Six causes of merger failures

I was going through some old books at home, looking for something to read on a lazy Sunday morning and stumbled upon an old book titled "Deal from Hell: M&A lessons that rise above the ashes" where the author, Robert F Bruner, outlined views views and merger failures and what he thought of the failures.

Just like when you go through an old album, you just can't put it down.

Anyway, I thought that it would be interesting to look at some of his findings and compare them with the M&A that has happened ("SapuraKencana Merger") and the M&A that might happen (the CIMB, RHB & MBSB proposed merger).

Robert F Burner, in his book outlined 6 causes for merger failures. And merger failure does not mean that the merger itself did not materialise, but rather a merger that resulted in a destruction of market value, financial instability, impaired strategic position, organization weakness, damaged reputation and violation of ethical norms and laws. In other words, post merger mess ups.

Based on the recent performances of both the fundamentals and share price of SapuraKencana, I definitely do not think that the merger was a failure. I thought I would also throw in the proposed mega bank merger to see how does it stack.

1. The business and or the deal were complicated.

SapuraKencana: Although the terms of the merger appeared complicated with all the SPV, share swap and pricing and swap ratio, it actually was a very straightforward deal.  Two companies of almost equal size (approx RM6 billion each) decided to get together. The valuation was done such that Kencana was valued just slightly  more than Sapura, which would give the shareholders of Kencana slightly above 50% shareholding in the new entity and Sapura shareholders slightly below 50%. Oh by the way, since the valuation was being done, the price was set at premium to the historical prices of both companies, so on the onset, both shareholders did not lose (and since the share price did not drop, both shareholders did in fact win). That was it.

Business wise, both companies were in the same industry doing complimentary things. I did not expect any major system upgrades and changes in the business model had had to be made. This 'no-complication' enabled the people on the ground to quickly focus on business rather than spending too much time on integration.

Mega Bank Merger: In my view, it has the potential to be uncomplicated and straightforward. There is one common major shareholder who is EPF would could make quick decisions. I have a feeling it is not going to be done by purely cash.  My reason is, firstly,  CIMB, like many other banks under Basel regime, would be holding cash dearly to meet the various threshold. Secondly, the share swap deal allows flexibility to assign premium much easier than cash. In the cash deal, the premium would have to be realized, in a share swap deal, the premium is on paper. If the merger decide to follow the SapuraKencana route, they may use a SPV which would use a combination of share-swap and cash to buy the businesses of the three, and if they can convince some financiers to lend them the money for the cash portion that even better as it is almost akin to a 'leveraged buy-out' by the existing shareholders. If you need more info on the, drop me an email on the comment box and I will send you my lengthy opinion.

Business wise, this is slightly a different story that the SapuraKencana deal. In the SapuraKencana deal, the merged entity was going to be involved in a rapid-growth (albeit very risky) and margins that are big enough to absorb any temporary operational slack during the transition period. The focus was on boosting the revenue by getting more contracts. However, in the Mega Bank merger, the industry is considerably more mature than the oil and gas industry in Malaysia. Margins are very competitive and operational efficiency is the key to avoid failure.  Slacks in the operations during transitional period post the merger (if it happens) could attack the bottom line very quickly. Nonetheless, to be fair, both RHB and CIMB are seasoned acquirers so they both should know how to handle the business transitions pretty well.

2. Minimum flexibility or rigid business system

SapuraKencana: The SapuraKencana have plenty of flexibility in its business system as it is in a rapidly growing industry (in Malaysia) where the business system are fluid to adapt to the changing business environment. The business system of the merged entity, which then included a wider spectrum of services along the value chain,  appears to have plenty of slack to act as buffers to any problems that a business unit might face.

Mega Bank merger: Banking system is mature and is much less flexible with plenty of regulations influencing its capital and how the business is managed. This s an areas which the dealmakers and project managers need to look at carefully.

3. The new 'merged' entitiy had an elevated risk exposure

SapuraKencana: A larger balance sheet and more product offerings does not appear to increase the level of risk of the merged entity. Although the management seemed to be taking more projects which may have riskier profile, the size of the company appears to have mitigated some of the additional risk.The decision making process does not change much as the decision maker largely left with the two 'owners', well one now. As the decision maker is largely the same people, I don't expect the  risk appetite going to change significantly.

Mega bank merger: They all appear to share the same risk profile. Does not seem to be an issue here. The decision making process in these seasoned banks would also have been very mature and committee driven. Again I don't expect the management to be taking on a significantly more risk than before.

4. Biased decision process due to recent sucesses, pride, overoptimism etc.

SapuraKencana: Many M&A were driven by hubris, or ego, and hence why many M&A failed. Ego and pride create bias decisions. In the case of Sapura Kencana, considering the ultra high personality of the two owners, it was very exciting to see how both owners put this aside and put business first. Between them, there was common ground and that was to make more money by having a bigger business.

Mega Bank merger: They have Nazir to keep things in check. Enough said :-)


5. Business is no longer as usual

SapuraKencana: Business was definitely as usual after the merger, albeit much bigger. Same expectations and same business process, in principle.

Mega Bank merger: They are buying into similar business so it should be business as usual post  merger.

6. The operational team broke down due to cultural or political differences.

SapuraKencana: The two owners were so commanding that they could ensure that the people and the culture merge for the good of the company. There was no major talks of camps and warlords emerging from within the merged entity.

Mega Bank merger: Again I would rest this on the experience of CIMB and RHB in handling cultural integration.

In conclusion, SapuraKencana fits the bill of not having any of the causes for a failure in a merger. Thsi is clearly translated into skyrocketing share price movements as a reward and vote fo confidence from the investing community.

As for the new bank merger, we will just have to wait and see if they could circumnavigate these sinkholes succesfully.

SYWBS Part 4: Putting it all together

I guess this is a good time to illustrate in a bit more details the stuff that we have been talking on the "So you wanna buy shares" series. It was also opportune that we had a great piece of news of Norges' additional investment into the small and mid cap companies on Bursa Malaysia.

Lets recap.

