TTI’s New, Puny Position – S i2i

March has been an absolutely crazy month for me thus far, work-wise. Probably cos it’s sandwiched between 2 holidays, and I’m paying for my travel sins. It’s almost the end of the month, and I have not had a weekday lunch in the whole of March. That’s really not very healthy.

It’s screwing up my GI system, and I’ll probably see the consequences 2 decades from now. But it’s just 1 of those things. That’s life. I hope that by then, someone has figured out a way to grow a whole new GI tract with genetic engineering.

On the investing front, I’ve recently opened up a new, absolutely puny position in S i2i.

I’ve previously posted a well written analysis by a reader Alain T, and written about my thoughts on the company, so this would be a continuation of that:

S i2i Investing Thesis

TTI’s Follow Up On S i2i

My new investing thought process necessitates a certain level of predictability before I take up a sizable position. I think that has served me well thus far, and I’m hoping S i2i is a continuation of the most recent 2 successes in Dutech Holdings and Geo Energy Resources.

In short, I’m willing to forgo a potentially good investment opportunity, if my analysis deems it to be good, but yet I don’t have relative visibility on it’s immediate to mid term prospects.

At the time of writing this, I’ve only an absolutely puny position of 2,000 shares of Si2i, bought at $2.45 last week. I’ve deliberately kept my position very very small, and it’s unlikely I’ll cross 5,000 shares. This is mainly because of the extreme illiquidity and the wide spreads. It’s just going to be very difficult to build up a large position, or liquidate one without getting affected by the spread in this instance.

As per my previous posts, Alain T has done really well with his investment in S i2i. I’ve also mentioned in my previous post, my personal opinion. And thus far, it seems that it’s played out as I described:

The company did fail to exit the watchlist by meeting the requirement of having an average market cap of $40mil over 6 months, by March 2017.

I got that right.

But they managed to get a time extension from SGX, and will now have until March 2018 to meet this requirement:

The share price as it stands now is about $2.45. For a market cap of $40mil, the share price has to be maintained at an average of $2.92 for 6 months.

So this means that from now till March 2018, either the share price rises another 19% to meet this requirement, or it doesn’t.

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Along the way, a saga broke out.

S i2i received a letter from Blue Ocean Capital, claiming to represent some clients, and collectively they own 1.73% of the company, which is really too small a stake to do anything actually.

These guys are demanding that Dr Modi either buys out the company and privatizes it, or liquidates the company to recognize (close to) the NAV for the company.

Both outcomes, would be good for minority shareholders. Privatizing the company, or liquidating the company, would mean that shareholders would get to exit at a minimum of the NAV value. That’s $3.86 currently, which is a 58% premium to the current share price!

What makes this letter a “saga” though, is that one of the guys at Blue Ocean Capital, has a “related interest” in that his father is a director at Globalroam, which is the same company that Si2i is currently suing.

Globalroam converted a loan of $3.88 million (The loan is actually $5.5mil, back in 2014, but Globalroam has paid back partially, and this $3.88mil is what remains of the loan + interests) from S i2i into equity in Globalroam, instead of repaying the loan. It is S i2i’s position that this conversion is illegal. So this issue is now in the courtrooms.

I’m curious about this, because isn’t a convertibility issue clearly spelt out in a loan agreement? Either it is convertible, or it is not convertible. Wouldn’t the lawyers draft out something that’s iron clad and NOT up for interpretation? This is really curious to me.

Plus based on the initial loan announcement back in 2014, it does seem like there is a convertibility feature to the outstanding loan. I guess the dispute arises from WHO exactly, has the right to determine if the loan should be converted.

So is the right to call the conversion with Si2i? Or Globalroam? We’ll let the courts decide that.

Also, try as I might, I can’t find where in the balance sheet is this loan parked under. Is it written off? Or is it parked under receivables? It’s not explained in any of the annual reports so there’s no way of telling.

In any case, like Alain T, I view this whole episode with Globalroam and Blue Ocean capital as a side show. It’s a neutral event, or a slight positive for me as a minority investor. It’s a slight positive because Blue Ocean is applying pressure on S i2i’s management, and both outcomes they’ve suggested, would suit me very well.

Plus this is getting personal. What’d you think this does to the egos and reputations of Si2i’s management and Dr Modi, if Si2i fails to meet the requirement to exit the watchlist?

If I am part of Si2i’s management, and/or Dr Modi, the 1st thing I’d want to do, is to exit the watchlist, and simultaneously, bring this dispute to the courtrooms and try to get back the $3.88mil + interests.

