SMRT Corporation Buyout Offer: An Alternative Viewpoint

Temasek is buying out the 'troubled' transport firm SMRT at S$1.68 - valuing the company at about S$2.56B. Because Temasek owns 54.1%, they have to pay about S$1.18B for the remaining stake.

Readers of my blog would have known I bought SMRT back in 2014 at an average cost of about $1.02 and sold the same year at $1.49. I left a comment and highlighted that the non-fare segment of the company seemed attractive as follows:

Comment: Quite lucky here as a short while from my initial purchase, the price spiked up due to government's announcement about the new model. Nevertheless, the price at S$1.02 was clearly undervalued. The non-fare segment of the company was rather attractive too. Considering the nature and moat of the business, I probably run the risk that I've sold too low at S$1.49. Price now is S$1.58.

Some SMRT Non-Rail Results

Let's have a look at the results of 3 of the largest Non-Rail segments, namely: the Taxi, Rental and Advertising Segment -

As can be seen, all 3 segments have shown marked and consistent increase in both the topline and operating results (total in 2016: S$123M) over the past 6 years. The total operating profit for the Rail & Non-Rail Segments is S$142.6M. That means the 3 biggest Non-Rail segment is >85% of the total Non-Rail and Rail operating results. I think it is not unreasonable to expect that the Non-Rail segments will do quite well in the foreseeable future. These 3 very profitable, inherently stable and growing segments combined could probably be worth about S$1.7B (this is only a quick and dirty estimate of 13X - 15X operating profit). Also take note that there are other Non-Rail segments that may be of some value as well (classified as Engineering Services, Other Services and Investment Holding and Support Services).

I'm not so sure why the focus out there concerns so much about the Rail segment and why the management has not expressed any thoughts on the striving Non-Rail segment with regards to the buyout offer. But from the standpoint of the investor and those who are supposed have a duty to look after shareholders' interest, it is unwise to focus solely on the Rail segment and keep harping about the Rail's corresponding risk.

There seems to be much confusion whether SMRT Rails should be more concerned with the investors' interest or the public's. Also, Chief Executive Desmond Kuek (former army general) said that "significant risks remain and many factors are outside the control of SMRT such as uncertainty over future fare increases and ridership numbers." I'm not so sure how 'significant' the risk for the rail segment is in the future despite being relieved of their heavy operating assets under the new Rail Financing Framework. I would hazard a guess that both fare and ridership numbers will at least remain stable and it is likely that operations will be less risky compared to before the implementation of the framework.

Proposed Solution

1. Since the focus of the buyout seemed to be on the Rail segment: spin out the Non-Rail segments so that their proper value can be realized by the market. Existing shareholders should be more than happy to then sell off the operations of the Rail and Bus segments not owned by Temasek for a lesser, say S$500M (this values the Rail & Bus segments to be about S$1.1B. Assuming the above valuation of $1.7B for the 3 Non-Rail segments are correct, SMRT could potentially be worth in excess of S$2.8B which corresponds to a price of about S$1.84 per share). 
2. Offer a (higher) price that truly reflects the value of both the Rail & Non-Rail segments. (I read in the news that in the past 10 odd years, SMRT's price averaged about S$1.64. Offered price is S$1.68. Obviously some shareholders might be unhappy with the current offer).

Advantages are Two-Fold:

1. Rail and Bus assets out of the way and privatized - the role of a public transport operator can be better fulfilled in the long term without taking the pressure of short-term market expectations.
2. With the Rail segment out, the market can more easily discern the true value of the remaining Non-Rail entities. Not only can shareholders receive some cash from the disposal, they would probably be very pleased to have their hands on a growing and very profitable Non-Rail segment.

Some Things to Work Out

Now, the Advertising and Rental businesses are obviously highly intertwined with the Rail business. Therefore, the question to ask is if the above solution is possible at all? I'll leave these to the shareholders and management to answer for themselves. It's tough, but a fair and equitable solution should be created for all parties involved.

Disclosure:
No position in SMRT (S53.SI) as of 21 July 2016

Koyo International (5OC.SI) - Is It Worth The Risk?

Koyo International (Company Website) is listed in the SGX Catalist since 2009 and its principal activities broadly consists of four core segments, namely:

1. Mechanical and Electrical engineering services
2. Supply of renewable energy and green products for building services
3. Property development and construction
4. Supply of construction materials and ancillary services

The company has been operating since the 1980s. As of 1H2015, it has S$42.2M (VS S$20M Revenue for 2014) worth of contracts on hand with completion dates between 2015 to 2021. I'm not going to talk much here - readers can understand more and judge for themselves in the annual reports or company website.

As mentioned in my previous post, I would prefer to keep my articles brief in the future. I'll keep this analysis simple without delving too much into the specifics. Some basic metrics are as follows:

Price = S$0.061

P/E (ttm) = 7.8x

EV/EBIT = 3.7x (est $6M excess cash VS $14.9M net cash)

P/B (mrq) = 0.66x

ROE (TTM) = 8.4%

The Story

Over the past 1-2 years, for largely unknown reasons, the share price skyrocketed from around S$0.05 all the way to a high of S$0.40. Readers of my blog would have known that I bought into its shares a couple of years back and sold it for a decent profit. More details here.

On 15 Jan 2016, SGX released a statement and urged caution when dealing with Koyo International's share as >30% of the trading was done by the same group buying and selling among themselves.

When the market reopened the next trading day (18 Jan 2016), the share price crashed >80% to about S$0.05 and subsequently recovered to between S$0.055-S$0.065 range.