1. Know yourself and what you want to do

The first thing we want to do before we invest is to get our objectives clear. In order to do that we would need to know our investment horizon: long term or short term. This horizon is not dictated by our preference, really, but rather our constraints in terms of capital, the need for cash (liquidity) and our time to monitor the market.

In this 'simulation' I would assume that the investor (Lets' give our hypothetical investor a name: Adam) does not have the time to monitor the shares hourly. At best daily at the end of the day or weekly. He has a day job that occupies his time. He has some money that he sets aside each month from the paycheck for investment purpose, so he does not need regular cash from his investments. Based on that, the investment horizon would be a mid to long term and by that I would mean he would not need to touch his investment money for at least 12 months.

2. Know what you got to do (strategy)

As Adam does not have the time to punt the market, he would need an alternative investing strategy and that would be building a portfolio. In our previous article, we touched on a top down strategy as one of the thought process that we could apply in trying to narrow down our investment focus.

The strategy may be different if Adam has the time to say monitor the market on full time basis. For the time being, let's stick to the top down approach.

3. Do what you got to do

The first thing that Adam would need to do is decide which market would he want to invest in, i.e. the top of the top. Assuming that Adam is only investing in Malaysia, that would mean he has to select which market sector to invest in. Well, the choice is not as easy as it seems. There is activity-based sector (utilities, O&G,  Banking) and there is cross-activity size-based sector (Large Cap, Mid Cap, Small Cap, Fledgling). So where does he start?

Well, there is where the economic outlooks and reports that appear in the newspapers come in handy. And more tellingly, we have indices to help Adam decipher the health and wealth of a particular sector. Bursa Malaysia, via its index series has the following sectors indexed:

• FTSE Bursa Malaysia KLCI - 30 largest companies in FTSE Bursa Malaysia EMAS Index (FBMEMAS) by full market capitalisation.
• FTSE Bursa Malaysia Mid 70 Index - next 70 companies in FBMEMAS.
• FTSE Bursa Malaysia Top 100 Index - sum of constituents in the above two indices.
• FTSE Bursa Malaysia Hijrah Shariah Index - 30 largest Shariah-compliant companies in
• FBMEMAS screened by Yasaar Ltd and the Securities Commission's Shariah Advisory Council
• FTSE Bursa Malaysia Asian Palm Oil Plantation Index (USD and MYR) - companies earning substantial proportion of revenue from palm oil activities in the Asia Pacific Region.
• The FTSE Bursa Malaysia EMAS Index - constituents of the FTSE Bursa Malaysia Top 100 Index and FTSE Bursa Malaysia Small Cap Index.
• FTSE Bursa Malaysia EMAS Industry Indices - 10 Industries, 19 Supersectors and 39 Sectors.
• FTSE Bursa Malaysia Small Cap Index - top 98% of the Bursa Malaysia Main Market excluding FTSE Bursa Malaysia Top 100 Index constituents.
• FTSE Bursa Malaysia EMAS Shariah Index - Shariah-compliant constituents of the FBMEMAS that meet the screening requirements of the SAC.
• FTSE Bursa Malaysia ACE Index - all eligible companies listed on the ACE Market.
• FTSE Bursa Malaysia Palm Oil Plantation Index - based on FBMEMAS and comprising companies earning a substantial proportion of revenue from palm oil activities.

Now Adam has to bear in mind that these indices would differ from one index provider to another and be mindful to read the fact sheet.

Broad based

Lets assume that Adam was interested with the news that Norges is investing more in Mid and Small cap companies in Bursa Malaysia. He would therefore would like to know more about the companies within this categories that would be on the radar of Norges. But since there are hundreds of companies out there, how could Adam narrow down the list further? His monthly investment coffer cannot buy them all.

But could he? Technically, he can. He can buy the exposure into the sector by investing in a collective investment scheme that invest in the same sector and share the same objective (of course after reading the prospectus). He can look up the unit trust funds that invest in small and and mid cap companies and invest there. There are plenty of unit trust agents who could advise him over a cup of coffee and an EPF form in hand :-).

But if that is not his cup of tea, he could also try investing in a close-end fund. Which is also a collective investment scheme but is close-end (as opposed to the open-end unit trust schemes) and is listed and traded on Bursa Malaysia. We have only one example on Bursa Malaysia and that would be icapital.biz Berhad. Based on its annual report, the investment strategy are : "Your Fund invests in undervalued companies which are listed on the Main Market of Bursa Malaysia Securities Berhad (Bursa Securities) and the ACE Market of Bursa Securities". Well, that investment 'universe' is a bit too wide for Adam's Small and Mid cap strategy hence no can do...sigh.

He can try investing in an exchange traded fund ("ETF"), a passive collective investment scheme that tracks an index. An ETF that tracks the (say) FTSE BM Mid 70 index and FTSE BM Small Cap Index would fit in nicely in this strategy. Investing in ETF, would relieve Adam of the headache of punting in the sector.Let's have a look at the ETF's that are available in Bursa Malaysia:

List of ETFs

Equity ETF

• FBMKLCI-ETF (0820EA)
• CIMB FTSE ASEAN 40 MALAYSIA (0822EA)
• CIMB FTSE Xinhua China 25 (0823EA)

Equity ETF (Shariah Compliant)

• MyETF-DJIM25 (0821EA)
• MyETF MSCI Malaysia Islamic Dividend (0824EA)

Fixed Income ETF

• ABFMY1 (0800EA) 

Hmm... no ETF on Small and Mid Cap indices... so ETF is also out of the question on this strategy. It looked like all the broad based options are not really there, so Adam have no choice but to try to look at the individual stocks and building his own portfolio.

Narrowing it down

In order to narrow it down, Adam would need to have to know the relevant stocks that would be on the radar of the fund manager and other investors. Where could he find the clues?

The first clue would be from the index constituents. If Adam were to look at the FTSE website, he would stumble upon (I choose this phrase for a reason) the fact sheet and reports on the indices we mentioned earlier. Unfortunately the index provider does not release the list of all the index constituents unless you pay them a lot of money. FTSE however did give out this information to the public in the June 2013 report on the indices (all information here are sourced from the FTSE website). 