That scenario, would be a big win for both Si2i and Dr Modi, and a slap in the face for Globalroam (and a smaller tap on the wrist for Blue Ocean since they’d benefit directly from their equity stake)

At this stage, I don’t think it’s likely that Dr Modi would privatize the company. Again, that conclusion comes from the fact that there’s animosity between the parties, and well, it’s just human nature that you don’t let your adversary win right?

Privatization would only occur if the company truly is unable to meet the requirements to exit the watchlist.

So in my mind, there are 3 scenarios:

1. Si2i fails to meet the requirements and eventually gets delisted by force. Alain T has worked out the dynamics of this scenario, and I think shareholders would get to exit in this scenario at a good price. (Pls go read the intial investing thesis). This is not my favorite scenario though, cos there’s a chance I might end up holding shares in an unlisted company.
2. Si2i meets the requirements and exits the watchlist and stays listed. That’s a 19%+ gain from now to March 2018. It’ll likely be more than 19% gain, because the $2.92 is an average.
3. Dr Modi accepts Blue Ocean’s recommendations and either buys out the company, or liquidates it. This is an unlikely scenario in my mind, but a highly profitable one for minority shareholders. The gain would be around 58%

Along the way, there’d be the smaller side show of the lawsuit. If Si2i wins the suit, that’s a positive because they’d get back the $3.88mil in cash. If Si2i loses, well, it’s currently expected by the markets. I don’t think there’ll be much impact.

So there are 3 potential scenarios, all of which seems good for the other minority shareholders. That’s what I mean by relatively high predictability.

On the business front, the company’s FY16Q4 results again turned out to be as I expected. In my earlier post, I’ve described how it seems like the company is improving, but they’ve thus far done that only by cutting costs, and not by growing their topline.

In Q4, we see that happening as the company slipped into losses, as the effect of cost cutting becomes diminished each quarter (There’s only so much fat you can cut)

CONCLUSION

This is a unique scenario. I hesitate to call it an arbitrage situation because it’s not, but it’s not the typical deep value scenario I’m used to looking out for either.

It’s simply a calculated risk whereby I view the most likely scenarios going forward, to be favorable.

As mentioned earlier, I am not a fan of their new business directions (electric vehicles). I didn’t work it out in this post, but in Q4, that new direction contributed to the losses (not making profits yet, which is expected for a new venture)

Dr Modi has continued to buy up shares, even recently, which leads me to believe scenario 2 is currently the most likely. The fact that they’ve applied for an extension to the deadline also tells me that the management wants to exit the watchlist and keep the company listed.

I can live with a 19% gain a year from now.

In any case, this is a puny position, and even 5,000 shares would not account for 1% of my total portfolio by value, so I’ll just grab a popcorn and enjoy the ride. After Dutech and Geo Energy though, I’m hoping this would eventually grow to become the 3rd success for TTI for 2017.

Stay tuned for a good show.

Addendum!

That’s the problem when you start writing a blog post, save it halfway, and come back to finish it a few days later. Earlier, in this post, I talked about the loan convertibility saga with globalroam. Well apparantly, it’s not the most updated, cos just a couple of days ago:

As described above, there is a convertibility feature attached to the loan based on the initial agreement back in 2014. I am curious why Si2i’s management thinks they had a case to begin with. No mention on the specifics, so I guess I would never know.

Grass Is Always Greener On The Other Side… + CDW Holdings FY16Q4, TTI’s Thoughts

I did say there’ll be the occasional travel pics.

This has to be one of the most beautiful places I’ve been to. Plus my son had crazy fun here. It’s a lot colder than it looks though, and somehow as age progresses, my homeostatic system isn’t as good and I don’t do so well with cold anymore.

This was towards the end of last year in Austria, not now. Path leading to the ice caves (that’s the opening in the mountain). Boy, glad I did this. Not sure if I’ve the stamina in a few years time.

This other pic though, is something that I find really interesting:

I was feeding these goats with grass that I tore off from the ground. As far as I can tell, the grass is EXACTLY the same type as the humongous patch just behind the goats, and yet they were all clamoring to eat grass off my hands! Like I’m feeding them “gourmet” grass!

Even after I stopped feeding them, they didn’t go back to grazing and instead, followed me while I walked around the fence.

LOL, interesting isn’t it?

This is, quite literally, a perfect example of “the grass is always greener on the other side”!

Come on, tell me I’m not a weirdo and I’m not the only one who finds this entertaining. Funny too.

In a post sometime last year, I said that I’ve resolved to cut down on leisure travelling for 2017, because I felt that I’ve kinda had too much fun, and… just generally, have been too… lazy?

