spend $$$ to acquire unrelated assets to “expand” or “diversify revenue stream”, common reasons managements give to justify going into uncharted territory, I’d think the 1st thing you want to do is to make sure it pulls up your overall ROE figures. Which is why I said it’s asinine.

3. Account for goodwill when determining valuation based on BS

To add on to why USP acquisition is dumb, the company paid up massively more than the book value of the acquisition.

261) LTC USP balance sheet 2016.jpg

Of the recorded $24.07mil in the BS, about $10.5mil comes from “goodwill on acquisition”.

That’s jargon for “additional money paid above the market price of the assets of the company”.

I get that sometimes, we do have to have goodwill payment. But not for retail. Not for retail in Malaysia. And certainly not for retail, in Malaysia, in the present climate.

Anyway, my take home message here is that when determining intrinsic value, I would write off the goodwill portion completely.

4. Minimal impact from FRS109 implementation

To summarize, basically LTC has to implement FRS109 by 1 Jan 2018. FRS109 basically states that you’d have to mark to market price, any unquoted equity investments that the company has.

Currently, LTC carries these unquoted equity investments at historical cost.

The company doesn’t release any info about what these “unquoted equity investments” actually are, so there’s no way to evaluate if the current market value is more or lesser than the historical cost.

In any case, it’s not that important as there’s only $3.69mil of these unquoted equity investments carried under long term investments. Don’t think it’ll make much of an impact.

5. Associate company, Kairong developments, has paid off a chunk of the shareholder loans

This is certainly a good thing. Always nice to see shareholder loans to associates been repaid. From my previous experience with King Wan, this is a metric that’s very important to track.

If $$$ starts getting repaid, everything is great. If not, start worrying and digging deeper.

265) LTC Kairong developments 23102016.jpg

This is taken from page 61 of AR16.

As highlighted, I noted the drop in shareholders loan by just over $10mil.

This shows up accordingly in LTC’s CFs (Page 36 of AR16)

266-ltc-cf-partial-statement-23102016

Hooray.

To kinda sidetrack a bit, I love tracking these figures in various statements. If it all adds up, it’s very satisfying. Like putting in the final pieces of a puzzle.

Collectively, the numbers tell a story.

6. Value and rent of the industrial investment properties has held up in 2016

Self explanatory. The value (as determined by Knight Frank), has remained constant at $118mil. The rent has decreased very very slightly in FY16.

While all these have held up thus far, it is hard to say how they’d perform in FY17. My best guess is that we’d again see fairly constant valuations and rent in FY17, without much change y-o-y.

7. Fx is favorable for the company thus far

LTC is exposed to currency risks. Fx though, has thus far been kind to the company.

A strengthening USD-SGD is good for the company.  Every 3% increase in USD-SGD results in an increase of PBT of $1.42mil

A strengthening MYR-SGD is bad for the company. Every 2% increase in MYR-SGD results in decrease of PBT of $39k

Surprisingly, the ringgit doesn’t have too big an impact on the company. Only $39k for every 2% change. The USD impact is much much stronger, and thus far it’s been all good. We all know how strongly the USD has performed versus the SGD.

8. Big shareholders have increased their stake in the company in in FY16 compared to FY15

Again, self explanatory.

Top 20 shareholders list in 2015:

262) LTC major shareholders 2015.jpg

The same list in 2016:

263) LTC major shareholders 2016.jpg

Morph Investments Ltd in particular, is interesting. They’ve increased their stake quite a lot in the past year, from just under 1.4mil shares, to 2.16mil shares as of FY16. I have zero knowledge of Morph Investments, but I did notice them in many undervalued companies that I have studied over the years.

These guys obviously practice a very strict, warren buffett inspired “cigarette butt” type of investing style, going for deeply undervalued companies, with ultra long holding periods. I don’t think they’ve ever over paid for anything. They’re the kinda guys who go straight to the bargain bins when shopping.

Can’t be a bad thing at all to see them increasing their stake.


Finally, I stress-tested the valuations (based on the BS), just to have a sense of how ridiculously low the market is pricing the company currently.

The equity attributable to owners of the company is currently $251,539,000.

This is the latest asset side of the BS:

264) LTC corporation BS 23102016.jpg

Let’s start taking a chainsaw and cutting away big chunks of the assets to “Stress test” the company and incorporate a big MOS.

  1. Investment Properties – These are FH, but let’s assume the property market undergoes armageddon. The lowest in the past 8 years is $76,000,000, so let’s take that figure instead of the recorded $118,000,000.
  2. PPE – Let’s put a 50% write down to the $29.8mil figure.
  3. JV company – As mentioned above, I’d write off all of the goodwill of $10.5mil. But let’s be even more conservative and assume that even after writing off the goodwill, USP can only be sold at BELOW the net assets. So I’m taking off $14mil from this figure.
  4. Associated company – This refers mostly to Kairong developments. The figure has dropped as they’ve paid back the loans to LTC. But let’s be crazy and put a 50% write off to what remains.
  5. Long term investments, FDs, tax assets – Figures are not significant. Let’s write off EVERYTHING.
  6. Properties under development – another 50% write off.
  7. Completed properties held for sale – As mentioned above, the 7 crescent bungalows are all fully sold. All relevant QC charges have been paid (I forgot to add above that the AR also shows that they’ve reversed the overprovision for QC charges as well, so this project is def over for sure). Let’s just write off everything here. Assume whatever properties are worth 0.
  8. Inventories – well steel prices have really fallen, and these figures are weighted average figures (Explained in an earlier post). Let me assume the steel price market goes into another severe depression from the current already depressed figures, and drops another 50% again.
  9. Prepayments, trade debtors etc – OK, this is one hell of a crazy stress test. Let’s assume nobody pays back any debt, and we write off EVERYTHING.

So after the above mad scenario, we are left with equity of $99,322,500.

That means the book value per share is: 63.48 cents

The current share price is hovering between 50 – 55 cents.

This means that after the above scenario where the whole market has gone to hell, the world is facing the end of humanity type of crisis, Mr Market is still willing to give you 63.48 cents worth of value if you give him 52 cents or so. 

Oh, and did I mention that of the 63.48 cents, approximately 22 cents is in cash?

Crazy stuff.


CONCLUSIONS

I am expecting continued strong CF generation in FY17. In my earlier posts, I have mentioned that the CF is something that I’m monitoring closely, and I’ve shown how the company actually does generate a ton of FCF. It’s just that this has been used to pay down debt in the past years.

It’ll be interesting to see what management does with the FCF in subsequent years. FY16 was the turning point, FY17 onwards would be instructive.

On the other hand, the earnings picture will likely remain ugly. ROE figures are terrible, and will likely stay terrible.

In short, great on the BS/valuation front, great on the CF front, terrible on the earnings front.

This company smacks of the very traditional value investing, Benjamin Graham investing characteristics. Deep discount to BV, not paying for growth but focusing on value, strong CF.

I feel comfortable enough to continue holding on to my current stake. I have a moderate position sizing on LTC: Don’t intend for this to be excessively large, neither will it be a small/insignificant position. Haven’t added in 2016 as I think I can find more compelling situations. The upcoming results will be really interesting to study.