FMB 70 index had 70 companies listed in it. The top ten (by weight) is as follows:

• Gamuda
• IJM
• Dialog Group
• Malaysia Airports
• Alliance Financial Group
• AirAsia
• Bumi Armada
• IOI Properties Group
• Lafarge Malaysia
• YTL Power International

FMB Small companies index has 167 companies in it. The top ten is as follows:

• Star Publications Malaysia
• KNM Group
• MPHB Capital
• TA Enterprise
• Cb Industrial
• Muhibbah Engine
• Sumatec Resources
• Perdana Petroleum
• Scomi Energy Services
• Kian Joo Can Factory

If you would want to have a look at the report (which contains the best and worse performing of the sectors), please drop your email address in the comment box and I will try to email the pdf copy of the report to you soon.

The second source of clues are from the research reports and recommendations of research houses. For example, the following which appeared in the Star Newspaper recently where it delivered a report by UOBKayHian which said:

“We advocate being selective, picking beneficiaries of compelling investment themes or with specific event catalysts. These include Deleum, Barakah Offshore and Malaysian Resources Corp Bhd (MRCB),”

In order to narrow it down further, Adam should perform the fundamental analysis (and technical too) on these companies before buying the shares.  A topic for next time.

Well, that is all for today folks. Till next time :-)

Norges investing more in Malaysia

Here is an interesting bit of news that came out in the Star Newspaper today 31 July 2014:

Norwegian fund Norges allots RM800mil to invest in Malaysian small, mid-cap stocks

by liz lee

PETALING JAYA: Norwegian fund Norges has allotted RM800mil more to invest in small to mid-cap stocks in Malaysia.

A market source said the foreign fund appointed Eastspring Investments Bhd about a month ago and was investing in general equity, with a preference for the small to mid-cap equity space.
“There are no specific guidelines as to which sector Norges is keen on. It wants to look at good companies and it so happens the local small and mid-cap space is doing well this year,” the source said.

Norges has been one of the largest foreign fund investor in Malaysian equities since 2010.

In April, StarBiz reported that the foreign fund had invested about RM1.7bil in 53 Bursa Malaysia-listed companies, managed by Kenanga Investors Bhd.

At the time, the fund was already sitting on a paper gain of some RM600mil, with its entire holdings in Malaysia valued some RM2.3bil. Its performance in Malaysian equities was attributed to the big run-up in many of the small oil and gas companies since last year.
-end quote-

Many NEW investors would be asking this question: So, how can I benefit from this?

Well, in order to benefit from this, you would need to outsmart the fund manager that is managing this RM800 million bonanza.

Unless you have a crystal ball that monitors the investment committee of the fund manager, you would probably have not got a clue or very little.

Well, lets look at the information we have from the news paper above:
1. The investment mandate is to invest in small-cap companies (companies with small market capitalisation).
2. The investment is managed by a fund manager.

Based on the "Information 1" above, the easiest step would be to put our money into small cap unit trust funds and hope the fund manager of our unit trust can outsmart the managers of Norges' money. If there is an ETF that tracks the small cap fund, then we can also take this investing route via the ETF as the ETF would remove the headache of punting.

Boring? Well, we can always try our 'luck' in a more active investing by using the second piece of information, "Information 2" above these funds are run by institutional fund manager. If we want to try to narrow down our investment selection, we best know the nature of the fund manager.

1. Fund managers usually are run by mandates.
In this regards that means investing in small and medium companies. Larger cap companies, although they would be very attractive like for example SapuraKencana could fall outside the mandate and would not attract this investment despite all the favorable outlook. The fund manager would not score any point if they invest outside the mandate, in fact usually they would avoid it as they risk being accused of going beyond the authority given to them - a very very bad thing for a fund manager.  The first thing in narrowing down your focus is to look at the mandate.

2. Fund managers usually have a benchmark to beat.
In rewarding a fund manager, the investors would need to be to assess the performance of the fund manager and that means assessing the absolute return and relative return performance of the fund manager. When it comes to relative performance assessment, that means comparing the performance of the portfolio of investments of the fund manager against an index, usually. In this case, it should be a small cap index which are provided by various index providers like MSCI, FTSE and the works.

In order to beat the index, the fund manager invariably would have to keep a significant portion of their investment in the index stocks as a cushion in trying to beat the index. Therefore, the next place to look at would be the stocks that make up the small cap indices. The is a chance that some of the Norwegian money turning up there.

3. Fund managers usually target companies with higher (or potentially higher) liquidity (relatively speaking)
Fund managers, like other investors, would need to convert all the paper gain into paper money: cash. That means liquidity plays a role as the last thing a fund manager wants to to be holding a dead stock which no one wanted - big messy publicity that would be. Liquidity or persistent active trading would be on thier screening criteria.

4. Fund managers usually have a much much longer holding period
The Norwegian money can stay for a very long long time in a particular stock. 

5. Fund managers may look for companies with better fundamental analysis to better keep their job
No one has a crystal ball and that includes the fund managers. In order to make sure their make sound decision, or at least appear so to the investors, they need as much justification as possible. There is a term in the industry called "Cover-Your-Ass investing".

One of the best cover would be fundamental analysis. There is no guarantee that any price derived from fundamental analysis would actually materialize but it would give the fund managers something to show the investors if the price tank. Fundamental analysis would also be used to convince the investors from pulling out from the stock if the market is feeling a bit bearish.

Therefore, the third place for you to look at are companies with solid fundamentals as these would be the same target for the fund managers. Bust as we mentioned in item 4 above, the institutional money has a very very long staying power so be prepared to wait in some cases.

SYWBS Part 3: The Other Investors

This is the third part of the "So you wanna buy shares" series. You may read the previous two parts here:
1. Part 1: Getting to know the share buying 'battle field' and what affects share price movements
2. Part 2: Getting ready for the opening gambit, a top down approach, and the importance of selecting the right industry to invest in.

Before we get down to narrowing down our stock selection and making our opening gambit, I think is it better that we take this opportunity to get to know the 'opponents' on the field.

As I have mentioned in the previous articles, 'playing' the stock market is not dissimilar to being in a battle of wits with other players on the field.

