CLIQ has released is audited financial statement for the year ended 31 March 2013.
Since a SPAC, before the qualifying acquisition, is simply a shell company with a lot of cash, evaluating it using the common business valuation for a going concern company might not be suitable. It does not have the revenue or profit for us to do a relative valuation. It does not have a ready business to conduct a DCF analysis on.
But I was telling myself, there must be a way I could at least tell these SPACs apart. I must be able to make a judgement call to help me decide what to do. Otherwise I would be gambling and I would not want to do that. It got me thinking, how do I evaluate a SPAC before its qualifying acquisition?
We would have normally invested in a SPAC based on two main factors. The first one is the state of the industry the SPAC is in. We must have thought the industry was robust and full of lucrative opportunities. The second fact would be the management/promoter. We must have had the belief that the management was competent to grab the opportunity that was present in the industry, transforming that opportunity into a business that will give me returns (in terms of dividends and/or capital appreciation) that will make us rich..oops... return that will be commensurate with our risk of faith in the management.
I cannot do anything about the industry so I guess I have to assess the management.
So how can I go about doing this?
I firmly believe that the management (who received 'free' stake in the SPAC) or promoter must behave as an entrepreneur rather than a typical salary drawing professional. These people already received their 'return' in the form of heavily discounted / free shares in the company for their part, regardless of it being under moratorium. As a management entrepreneur, we would expect the salary to be enough to maintain a decent lifestyle while waiting for the acquisition to bear fruit. Making a killing on the salary seems to me to be simply greedy and that is bad entrepreneurship.
The next is cash management or expense management. While it is understood that the SPAC has to set aside 90% of the cash proceeds (which I am hoping the regulators to push for 100%, applied retrospectively), it does not mean that the 10% is 'given up' to the management and promoters. A good entrepreneur would hold 100% of the proceeds with great care and prudence. A good entrepreneur should not treat the 10% as a kind of grant. Unfortunately, I could not find a section in the financial statement that talks directly on the utilisation of the 10% of the proceeds, despite its considerable amount, which left me having to read between the lines a bit.
The most glaring information would be the amount spent on looking for the qualifying acquisition. CLIQ reported that for 2014, it had spent about RM6 million on looking for the qualifying acquisition. It that too much or too little? No one knows except for the management of the company. What we can do though is compare the similar expense made by another company and for this purpose we can look at Hibiscus. Hibiscus, in 2012, had spent about RM5.7 million for the qualifying acquisition. Based on this it does not look too bad, except that Hibiscus had included the acquisition of LIME in the FYE 2012 accounts. Therefore IF the amount stated in Hibiscus' account included the all the costs to complete the LIME acquisition, then in my view, Hibiscus was better at managing the cost then.
Although I agree that SPAC is akin to a private equity and private equity ventures are famous for being secretive, but by choosing to take the public's money via an IPO it is also a public entity. The disclosure expectation of a public entity is much higher than a private entity, and in this respect I am sorely disappointed on how little SPACs reports on their expenses management compared to an operating company (well, since they do not have an operation to account for I guess they could spend more time on this compared to others). Sigh.
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At the time of writing this article i owned shares in CLIQ (though i bought solely based on the cash value of CLIQ and one clause in the prospectus that stated, roughly, that they have to return the cash proportionately to the dissenting investors when calling for a vote on the qualifying acquisition.)
Showing posts with label SPAC. Show all posts
Showing posts with label SPAC. Show all posts
Sunday, July 20, 2014
Sunday, July 13, 2014
GLCs 'REACH'ing into SPAC IPOs
"IN a monumental move, government-linked investment companies (GLICs) Lembaga Tabung Haji (LTH), Koperasi Permodalan Felda Malaysia Bhd and Pelaburan Mara Bhd have taken stakes in special purpose acquisition company (Spac) Reach Energy Bhd, which is slated to be listed sometime in August"
It is my firm belief that SPAC is not a bad company, but investing in SPAC without fully understanding the nature and risk profile of SPAC is bad investing. In my previous posts, I put forward my arguments that SPAC is in essence a private equity business which could transform into a normal operating business (upon the completion of the qualifying acquisition(s)) or maintain its model as a private equity business. The perspective on the valuation and pricing of SPAC shares depend on the business model it is operating under.
In this regard, I believe that it is not wrong for any institution to invest in a SPAC as long as it understands completely the risk and rewards of a SPAC business and the investment fits its risk-return portfolio. These GLC's are managed by professional managers who would have to ensure that proper due diligence have been undertaken and they would have access to the latest information and analysis to decide on SPAC investments.
My only concern is this. I remember once I have asked an experience fund manager as to what were the key drivers for his fraternity of fund managers. One of drivers, which stuck to my head until today, was the fear of 'missing the boat'. I place my confidence and hope that this should not be the case here.
