Thursday, August 11, 2011

I-Power To Be Transformed?

There was a major announcement on I-Power. Instead of just focusing on IPOs, some of which have been performing quite poorly, Bursa and SC should look more into "reviving the fortunes" of some of the PN17, GN3 or companies that are close to those classifications. Some businesses flourish and some flounder, that's part and parcel of the business. What we have are that a lot of companies that are PN17/GN3 or close to those levels, and we need a more proactive approach to address these companies.

We can leave it and ultimately delisting the counter, of which many long suffering shareholders would have their investments wiped out. I would recommend more of the RTOs to help revive these near defunct companies. The flip side is that many of these would come under "heavy syndicate plays" if left alone, causing untold losses to the general public. As penny stocks go, they are always huge volumes for them.

Of course, having invested in a business that failed, even minority shareholders would need to be punished somewhat. To that end, the recent RTO of RA Telecommunications into KZen has to be lauded, if not we would have seen the shares of the company dwindling from below 10 sen to just 1 or 2 sen. That RTO did not require any capital reduction because it was pretty cleaned up already readying for such an exercise.

The I-Power exercise is more interesting. It was a sobering move on the part of the board of I-Power because it entails a 10 to 1 capital reduction, i.e. buy 10,000 shares it will become 1,000 new shares after the RTO. Its sobering because the RTO proposed would clean up the balance sheet and accumulated losses. It is necessary to erase the RM65m in accumulated losses.

Let’s look into the merits of the Acquisition:-

The company is proposing to acquire a 100% equity stake in Instacom Engineering Sdn Bhd (principally involved in the telecommunication sector), a company which is principally involved in the following:-

·                     Turnkey Finance and Build;
·                     Radio Frequency Design;
·                     Drive-test, Post Processing, Analysis and Optimisation of Coverage;
·                     End to End infrastructure Build (Site Acquisition, Technical Site Survey ("TSS"), Local Council/ Authority Liaison/ Tower & Cabin works);
·                 Equipment Installation, Commissioning & Integration and Upgrading 2G to 3G/ 4G/ Long Term Evolution ("LTE");
·                     Managed Services Operations & Maintenance;
·                     Fixed Network Solutions (includes outside plant, open trenching, micro-trenching, Horizontal Directional Drilling ("HDD") and Optical fiber installation); and
·                     Fabrication of Steel Structures and Materials.

From the above it appears to have similar principal activities to RA Telecommunication Group Berhad which was recently listed on the ACE Market via the RTO of another ailing ACE counters namely KZEN Solutions Berhad.

As mentioned in my previous write-ups, telcos spend almost RM3bn-4bn a year locally to upgrade, test, install more coverage in the country. Surprisingly, that spending is not reflected in any listed entity as that sub industry is highly fragmented with many bit players. It is also known that big contracts are dished out to cronies who then sub them out to other small players.

This sub industry saw a dramatic shift in the way telcos operated over the last 3 years. The telcos followed the global best practices by being "asset light", not needing or wanting to own any heavy assets. A few years back, each telco has about a few hundred staffers doing all these "backend work". Working with equipment vendors, sending staff to learn about each equipments, installing, testing them, etc. If you check with the telcos now, most have a skeletal staff for its backend. Asset light, people, just concentrate on your phone, broadband and mobile services.

To do that, the trend has been to narrow the number of parties telcos wish to deal with. Maxis started a Smart Partner program, two years ago and that is what is making some of them highly attractive. Maxis has 3 Smart Partners, Instacom and RA are two of the three. RA Telco, Sediabina and Instacom (the biggest player in East Malaysia) are considered to be the country's top 3 players in this industry. They are all locked by the amount of capital they have to do more jobs, they continually have to refuse to take on more jobs from some telcos. Listing is the necessary next step for them.

Looking at the price tag (acquisition price), I-Power is acquiring 100% equity stake in Instacom Engineering Sdn Bhd for RM102 million. Do take note that the price is based upon a modest PE multiple of 6.8 times over the more than adequate profit guarantee of RM15 mil for the FYE December 2012. Also the acquisition price would be fully satisfied via the issuance of shares (no cash involved). I think in terms of valuation – it’s a fair deal (given that the previous RTO involving similar nature of business namely RA was tagged at approximately 7.9 times PE over its profit guarantee).