To quote Sun Tzu:
“If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”
― Sun Tzu, The Art of War

So, who are your 'enemy' and who are you allies? Well in this game, no one is your enemy forever and none is your ally forever too. There is no loyalty except to profit and money. So your enemy today could be your ally tomorrow. It is therefore imperative that we spend some time getting to know the others.

The players in the market have been describe in many way and facets.Some categorized them based on their trading activity (passive investors, active investors, speculators), some based on strategy (long term investors, short term investors / punters), and some based on type. I prefer to start with the type of players, which I have dividend into the following categories:
1. Institutional player
2. Retail long term player
3. Retail punters
4. Market manipulators

Institutional players
Who: Unit Trust Funds, Government Linked Investment Companies (EPF, KWAP, Valuecap, Khazanah, Tabung Haji, PNB), Insurance Companies, Takaful companies, Foundations
Size: Very very large. This category of investor accounts for more than 2/3 of the stock market
Ticket size: very very large
Motivation: Keep the job. Hahaha. Although it might sound funny, but this is largely true as the funds are run by professional managers who are paid as long as they have the job.  That means there are other factors than the immediate task of making the trading profit (which is more difficult as when they move, everyone will be alerted).
Investment horizon: Very long term
Investment style: long term portfolio strategy. This is based on a mandate for each fund, like balanced fund, asian equity and the likes. So even if a share is hot some of these investors would not be able to buy it if it is not in the mandate. Likewise, even if a share is cold, they might need to buy them to meet the mandate. This mandate driven strategy is evident when, for example, a stock suddenly gets to be included into the KLCI index (I think SapuraKencana had this scenario). When a share gets included in the index, all the funds that has track the index may need to buy the share just so that they can ensure they track the index well. Likewise, if a share gets thrown out from say a Shariah index, you might see large and persistent selling pressure on the share as Shariah funds seeks to exit from the shares, even if it is making huge trading gain. They simply cannot go against the mandate. Profit is secondary, in a way.

Retail long term players
Who:Wealthy high net worth individuals (or corporations), mostly. They are normally assisted by experienced remisiers, brokers are financial consultants.
Size:  Large.
Ticket size: large. Due to the large size of their capital, they have to trade in larger volume to make up the return.
Motivation: Make long term stable return in terms of trading gains and dividends.Dividends becomes a significant consideration due to the size of their capital
Investment horizon: Medium to long term
Investment style: A mixture of long term portfolio strategy and opportunistic punting. These people are well informed and could take sizeable position. Their trading sometimes large enough to move the share price and could affect the trend of the share that appears on the technical charts.


Retail punters
Who: Wealthy and less wealthy individuals, mostly. Because punting requires a constant eye on the market, they are dominated by traders, remisiers and some career market punters.
Size:  Small to large.
Ticket size: Flexible. As punters wants to ride on the wave, their size can vary  depending on their appetite and risk assessment for each trade. But their size are not normally large enough to create and sustain a price wave, but they can add to prolong a wave. They cannot be too big as that would make it difficult for them to exit the wave without breaking it midstream.
Motivation: Make trading gains and the hell with everything else.
Investment horizon: Short
Investment style: Constantly picking stock on a daily basis. Focus more on trend rather than fundamental analysis.

Market manipulators
Who: These dark shadowy characters exists and sometimes some of the are caught by the regulators. To ignore them is to seek for death in the stock market.
Size: Large.
Ticket size: Flexible. The ticket size would be designed to be large enough to move the share price but small enough to run undetected.
Motivation: Make trading gains and the hell with everything else. These people usually work with inside information in hand and with the financial support of some opportunistic investors.
Investment horizon: Short
Investment style: They work to fool the rest of the investing public into buying (or selling) shares at artificial price which they know is not sustainable once they are out of the picture.Because they need to be able to have control over the majority of free-floating shares with the limited capital that they have, they usually target penny stocks or some fairly illiquid shares.


If you are a beginner in stock market investing, you need to know investors and over time, you would be able to sniff them out with experience. As we mentioned before, these people could be your enemy or your ally depending on where you are when they come in.

See you next time :-)

Invest smart peeps!
-----

You can read previous articles in the "So you wanna buy shares" series by clicking the link below:
1. Part 1: Getting to know the share buying 'battle field' and what affects share price movements
2. Part 2: Getting ready for the opening gambit, a top down approach, and the importance of selecting the right industry to invest in.

We share as the more we have the merrier, kan?

SPAC, a view post QA

REMINDER/ DISCLAIMER: THIS IS NOT A RECOMMENDATION TO BUY OR SELL HIBISCUS OR ANY SPAC OR ANY SHARES. IT IS INTENDED TO EDUCATIONAL AND DISCUSSION PURPOSE WITH A VIEW TO PROMOTE MORE ANALYTICAL INVESTING AND LESS GAMBLING.
 
I decided to continue to share more of my understanding of SPAC due to the very encouraging responses I received on the previous two postings on SPAC, the first which discussed on the nature and understanding of SPAC and the second one which talked about the enigma of trying to grapple with the valuation of  SPACs.

I started by listing down all the SPAC in Malaysia again. While the imeediate number that came to my mind was 3, I stopped writing after the names Sona and Cliq. I hesitated to include Hibiscus as i recalled that it had completed its qualifying acquisition (QA).

The question that I had to answer was: was Hibiscus still a SPAC or should I now consider it as an oil and gas company? The answer to this question it only then would I be able to appropriately understand, assess and evaluate the company.

The first thing I checked was the Bursa Malaysia classification. Nope, Hibiscus is no longer classified as a SPAC. How about Bloomberg? When I checked on 7 June 2013, it is stated as Sector: Financials; Industry: Specialty Finance. Sounds like SPAC to me. Well now we have two different 'market experts' with two different opinions on the nature of the beast entity.

But the nature of the company is not as simple as a reclassification on the board. In the actual sense, it should be determined by its business model.

As I had argued in previous posting, I view a SPAC before the QA as a private equity fund. The question is whether post QA, does a SPAC cease to be a private equity company and become a normal operating company or does it continue to be a private equity company. The answer will change the perspective in which I view a SPAC, the risk assessment and the evaluation (some may say valuation).