More interestingly, it was further reported by the STAR that :
“What attracted the bumi funds was the investor protection. Reach was putting in 94.75% of its funds into the trust fund, instead of the stipulated 90%. Should a QA not be executed in 3 years time, the 75 sen per share put in by the investors actually becomes 76 sen, based on the existing interest rate. Furthermore, they could trade their warrants. It was a no-lose situation,” said one banking source
I do not know why Reach is putting an extra 4.75% into the trust fund from the 90% applied by its predecessors (HIBISCUS, SONA, CLIQ). If it was driven by the regulators, then it is good. If it was driven by Reach itself, then it is great! I personally think that the amount should be 100% of the funds raised and that the rule must be applied retrospectively to the other two SPACs not making their qualifying acquisitions yet.
The capital market (via the IPO) would have given the promoters/managers liquidity, visibility and the monetary muscle to increase their wealth, not to mention the millions (in terms of worth) ascribed to their collective stake in the company. They should not need to dip into the cash of the IPO subscribers at all to survive for the next three years (which should mainly comprise salary, rental and travel). At the very least have a budget which does not include paying tens of thousands a month salary and maybe get a fixed sum from the IPO coffers.
SPAC promoters and management (that gets the shares) are entrepreneurs in my eyes; and to keep the entrepreneurs hungry to be successful and remove any executive conflict, they should not be seen as 'profiting' from the salary and benefits from the SPAC. Their reward should come from the success of the SPAC only, fair considering the other partner (other shareholders) are also banking their reward on the same.
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Disclaimer: At the point of writing the Author has shares in CLIQ Energy Berhad. Not much but got'lah'.
Monday, July 7, 2014
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
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.
Sunday, July 6, 2014
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.
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.
Wednesday, July 2, 2014
Decyphering SPAC of Oil & Gas companies, the valuation enigma
First and foremost, I would like to thank the readers for the unexpectedly rousing responses to the first part of discussions on SPAC, which we had tried to unravel certain aspects of the SPAC in Malaysia.
This time round we are going to look a bit deeper into the valuation aspect of the SPAC, at IPO, before qualifying acquisition and after qualifying acquisition.
At IPO
As we all know, SPAC is a 'shell' company and in my view, works in a similar fashion as a private equity fund/outfit.Basically it does not have any business, just a 'plan to make money in the oil and gas sector' and a group of experienced professionals who, in a way, 'promised' to turn that plan into a reality via acquiring businesses or part of businesses (inorganic growth). There were in a way, no hard assets and the only 'assets' would be the know-how and know-who of the management and promoters of the SPAC.
Because of the absence of businesses, there would be no fundamental analysis or valuation based on the fundamental to find the intrinsic value of the SPAC. No PE, Price to book, EV/EBITDA or the likes. The parameters were simply not there. We can't do it. We can't even do a projection of DCF because no possible business has been identified at that juncture. That was why some quarters dubbed such pooling of funds as 'blind fund'. I don't agree with that term though, I would term is as 'pure faith' fund.
This would also explain why some investors who had invested in IPOs before might be a bit baffled, especially if they were used to having a point of reference, an intrinsic value to give an indication on the value of the shares that they were paying.
I hold this opinion about the value and price of shares listed on an exchange. They are different but linked. The intrinsic value of the shares is not the same as the price of the shares. What were transacted on the exchange were the prices of the shares, determined by the supply and demand of the shares - someone was willing to sell at that price to someone who was willing to buy at that price. Simple as that.
Intrinsic value or valuation, in my book, is akin to a shadow in a painting or drawing. If we were to draw a chicken on a clean white canvas , the chicken will look like it is hanging in midair (this is fasting month so my analogies and references are automatically drawn to food or its source, my apologies). Once we drew the shadow for the chicken, then we would be able get the perspective of position. That, in my book, what intrinsic valuation does. It brings perspective to the price of the shares (the picture of the chicken).
So, in the case of a SPAC, that was what was missing. You have a price yet you have no calculation of intrinsic value. That should explain why some people could not grasp with the price of the SPAC - they are unable to get a perspective on the price. There was no reference point.
So then how did they arrive at RM0.75 sen a share or RM0.50 sen a share or even RM1.00 per share? What were the basis?
The only way I was able to put this into perspective was to go back to the most basic of valuation and not rely on the per share valuation techniques available. I looked at the price of equity stake. Meaning I had lumped the entire shareholders together and split them into two groups, original shareholder and IPO shareholders.
The original shareholders and IPO shareholders would make up 100% of the total equity stake in the company, no more, no less (Yes there were warrants but they were almost evenly distributed so we can ignore it for the moment). So, if the IPO shareholders, collectively, held 75% of the SPAC after the IPO, that means the original shareholders, collectively, would have held 25% stake in the company.
To repeat what I wrote in the previous article:
"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."