Summary of Investment Thesis

1. There's currently no evidence or indications from SGX that the management or insiders themselves are manipulating the share price.
2. On 18 Jan 2016, the company bought back 6,300,000 shares @ about S$0.099 for a total of $630K. That's about 3.3% of outstanding shares.
3. On 19 Jan 2016, independent director Serena Lee purchased 800,000 shares and raised her stake from zero to about 0.42% of outstanding.
4. On 20 Jan 2016, Serena Lee again bought another 700,000 shares, raising her stake from 0.42% to 0.78%. A quick check shows that if Serena does not sell any shares from this point on, she should be one of the top 20 largest shareholders of the company. To my knowledge, Serena did not own any shares of the company since at least 2011.
5. Current price is one of the lowest since 15 months back and my valuation work shows that the company would be worth at minimum S$0.07 and its intrinsic value should be closer to S$0.10.
6. Some brokerages have instituted trading restrictions on the company after the "Trade with Caution Alert" by SGX, causing the share price to remain depressed even after crashing significantly.
7. The company has a relatively long operating history, is in sound financial condition and I can reasonably expect it to continue turning in respectable results in the next 5-10 years.

Key Risks

The 2 main risks I observe were: 1. Accounting issues with financial statements and/or 2. Certain parties are in fact the ones manipulating the share price (its not hard to find out who stands to gain most when the share price of the company is up). If an analyst bought it even at such low prices, any one of these materializing may mean a disastrous investment result. No amount of margin of safety can save an analyst from a fraudulent financial statement and a management that lacks integrity.

So far, there's no indication or evidence of such risks materializing (yet). Also, the share buybacks from the company and an independent director provide some level of comfort.

Conclusion and Some Thoughts

At S$0.40, Koyo International is clearly expensive and a purchase at that point would certainly prove reckless. At the same time, a price of S$0.056 clearly undervalues the company and absent the 2 key risks coming true, a purchase should turn out profitable.

Does being slapped with a "Trade with Caution" alert by SGX warrant a significant sell-down to huge undervaluation territory? It really depends. Security selection requires a skillful balance between the facts of the past and possibilities of the future. The future is uncertain and as investors, we always have to take and manage risk. The risks mentioned above are very real but the fact is that there are currently little evidence that it will happen. An investor always have to deal with probabilities and as of now, my own judgement (I may be dead wrong) tells me that the risk to reward ratio is largely skewed to my advantage.

To be sure, if any of the risks mentioned turn out to be true, it is sensible to sell the stock (even at a loss). Before that, one can only control his/her risk by first understanding them and then diversifying adequately as well as sizing such positions appropriately so that it will not inflict mortal damage to the portfolio as a whole.

Interestingly, this situation bears some resemblance to that of Avi-Tech Electronics which is listed in the SGX Watchlist due to 3 consecutive years of pre-tax losses. The share price got hammered so badly that a purchase (do refer to my write-up here) made just last year would have reaped respectable results and dividends for the aggressive investor.

Let me know what are your thoughts.

Disclosure:

Long Koyo International (5OC.SI)

Note: Disclaimer applies. Not a recommendation to buy or sell.

What a Start to the Stock Market in 2016!

Portfolio Results for 2015

I think readers of this blog would probably have guessed that I did OK in 2015. AP Oil

gained >46%, Avi-Tech gained >38% but Sembcorp Industries crashed a hefty -34% (all returns before dividends) since my write-up in this blog. What a crazy ride in 2015: On a portfolio basis and taking into account dividends received, my Singapore portfolio went as high as +18.7% (August) but ended off the year with a +12.8% gain while my Hong Kong portfolio went from +48.5% (May) and ended 2015 with +25.7%.

Will 2016 be a good year for stock markets?

Despite a 15% decline in 2015, our STI index continues to register losses in the first few days of 2016. From its peak of about 3550, the index had sunk about 23%. Will 2016 be a down year again? Honestly, your guess is as good as mine.

Opportunities Abound

For me, rather than trying to predict at the macro level, I feel it is more fruitful to focus on valuations of individual companies. Despite the uncertainty surrounding the market, make no mistake about it: there are more opportunities to take advantage of than it was just a few months back. Uncertainty is the friend of the buyer of long term values. Always be extra cautious in your dealings with the Mr Market but never be afraid of taking strategic advantage over him.

What I am going to do in 2016?

The wider the fluctuations of the market, and the longer they persist in one direction, the more difficult it is to preserve the investment viewpoint in dealing with common stocks. I think it is of utmost importance for an investor to have a logical process for investment and have the mental & emotional fortitude to stick to it despite daily market gyrations & noises. Different investors have different philosophies and the following is what I found quite useful (at least for me) thus far:

1. Try to get a general sense how the business operate
2. Ask yourself honestly if you can reasonably see the company still in existence and operating well >10 years later
3. Limit your risk - ensure the company is in sound financial condition
4. Limit your risk yet again - make sure the price you pay is significantly below your estimate of the business' value
5. Diversify your risk adequately
6. Have patience and conviction for value to be realized - the market for short term returns is very competitive but the market for longer term returns is much less competitive

These pointers are quite similar to my post on Our Investment Philosophy and I intend to adhere to it in 2016 and beyond.

Final Note

I’ve been slowly accumulating a few SG and HK stocks in the past few months and one of them appears to be a rare find – having reasonable defensive characteristics with potential for growth and selling at extremely attractive prices. I intend to concentrate more on that particular stock, probably towards 15-20% of my portfolio. If I have the time, I’ll probably discuss more about them.

A few friendly readers actually emailed and asked if I’ve stopped writing. I very much like to continue but will likely do so with shorter posts and at a very leisurely pace. Meanwhile, I’ll be more than happy to discuss investment related questions via the comments section of this blog or email at secretinvestors@gmail.com. Happy stockpicking!