Let me try to explain why. A private equity company makes money from buying, investing and finally exiting the investment. Cashing in from the dividends and proceeds of the sale of the investee company. It does not need to hold a majority stake as it is more interested in the ability to groom and sell the company later rather than managing and living of the profits and cashflow of the company. The proceeds of the sale of the initial investment will be used to find another acquisition which it will try to replicate the success with the initial investments. The value of the investment in the private equity will grow  based on the size of the assets it has and the quality of the private equity will depend on the liquidity or ability to convert those assets into cash.

A normal operating company, especially a normal operating company listed on an exchange has to have a business model and business operations that are in perpetuity. The operations must be on going concern basis and the company must have control over the assets (most importantly cashflow) and the business direction of the operations and assets, particularly when it comes to paying dividends. In other words, the company must have an identifiable core business. And to be listed, the core business must be able to satisfy the listing requirements of the exchange. If this is the business model, then the evaluation and valuation will be done on the fundamental of the company in the same manner as all the other companies operating in the same industry, which in this case the oil and gas industry with the likes of Yinson, SapuraKencana, UMWO&G, Bumi Armada and others.

So, where do I put Hibiscus as? As a private equity or a normal operating company? The only way I can objectively  put my mind at ease is to look at the equity guidelines of the Securities Commission Malaysia to see if Hibiscus would have made it as it is to the exchange.

Under 'Profit Test' an applicant needs to have a core business, defined as "the business which provides the principal source of operating revenue or after-tax profit to a corporation and which comprises the principal activities of the corporation and its subsidiary companies". Well, assuming we take the QA of Hibiscus as the 'core business', it may have passed this test if it provided the principal source of revenue and profit for Hibiscus. But that is only because Hibiscus bought and now owns 35% stake in Lime, which allowed for equity accounting. It does not come across as a typical core business in a normal IPO where ususally we would see the listing company owning 100% of the core business via direct ownership of the assets and operation or the operating company. Well, if not 100%, then a majority control is more familiar to us. In other words, no matter how big Lime grows into, the stake is only 35% (Lets not get into the RM20 million requirement and track record.)

Why is the majority control of core business is important to me? It is because if i were to treat the company as a perpetuity, I must have the comfort that it can determine the perpetuity itself, independently and without any hindrance. If I were to own less than 50% of a company, I have a much restricted rights and say on this matter. I am a minority shareholder. I mean if we were to put, size aside, the control over the core contributor of profit between Hibiscus and SapuraKencana, UMWOG or Yinson, we would able able to see the difference there.

Is it wrong? NO. Remember, the purpose i made this comparison is just to put the business model in the proper perspective according to my views. I do this so that I can try to make sense of the valuation and pricing of the shares of Hibiscus. The 35% stake in Lime has some value, and in some cases it could be more valuable than 100% of other company. 

However, lets assume all is good and lets take one common valuation indicator, the PE ratio. Based on the following, the PE for 2013 was 66.80 times! Really? That is way higher than SapuraKencana or even UMWOG, let alone the industry average of approximately 13 times.
Stock Price : 1.75 (2013-12-31)
EPS : 2.62
P/E Ratio: 66.80

How else could I make sense of all this? Well, another possible way for me to look at the price is to assume a different business model for the company.

A private equity model usually values the 'assets' on piecemeal basis. They are valued based on the a view to exit. From there, we would be able to arrive at the value of the private equity fund by adding on all the pieces of investments together. Interestingly enough, I stumbled upon a research report by a local institution that did exactly just that for Hibiscus: valuation based on the sum of parts. And the stock price of RM1.75 was within their range of estimated worth of the company.

Well, what is the takeaway here? Well, in my opinion, price is different from the value, as I have discussed previously. The demand for shares depends on the expectations of profits to be made from the movements of the shares and expectations are a function of how the investors view the company.

 If I had assumed that a SPAC post acquisition is a typical oil and gas company, I would have been baffled as to why the demand was so high compared to the fundamental of the company. However, it feels that the price makes more sense when I view the company as still a private equity venture: something that carries a high potential (hence expectations) together with an equally high amount of risk.

REMINDER/ DISCLAIMER: THIS IS NOT A RECOMMENDATION TO BUY OR SELL HIBISCUS OR ANY SPAC OR ANY SHARES. IT IS INTENDED TO EDUCATIONAL AND DISCUSSION PURPOSE WITH A VIEW TO PROMOTE MORE ANALYTICAL INVESTING AND LESS GAMBLING.

Share price: demand, supply and expectation

The price of a share is indeed an interesting item. It had brought joy to many and brought tears to just as many (if not more) investors.

Why is it interesting? To me it is interesting because the 'behaviour' of the price is unique. While it uses the same platform of demand, supply and price equilibrium mechanics of a commodity (sugar, rice, coffee etc), the characteristics could not be more different.

Understanding the characteristics and behavior of  the share price is so important that it would either place the investors as a clairvoyant, a gambler or a buffoon. 

Share price is the equilibrium price at any point of time when a buyer and seller agreed to buy and sell an amount of shares.

The above would immediately make us think of the supply and demand curves that determine the prices of commodities like sugar and rice. The price of commodities are also determined by the the intersection between the supply and demand curves. A typical demand and supply curves of a commodity would like an 'X' where the demand is higher as the price gets lower (indicating people will consume more) and the supply gets higher as the price gets higher (indicating people will produce and sell more).

But then there is a major difference between the commodity and share. Commodities are purchased to be consumed, shares are purchased to be sold back again (let's ignore dividend for the time being). You cannot chew on the share certificates or even bring it to the neighborhood grocer to buy fish (unless he trades in shares too). Generally, it has to be sold and converted into cash at the end of the day. Therefore, shares are bought with the EXPECTATION to make profit by selling the shares.

Therefore, in my opinion, the demand curve for shares are not driven by actual price but rather expectation of profit or future price. Therefore, that would explain why sometimes, as the price of the share increases, the more demand it seemed to attract. Until at one point when the expectation of further profit is nil, then the demand starts to fall.

Same with the supply side, instead of the supply being driven by the price of the shares, it is actually being driven by the expectation of future price and profit (or losses). If the expectation of the profit increases, the supply would be less as people would hang on to the shares to expect more profit.