It’s march now, and I think it’s safe to say… that I’ve failed.

I read a recent article that the way to truly “buy happiness”, is to buy experiences.

I couldn’t agree more. Yet, buying experiences cost $$$. And this is what I’ve been neglecting of late.

Anyway, 1 more trip to Perth is penciled in, in April and I’m done for the year. Gotta bunker down and go back to work. From some of the emails I’ve received, I think even readers of SG TTI noticed the tardiness in my posts. No analysis done = no posts!

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On a different note, I received some emails, (and a comment somewhere) asking about Dutech. I’m not writing an update on Dutech’s FY16Q4 because if you look at the post categories on the right ——>

I already have several posts on Dutech, and I think it’s better to have some variety perhaps?

So in a very brief summary, for Dutech’s FY16Q4, the extraordinary earnings that they recognized from the Metric acquisition is a lot lesser than I expected. Yet, the stated the NAV and the goodwill is actually recognized accordingly in the asset side of the BS.

The balance sheet is balanced by adding in certain liabilities (that was previously not announced during the acquisition), and these liabilities relate to pension schemes and related stuff. Not surprising… Europe workers have all these pension stuff.

It doesn’t change my investing thesis though.

Yes, I’m aware CIMB has downgraded Dutech to a hold, but well, if you’d read the earlier posts here, you’d know that I generally don’t pay TOO much attention to analyst reports. They do move the markets though. That’s the reality, which is actually a good thing if you have strong FA.

For eg, a large concern flagged up (and that’s the main reason for the downgrade), is that the margins are impacted because of rising roll coil steel, as reflected in the Q4 margins y-o-y.

But literally right after the report, the steel price has since fallen somewhat. So my point is, if one keeps trying to track these and pull or add capital whenever there are all these little waves, you’d always be behind the curve.

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Anyway, let me not hijack this post. This post is supposed to be about CDW Holding’s FY16 results. I’ve previously invested in CDW, but has since divested:

Post-mortem Of CDW Holding Ltd Divestment

While I was vested though, I’ve always found CDW’s management, particularly the CFO, to be honest and straightforward in his replies. Unfortunately, the company is in a very tough spot currently, and has been in fact, for the past couple of years.

Coincidentally, while I was updating myself with CDW’s performance, NextInsight published an article on the company. NextInsight has always been a platform that I respect a lot, so obviously I try to keep myself abreast of the commentary there.

https://nextinsight.net/story-archive-mainmenu-60/939-2017/11356-chan-kit-whye-on-cdw

The top part of the article is mostly factual, nothing much to discuss there. The bottom part has some bullet points on the merits of the company, and while they’re all true, it doesn’t reflect the challenges facing the company. Let me try to substantiate and paint an intimate picture with this update.

Yes, the company is trading close to net cash. The BS is still rock solid too. Nobody denies that. Total bank borrowings, although increased from last year, is still very low, and their cash holdings can wipe out the borrowings completely.

That’s a good start.

Here, we can tell that the company has always been prudent. Debt has always been very manageable.

“Market cap supported by 91% of net cash”. Sure, that may be true, and good too. But I’d also point out that cash and cash equivalents, net of debt, has been dropping over recent years, and is at the lowest level in the past 5 years:

FY12: $43.6mil

FY13: $46.5mil

FY14: $55.1mil

FY15: $46.7mil

FY16: $40.2mil

OK, granted that the BS is STILL very strong and the drop is not that great. But just thought I’d have to point this out. The BS is strong, supported by a lot of cold hard $$$, but it is also deteriorating and just a bit “less great” than before.

The company has also been buying back their shares (As stated in the NextInsight article), presumably that indicates that the management thinks their shares are currently undervalued.

Normally that’s a good thing for shareholders. In this instance though, CDW’s management also has 8,500,000 share options outstanding, with an exercise price of $0.216. This means the options are currently in-the-money.

It’s been painted as a good thing by the NI article, because presumably management will have an incentive to keep the share price above the option exercise price.

This is where I disagree. A dilutive share option scheme is never a good thing for shareholders. Plus, this brings up some doubt as to whether share buybacks are done right now because the shares are really undervalued, or are they done to support the issuing of shares from the exercising of options.

Anyhow, it’s only 8.5mil outstanding share options so it’s not a game changing event either.

The earnings have really come down hard in FY16. Things are not good at an operational level:

A bit of history here.

In 2014/2015, CDW actually projected that they’ll have a shortage of light guide panels to meet demand. In response, CDW acquired a 25% stake in Pengfu, a company that supplies CDW with these light guide panels, which CDW then assembles into backlight units that are used in smartphones, gamesets and vehicle displays.