Now let’s look at the financials of the company (as extracted from the announcement):-

From the table above it seems to be doing fairly well whereby the based on the latest audited accounts for the FYE 2010 it made a PAT of approximately RM3.4 mil. Also for the 6 months period ended 30 June 2011 it recorded a PAT of approximately 4.2 mil ( based on annualized it could be making about RM8.5 mil for the FYE 2011!!!!! And not forgetting the vendors are providing a PG of RM15 mil………(seem to me like a possible main market candidate in the future). Minority shareholders of I-Power should be fairly happy I guess.

Of course on the flip side the gearing of the company might look a bit steep on the surface, however I think if we look deeper into the details of the transactions (as provided in the announcement of the company done by its advisers) it appears that the gearing was mainly for its projects whereby the projects were structured where Instacom bears the heavy initial cost of construction and the repayment is secured against the long term assignment of the rental of the completed projects (just the type of the company which I like – it has a steady stream of income to complement its project based income). Also the gearing seem to be on a decreasing trend over the years. Based on the pro-forma balance sheet the gearing of the group is approximately 0.8 times after the completion of the proposals – A fairly decent gearing level given the possibly capital intensive nature of the industry in which the company operates in.

Also, shareholders are taking a hair cut in terms of their shares in I-Power as the company is undertaking a capital reduction exercise, however I think this is a necessary step for the company / shareholders to take in the interest of restoring the company on a better financial footing going forward as I-Power has huge accumulated losses and this needs to be cleaned up before moving forward with the acquisition. Also, the share consolidation (to reduce the number of I-Power share in issue prior to the acquisition) is required especially looking at the large number of shares in issue for I-Power which is not represented well in terms of the current earnings level of ipower’s current business.

In addition, the acquisition is also seem to be earnings accretive, based on the profit guarantee of RM15,000,000 for the financial year ending 31 December 2012, the combined PAT of the enlarged I-Power Group would be approximately RM14,958,667. Based on the enlarged issued and paid-up capital after the Proposals of 1,219,301,691 Consolidated Shares in the minimum scenario and 1,227,700,447 Consolidated Shares in the maximum scenario, the EPS of the enlarged I-Power Group will further increase to 1.23 Sen and 1.22 Sen, respectively.

It would appear to be a good deal for all even though I-Power shareholders would have had to go through a 10 to 1 capital reduction. Owing to my prior knowledge of the industry after following RA Telecommunications, I know for a fact that Instacom is a bigger catch as it virtually captures all related telco works for East Malaysia.

Bearing in mind all that, if investors were buying at 3 sen now, you are basically looking at a minimum of 30 sen for the new share on an ex-basis before you start to make any money. It may get there and beyond, but I would be very guarded on that for now. If you can get at 1 sen or 1.5 sen, that would make more sense.

What SC and Bursa have to keep in mind is that RTOs to revive these companies should be applauded, but make sure that it is of a decent size (i.e. more than RM60m market cap) and that the business must be a growth business and not a "inject to cash out for a dull sunset industry". To that end, I would like to see more of these type of RTOs.

Am trying to get an appointment to meet the bosses of Instacom soon…..will follow up with a more detail write up on their business if my appointments are granted by them.


ronnie said...

Dali. This must be the first time you featured a female politician in your line-up of beauties.

The most beautiful PM ever! Drool, drool ...

ccsjoey said...

instakom gurantee a profit of RM15m in fy2012, where they will get the money if the actual earning is below that figure

solomon said...

There are a good looking Japanese MP (sigh forgot her name)...Ukraine ex-PM also not bad looking....

Have my bet on Perdana Petroleum for turnaround...why so many foreign emerging funds come knocking on Malaysia lately?

Heard that Morgan Stanley Heads are in town next week...maybe your earlier statistics on emerging markets are something going to be true??