However, we have to remember that on the supply side, there is another important factor which is realization of profit, i.e converting cash into shares or cashing in on the opportunity. This is sometimes, especially for institutional investors, may be insensitive to price or expectation as they would be set at an arbitrary figure for example 'sell when share price makes 30% gain for example". While the demand side may have this rule, it is less prevalent.

The effect of expectations on share price, in my opinion, explains a lot of things.

It explains the frustrations of investors trading on fundamental analysis and valuation as to why sometimes despite the wonderful fundamental results, the share price does not budge, or worse drops. In my book, that is because it failed to increase expectations.

Expectations are a function of the number of investors and their expectation level.

If the shares are not known to many investors, in other words they are below the radar, then any fundamental result would have a minimal effect on the shares simply because there are not going to be many investor affected by it. That is why research reports and newspaper highlights are crucial. That is why investor relationship are vital for any publicly listed company.

If we have discovered a gem of a share based on our own fundamental analysis, no matter how accurate our calculations were, it would mean nothing if our expectations are not shared by others. Not that we are wrong or anything, it is simply that other are not aware (or worse not interested or not in their mandate).

Similarly, if we were to conduct a technical analysis of a certain share, we might seem to believe that the share had turned a corner and is expected to rise. But again, if this is not known to others the price would not budge until a significant number starts to see the same thing and have the same expectations. And since the trend of a technical chart is built upon the actual historical prices of the share itself (sort of a self fulfilling prophecy),  the absence of a large number of people believing in the prophecy would then render it unfulfilled.

But this does not mean fundamental analysis or technical analysis is not important, just that we have to remember that a correct analysis does not guarantee you a profit in the stock market. It simply gives you a chance at making a profit when everyone else catches up with your findings AND you have enough staying power to wait when they do.

SPAC IPOs of O&G, unravelling the acronyms, so to speak.

THE WRITINGS BELOW ARE FOR EDUCATIONAL DISCUSSIONS ONLY. IT IS NOT AN ADVICE TO BUY OR SELL ANY SHARES OR SECURITIES

Special purpose acquisition company, or SPAC is the talk of the financial town. Its the thing that you need to know if you are in the financial market. Its kinda like pop culture at the moment. Here are some of the points that may be of interest to you.

What is a SPAC?

In my book it is like a private equity investment model made available to the public. Private equity investment is where people pool their money together with the intention of investing in businesses that will generate profit and cash flow back to the shareholders. The main difference between SPAC and a conventional private equity model is that in a conventional private equity model, the fund is held private; meaning it is not offered to the public and it is not publicly traded. SPAC, through an IPO makes its shares available to the public, and by having the company listed on an exchange like Bursa Malaysia makes it possible to trade the shares over the exchange.

In a nutshell, although the liquidity of shares are different, the business model is still the same. As an acquisition company (which is similar to a private equity fund), the company makes its money by making SUCCESSFUL acquisitions. Unsuccessful acquisition should technically destroys value (which we would understand once we see how value and price are different animals.

If SPAC is so risky why did the regulators allow the listing?

I don't know.

But if I were to hazard a guess it would be because the regulators want to make the market more attractive to the local and international investing community by having more products on the market. A stock market is not unlike a wet market, the more products there are in the market, more people will come and buy things. We can see the regulators in the recent past introduced Closed Ended Funds, REIT (somewhat successful now), Exchange Traded Funds (lukewarm), Exchange Traded Bonds (almost cold), Business Trust (huh really?) and now SPAC.

Whether this is good or bad for the market is subjective and only time will tell. There has been talks that the SPAC market in the US has fizzled down and that other more developed market not even allowing SPAC listing on their market due to its risky nature but I think this time I agree with the regulators. In developing the market you got to take chances and SPAC is kinda a calculated risk. In development, you are going to end up either a hero or a zero, but that is better than not doing anything.

Are the investors paying too much for the SPAC?

Everything has a price and the key principle to investing is to get back more than what you paid for the investment. In the case of SPAC, the investing public paid the IPO price to get the investment. Collectively, the public paid RM235 million for approximately 74% stake in Hibiscus Petroleum, RM364 million for roughly 75% stake in CLIQ Enengy and RM550 million for roughly 77% stake in Sona Petroleum.

The rest of the respective stake in the companies are owned by the management and pre-ipo investors and this is how much they are worth (approximately) at ipo: Hibiscus (RM78 million), CLIQ (RM109 million) and Sona (RM155 million). Since there are no assets in the company except the expertise of the management, I would look at it as this being the value of the management (mostly) and their aim to generate return by making successful acquisition(s) in the oil and gas industry.

Someone was quick to point out that these are only on paper and they cannot sell the shares. True. But then you need to remember that the company does not have to return back the 10% of funds raised from the IPO and up until recently when the regulators changed the guidelines, that amount could be used to pay the salaries of the management. With regards to the 3 SPAC above, the approximate numbers are RM23 million for Hibiscus, RM36 million for CLIQ and RM55 million for Sona, CASH. Not a bad return for all the cost and expenses in setting up the SPAC and going through the IPO.

Anyway, back to the investors. Based on my opinion that this is a private equity in nature, what kind of return would I expect? This is important as it would determine the price I would be willing to pay and the quality of the qualifying investments later.

For me as an investor, I would expect at least a 30% return on my investment in a risky private equity venture. If normal equity investment in a running business, the high teens should be acceptable but the risk in SPAC is way higher, so I personally would put 30% as the expected hurdle rate. We all have different views and risk tolerance so you got to find your own. But what does 30% means. It means that I would get 30% return (profit) on my investment each year. If I invested RM1 ringgit, I want 30 sen profit back every year.

Too much? Well, that is when the concept of opportunity cost come into play because if it is not going to give me 30 sen return, I could use the same RM1.00 to get a profit of say 18  sen from a company which is already running and has a track record.

So, is the hundreds of millions for approximately 75% stake in the company, was it a fair price? At the point of listing, nobody knows. It will depend on the belief of the investors of what would be the management's capability to generate the returns, the profits. For the purpose of illustration, if you (the public shareholders) had paid RM100 million for 75% of the company, the entire company would assume a value of RM133 million. 30% profit from RM133 million would be RM39 million. This would give you a PER of 3.4 times, crudely.