At that point, my investing thesis was that with Pengfu, we should see CDW meeting demand. Plus with the acquisition, Pengfu would be contractually obliged to place CDW’s orders at 1st priority. (It’s part of the contract). On top of that, prior to the acquisition, CDW has been getting light guide panels from a competitor. Pengfu would not only give CDW priority, but would charge them a lower rate as well.

Well, the acquisition has turned out to be a disaster, as the smartphone demand dried up. In my earlier posts, I described how with the divestment of Sharp to Foxconn, the orders may dry up. In M&A, the acquirer obviously has to do something different to try to turn around the fortunes of the acquired business. Otherwise, why buy?

Then there’s also the part about their BLUs going obsolete etc, I think I’ve described all that previously so I won’t repeat these.

Anyhow, fast forward a year or 2, and my fears have been realized. Looking at the earnings statement above, the “share of loss of an associate” part relates to the Pengfu acquisition. In the 2 years since the acquisition, it hasn’t been profitable at all. More worryingly, the losses have widened comparing 2015 vs 2016.

Yet EVEN more worrying is the “impairment losses of investment in an associate”, found in the 2 rows below that. Those relate to the more recent investments that the company undertook, such as the Korean company, some product rights for shampoo and other, honestly, weird investments.

If you think it’s vague that I only mentioned “Korean company”, that’s because it IS vague. There’s  no mention of the operations of this company, just that CDW will do the “manufacturing and distribution” for its products.

Normally you’d assume, ok it says “manufacturing” so it must be related to CDW’s core business of BLUs, but CDW of late has gone rogue, investing in diverse stuff from ramen restaurant to hair loss shampoo. So I’m not so sure what to infer here.

Anyway, the losses are not large, but the significance of this impairment is HUGE IMO.

Pengfu loss is OK. Nobody gets business decisions right all the time. They tried to predict a trend, got caught out when demand dried up, it happens all the time in business.

But the impairment losses on the recent investments are unrelated to the core businesses, and are… well, RECENT. Not good at all IMO.

Previously, when I was vested, I was assured by CFO that the ramen restaurant is one with a long history, has built up a regular pool of patrons, and would be a sound investment. I don’t see any impairment here, related to this ramen restaurant. So that’s good at least. (or maybe it’s not mentioned cos the sum is relatively small?)

Still on the earnings front, CDW tried to invest and capture more clients by coming up with a new generation of light guide films. Back in 2015, CDW said that they’ve teamed up with “a Taiwanese company” to come up with this new generation light guide films, and have already sent samples to potential clients for testing.

In subsequent quarters, CDW said in its ERs that the response is good, they’re optimistic of getting orders blah blah. OK, let me go dig up the specific statements.

There you go. This was in FY15Q2:

“the Group is confident that this product will be launched in the fourth quarter”

Well, it seems they were overly confident then. Cos in 2015 Q4:

Nope, not launched yet. Instead, now the statement becomes a lot more ominous.

“depending on how well the key customer and other market players perceive the Group’s new generation light guide mentioned….”

But wait! There’s a glimmer of hope. Cos in FY16Q1, it’s looking up again:

Ah now we’re talking! “… were positively received by the key customer and its potential customers. Subject to market conditions and a pick up in demand, the Group expects to commence production by the second half of FY2016”

OK, so instead of the 4th quarter of 2015, now it’s pushed back by half a year to 2H16. OK, that’s still good. New product after R&D, +vely received, launch it, the turn around is in sight!

But 3 mths later, in FY16Q2 results:

Sorry! Wait for “Recovery of global economy and the demand to pick up”

I can go on and on, but I think by now, you guys get the picture. As of FY16Q4, no orders, no launch, nothing. I don’t care how “positively reviewed” it is by the client. No orders = No $$$ = not good.

Anyway, just to complete the picture, in the most recent FY16Q4:

“The Group’s new generation light guide film which is suitable for smartphones, tablets and notebooks shows promise, however it may be currently limited by the strong competition faced by the Group’s key and potential customers, which hinders their willingness to invest in new models. Nonetheless, the Group will be on the lookout for suitable opportunities to promote the Group’s new generation light guide film product.”

Suddenly, the picture doesn’t look quite as rosy as “market cap supported 91% by net cash” huh.

At this point, I’ll just say that it almost sounds like I’m critical of CDW’s management.

I’m not.

CDW’s business is such that it has a major client (Sharp, although they will never confirm this). Sharp is kinda screwed now, and is still struggling to compete in the smartphone market.