What would be my floor? Well in order to find the minimum level of expected profits, I would have to look at the average earnings of the other oil and gas companies. Lets assume the PER is 18 times. That means the price is 18 times of the expected earnings and if the price is RM133 million, then the expected annual earnings should be just over RM7 million per annum.

In any case, the above is based on RM100 million arbitrary figure, so the expected amount of profits will be proportionately higher the more money you collected from the public (for the same percentage of ownership).

Therefore SPAC is a great vehicle for those who understands the risks and expectations. It is a sheer gamble if you don't.

However, the value and expected return that were mentioned above are related to the intrinsic value of the business, not the price. I always hold the belief that the value and price of a business in not the same, and SPAC is the epitome of this concept. And this is most prevalent in a publicly traded company.

In an publicly traded SPAC, when the public shareholders invest they would hold tradable shares (we will talk about warrants later). The price of this shares is at the mercy of the supply and demand of the shares and valuations (PE, DCF etc) merely serve as a reference point relative to the price. The price of the shares include expectations, greed, risk aversion, liquidity, mandate, excess cash and other external factors, all rolled into one transacted price. In the case of SPAC then, even if there is no assets or profits being generated by the company, changes in expectation, greed level or risk aversions of the investors at large would have an impact on the prices the shares of the SPACs. If it goes up more than the IPO price, then the shareholders would make a positive return on its investment, if the price went down, then they would have made a capital loss. This is more pertinent to short term investors who has short holding period. They would be looking at the capital gain as a measure of return as opposed to the increase in the intrinsic value of the SPAC.

In a nutshell, short term investors in SPAC would need to bank on the increasing demand for SPAC shares to have the chance to make the return.For the long term investors, in addition to the demand for the shares, they would also need to take into consideration qualifying acquisition when it happens. This is important because once a qualifying acquisition takes place, the SPAC is no longer a SPAC; it then becomes an oil and gas company where the reference point now exists. As the profits and assets adds to the perspective of long term return, the price might adjust itself upwards or downwards accordingly.

It is also important when looking at a qualifying acquisition to ascertain the ability of the SPAC to realise the return of its investments in qualifying acquisitions. Some SPAC takes just enough equity interest to equity account the profit of the qualifying acqusition  by in reality, have limited ability to realise that investment within SPAC itself at it does not have access to the cashflow of the company. In such case, it would be dependent on the dividend up-flow to the SPAC only. Therefore, take a bit more time to understand the weight of the 'profit' of a SPAC whenever you are presented with one.

Are the management and Pre-IPO shareholders getting too much from SPAC?

The answer to this question is that only time will tell as it would depend on the success of the qualifying acquisitions.

Why does SPAC issue warrants?

Warrant is an instrument of chance and probability. It is a derivative where the return on the warrants depends on the price of the shares (in this case shares of SPAC) rather than the intrinsic value of the company (directly). As we have discussed earlier, price and value are two different things and hence the price of share depends, significantly, over the demand and hype of the shares rather than just the valuation of the shares.

Warrants are also an instrument of volatility where the more volatile the underlying shares (of the SPAC), the more valuable would the warrant be.  In addition to that the longer the duration of the warrants, the more valuable the warrant is.

Therefore, a warrant over a SPAC seemed like a perfect fit as SPAC, in the early days are almost purely speculative and is expected to be volatile. Offering free warrants to the subscribers of the IPO is in a way akin to giving a discount on the cost of subscribing for the shares. Hence if you were to say, forked out RM0.50 sen for one share and a warrant, your cost for the shares would reduce if you are able to sell your warrants for say 15 sen.

But why would there be a demand for warrants for SPAC? One of the reason could be that  some people might find SPAC to be a very risky investment but they do not want to miss the boat if the SPAC managed to be a success. Well, warrants would just be a cheaper way to gain an indirect exposure to the price appreciation of  the SPAC.

Well, these are some of the things that we have discussed about SPAC. If you have any question, please feel free to post them on the comments section below.

Eyeing Gold Investments in Malaysia

Some information on REGULATED gold transactions in Malaysia. 


Gold Futures on BURSA MALAYSIA, which i touched a bit in this article here.
 - Oct 2013 contract : RM132.15 per gram (-32 tick)
 - Dec 2013 contract: RM132.38 per gram (-30 ticks)
Note: 1 tick is equivalent to RM5. Contract size: 500 grams.
 

Selected Banks' Gold Investment Account (per gram) - which were discussed here.

As at 2.30 on 11.10.13
KFH (Buy RM127.76; Sell RM137.76; Spread 7.8%)
Maybank (Buy RM129.03; Sell RM134.02; Spread 3.8%)
CIMB (Buy RM129.00; Sell RM134.60; Spread 4.3%)

Historical data:
As at 3 pm on 17.09.13
KFH: Buy (133.54 per gram) and Sell (142.82 per gram), Spread (RM9.28 or 6.9%)
Maybank : Buy (134.70 per gram) and Sell (140.56 per gram), Spread (RM5.86 or 4.4%)
CIMB: Buy (134.80 per gram) and Sell (140.40 per gram), Spread (RM5.60 or 4.2%)


PREVIOUS ARTICLE ON GOLD INVESTMENT

Gold Gold Gold... its glitter has captivated the greed of men and women alike. And because of that, many has fallen victims to con-men and con-jobs.

Don't get me wrong. I do advocate investing in gold, just as much as you should save up. But it is not about the gold, it is more about how and where should you invest.

1. Safety first!
A lot of people ask me where to invest in gold and I always say to them that I only deal with the banks that sells gold savings account. Why? Because I think banks are safer than other non-regulated company or institutions.

So, where can you get gold / gold savings?
i) Bank Negara Malaysia : they have gold bullion / emas kijang. Click here to get more info from BNM.
ii) Local and Foreign banks (click on the banks to get more info): Maybank, CIMB and Kuwait Finance House

Is the deposits/ investment in Gold guaranteed by the banks? NO! But you would expect that they should manage the risk and liquidity better since they need to comply with the regulations, Bank Negara's audit and internal risk management. 