CDW has long ties with this major client (I’ve described previously how the ties date back to the founder of CDW’s father era). But business is business. If CDW’s main client is suffering, CDW cannot escape. And therein lies my greatest concern: their core business possibly, may never come back. It’s been 2 years and counting, and the smartphone industry is notoriously competitive.

After the acquisition, I’m not even sure if CDW’s historical ties to it’s major client still counts for anything.

This is not something that their management can control. It’s just the nature of the business. My investing thesis then, was initially based on Pengfu, which failed. Then this new generation light guide, but that has proved to be a failure thus far as well.

To put things in perspective, they could also not announce any developments with regard to the new generation light guide. Then nobody would know if they screw up. But they did, and that’s called transparency. I really wished it ended better for the management though.

Anyhow, let me move on to the cashflows, which is really important for CDW.

FCF has now been -ve for the past 2 years. But it’s a puny, small negative. At this rate, with CDW’s BS, it can afford to run through many years of -ve CFs, and maintain the current dividend for a looooooong time before the BS becomes stressed.

Like I said, BS is rock solid.

The business has always had minimal capex. Afterall, after you buy those machinery, they can last a pretty long time without replacement.

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CONCLUSION

I guess readers, or those who have vested, will now be asking the key question:

At this point in time, is CDW Holdings a good investment then?

I can’t answer that for others. I know it’s not for me now, but previously, there’s a point in time whereby I would.

The truth is, CDW is currently almost like it’s in “cold storage” or a zombie state. If I can be permitted to describe it as such.

Basically, the company has a strong BS, and will likely be able to survive for a long long while if everything stays the same. And it’s already a depressed environment for 2 years for them.

They cut their dividends in FY16, but at current rates, they can sustain -ve CFs and maintain dividends for quite a few years to come.

That’s the good part. The bad part is that their future prospect is very uncertain.

As I’ve illustrated above, investors would do well to forget about this new generation light guide panels in your investing thesis. 2 years of “about to launch” is enough. Management is trying their best to find new revenue streams, but thus far has only “impairment losses” to show for their efforts in the recent acquisitions.

Over the years, I’ve also learnt to be very skeptical of companies that stray away from their core businesses and go into unrelated ones. It’s usually not a good sign.

On top of that, for businesses who invest in unrelated industries, it basically means that as a shareholder, you’re trusting the investing prowess of the management. And as I’ve mentioned in an earlier post, (I think it was King Wan?), I’ve stopped trusting others to do DD and invest for me. I think I’d do it better myself, thank you.

So the lowdown is this:

Imagine I come to you with an offer. I’ve a medical clinic business that was previously doing rather well. Recently, it has fallen onto tough times, but I believe the operating environment will pick up soon and my business will go back to its glory days.

In the meantime, I’m offering to sell a part of the business to you, for every $10 you pay, you get an equivalent of $9 in cash that’s parked in the business.

That’s a very good deal. The downside is, you don’t control the business operations, and yea, this $9 may be whittled down if I decide I’ll use the business to buy a… restaurant or stationary shop tomorrow.

Dividends will take up maybe $0.50 out of this $9 every year, so you know that the business would be able to pay you dividends (current yield for CDW is about 3.5% – 4%) for a long time to come.

Would you invest?

Like I said, the old, previous TTI would at least consider it. Probably such a deal would have at least a non-core place in my portfolio then. (It really did actually!) The rationale then, is to monitor the business and wait for the operating environment to improve. I know the business is strong enough and prudent enough to sustain through a long cold winter. Like Jon Snow, I don’t know how long this winter would last though.

The current TTI though, wouldn’t even give this a thought.

So is this a good investment now? I can only display the intimate facts, everyone has to decide on their own. Even within myself, my thinking has evolved over time and so has my investing characteristics of late.

Honestly, and I hope I’m not being over confident here, I think my new thoughts and investing process would show even more stellar results over time. I applied these new thoughts to the 2 most recent investments,Geo Energy and Dutech Holdings, and thus far, results have been most pleasing.

2 is hardly a big enough sample pool, with such a short duration too, so I’ll have to wait longer to assess.

On a related note, one may note that “hey TTI, you spent all this time  following up and analyzing a company that you are not vested in and already know that you won’t be vested in??”

Well, I think Buffett was most instructive when he said that the decisions that would’ve the greatest impact on his returns, are the ones that he didn’t take. But we wouldn’t know how well or poor a decision is, until we track the results AFTER the decision has been made, right? And if we don’t know, how then would we learn, and if a similar scenario crops up, how then would we make an informed choice?

Anyway, this concludes my update on CDW Holdings for now.

As always, happy hunting!