2. Liquidity
This is an extension of safety above. Liquidity means that you can sell and get your money back based on the market price of the gold. Again this is why I would always prefer the banks compared to other non-banks gold scheme. If there is a run on the sale of gold, you must be sure that the person you are selling to have the cash to buy back the gold. Since there is no regulated exchange for the gold, the only buyer of any gold that you buy would be the original seller/counter-party. Therefore, the creditworthiness of the original seller /counterparty is paramount to the buyer.If the counter-party cannot honor the sale of your gold back to them, you are screwed.

Granted, if the counter party gives you physical gold for your purchase, you could technically go to a goldsmith and sell the gold. However, there will transaction cost and discounts that the goldsmith might impose, eating into your profit.

In this case, the counter-party for all bank-issued gold savings would be the banks itself and the chances of the bank going into default should be a lot less than an non-financial company. The counter-party for Emas Kijang BNM is Bank Negara Malaysia itself and if BNM default, then we are completely screwed - we would have a much bigger issue to deal with than the gold itself.

3. Spread
Gold is a volatile assets and have no cashflow like dividend or interest. Therefore in order to make money on gold is to trade it. Buy low and sell at a higher price, hopefully.

However, as I mentioned above, there in no retail exchange for gold therefore the counterparty is the 'exchange' and whatever price they publish would be the buying and selling price - no haggling. These counterparty makes their money by the spread, the difference between the buying and selling price. Therefore, a smaller spread means the cost of buying and selling your gold is cheaper.

As at 3 pm on 17.09.13
Maybank : Buy (134.70 per gram) and Sell (140.56 per gram), Spread (RM5.86 or 4.4%)
CIMB: Buy (134.80 per gram) and Sell (140.40 per gram), Spread (RM5.60 or 4.2%)
KFH: Buy (133.54 per gram) and Sell (142.82 per gram), Spread (RM9.28 or 6.9%)

Of course this spread is at the discretion of the banks so it might go up and down; hence you must monitor your target to see the average spread over time.

4. Tracking international gold prices
Gold has no cashflow. It is a pure asset as good as a currency that does not belong to any country.  The price of gold goes up and down depending on the market forces. And since gold is quoted in USD, the price of gold in Malaysia is also dependent on the exchange rate between RM and USD.

And since gold investing is the ultimate passive investment, it should behave like an ETF, where the quality of an investment scheme depends on how well does the price (quoted by the banks) reflect the movement of the international gold price. The best one would need to have a very low daily tracking error, meaning if the combination of gold and exchange rate changes by 2% for a particular day, the price of gold quoted by the banks should change by 2% or very very close to that, up or down. This is called a tracking error, something the banks are not providing to us yet. We just assume that they are being good boys and girls; giving us the true reflection of gold prices, which they might be doing already.

So there you have it. Some basic tools to consider before you think about buying that nugget.Remember, this is NOT A RECOMMENDATION TO INVEST, BUY OR SELL GOLD. Go ask your financial adviser for that. I am just sharing knowledge.

Salam :-)

Eyeing ETF - Removing the heartache of punting

Last Saturday we ran a workshop on Exchange-Traded Funds (ETF) and amongst other things, we discussed about one of the benefits of ETF: the ability to take a 'big-picture' position efficiently, with a much smaller capital.

Take for example the news today (7/10/2013) as reported by the STAR:

Public Bank underpins KLCI advance

by joseph chin

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KUALA LUMPUR: Public Bank led the FBM KLCI higher in early Monday trade, linked to talk that Chinese banks could acquire stakes in Malaysian banks.
At 9.05am, Public Bank was up 16 sen to RM18.06. Turnover was 1,900 shares done. Last Friday, it rose to an all-time high of RM18.10.
The FBM KLCI rose 1.64 points to 1,778.20. Turnover was 61.21 million shares done valued at RM25.73mil. There were 137 gainers, 40 losers and 108 counters unchanged.
However, BIMB Securities Research said it was cautious on the outlook for Malaysian equities despite the recent return of foreign funds into the region of late.
“Foreign funds into the local bourse had seen a net inflow amounting to RM329mil from the last five trading days. We doubt this would continue and remain adamant that some weakness will creep into the index with 1,770 as the immediate support,” said the research house.
Lower liners were among the major gainers. Triplc was the top gainer, rising 19 sen to RM1.58 while BoilerMech added 11 sen to RM1.90 and CCB seven to RM2.49.
CSL was the most active with 6.59 million shares done, adding 0.5 sen to 23 sen. GHL Systems gained 4.5 sen to 52 sen.
BIMB was the top loser, down 10 sen to RM4.63 with 100 shares done, Genting Malaysia shed three sen to RM4.30 and Genting Bhd two sen to RM10.42. KLCC shed three sen to RM6.35.

Without the ETF, in order for an investor to ride the rise of the KLCI, he would have to be right in his stock selection. He would need to have selected Public Bank into his stock portfolio for this occasion.

Well, that is definitely possible. Normally when people wants to take a position in the KLCI index/market, they would invest in some stocks which represent the bulk of the KLCI index. And that would include major banking stocks like Public Bank.

Therefore, if the rise in the index was caused by Public Bank like today, the investor would have been able to ride on the performance of the index.

However, what if the index was driven up by another bank instead, like CIMB or Maybank which also belongs to the index's constituents? Or if the indices were driven up by another sector altogether, like construction or telecommunications? In this instance, investors holding Public Bank shares would not benefit much, despite the KLCI making an upward movement.

An ETF, one which contains the constituents of the index itself, would mitigate this risk of missing the punt. Since the ETF has all the constituents of the index, it should move in tandem with the index, regardless of which stock is responsible for pushing it up. Therefore, the investors would not have the heartache of seeing the index move up while his portfolio remains stagnant.

Disclaimer: This is for educational purpose only and does not encourage you to invest, let alone making a recommendation for investment. If you do invest, make sure you read and understand all the information about your investment and risks involved. This disclaimer is not about avoiding getting sued, I mean it people, go read or get professional advice before you invest in anything.