Therefore, in order words, if I was to compare the three SPACs, the common denominator would be how much were the total value/worth 'given' to the original shareholders for their collective skills and connections. As rough 'ranking' (not to be taken as real valuation) indication for discussion purpose:
Hibiscus: RM78 million ( divided by 24% will give you RM3 million per 1% interest
CLIQ: RM109 million (divided by 25%, RM4.36 million per 1% interest)
SONA: RM155 million (divided by 23%, RM6.74 million per 1% interest)
Whether this is too much or too little is anybody's guess. This is, in my view and please correct me if I am wrong, the 'price' the shareholders paid to the management of the SPAC for creating this opportunity.
Before qualifying acquisition
At this juncture, the shares would be listed and traded on the stock exchange.
But the situation with regards to the intrinsic value remained the same, as there are no business and hard assets to speak of.
But the situation surrounding the shares and their prices have changed. While the IPO price was fixed, the open market price was not and would move depending on the supply and demand for the shares. But again, without the intrinsic valuations, it would be purely supply and demand.
It would be understandable if some investors, who are used to having fundamental valuation to back the price, feeling a bit queasy, almost sea sick. Some of my friends argued that I should anchor the price of SPAC to the 90% of the IPO proceeds as that was hard cash. Indeed that may be the floor IF there was no qualifying acquisition and the SPAC is still under the obligation to return the 90% of the proceeds back to the holders of the IPO shares.
I can buy into this argument at this juncture. As long as I have an unimpeded, unrestricted right, to 90% of the IPO price, the the value 'backing' the shares should be exactly that. I mean cash is cash. If the share price dropped below 90% of the IPO price, I would technically be making an arbitrage on the shares. There would be no risk (with the option to pull out on full receipt of the cash with interest) and I would be making a profit on the difference between the share price and the cash receipt (in case of pull outs).
But if there is any possibility or risk of me not getting the cash receipt in full when I opt out, then this does not work. Also I have to remember that I can only exercise this option during special occasions: when the company is seeking approval for a qualifying acquisition or after 3 years with no qualifying acquisition.
The same friends used this cash return clause to argue that SPAC investment is safe. SPAC ensured that you will get your money back (assuming the 3% annual interest makes up for the 10% of the IPO proceeds that were non-returnable) within 3 years. Well, my answer is that if you wanted risk free investment, then put the money in any (islamic :-) ) bank, you will at least make some profit at the end of the year. In my view, investment in SPAC is an equity investment which must be compared with the opportunity cost of investing in equity, oil and gas companies to be more accurate.
After qualifying acquisition
After a SPAC made its qualifying acquisition, it should now have its intrinsic value brought by the fundamentals of the acquiree company (or part thereof). It is therefore important to note the affect of the qualifying acquisition to the fundamental or intrinsic valuation of the SPAC post acquisition. Would the numbers be able to support the share price (or IPO price) when compared with the rest of the oil and gas players.
Back to the analogy of drawing earlier, the picture of the chicken now has a shadow, a point of reference. And when we put that picture of our chicken to the picture of another chicken, we would get a perspective of scale. In a sense, where did the company rank amongst its peers.
In this situation, the SPAC is no longer a SPAC, but an oil and gas company and could be compared, fundamentally, with other oil and gas companies. And the price will adjust accordingly.
Reminder: The above are my personal views and shared with the intention of creating discussions (and in turn increases [my] understanding) of the SPAC. It is NO WAY a recommendation to buy or sell any SPAC.
This time round we are going to look a bit deeper into the valuation aspect of the SPAC, at IPO, before qualifying acquisition and after qualifying acquisition.
At IPO
As we all know, SPAC is a 'shell' company and in my view, works in a similar fashion as a private equity fund/outfit.Basically it does not have any business, just a 'plan to make money in the oil and gas sector' and a group of experienced professionals who, in a way, 'promised' to turn that plan into a reality via acquiring businesses or part of businesses (inorganic growth). There were in a way, no hard assets and the only 'assets' would be the know-how and know-who of the management and promoters of the SPAC.
Because of the absence of businesses, there would be no fundamental analysis or valuation based on the fundamental to find the intrinsic value of the SPAC. No PE, Price to book, EV/EBITDA or the likes. The parameters were simply not there. We can't do it. We can't even do a projection of DCF because no possible business has been identified at that juncture. That was why some quarters dubbed such pooling of funds as 'blind fund'. I don't agree with that term though, I would term is as 'pure faith' fund.
This would also explain why some investors who had invested in IPOs before might be a bit baffled, especially if they were used to having a point of reference, an intrinsic value to give an indication on the value of the shares that they were paying.
I hold this opinion about the value and price of shares listed on an exchange. They are different but linked. The intrinsic value of the shares is not the same as the price of the shares. What were transacted on the exchange were the prices of the shares, determined by the supply and demand of the shares - someone was willing to sell at that price to someone who was willing to buy at that price. Simple as that.
Intrinsic value or valuation, in my book, is akin to a shadow in a painting or drawing. If we were to draw a chicken on a clean white canvas , the chicken will look like it is hanging in midair (this is fasting month so my analogies and references are automatically drawn to food or its source, my apologies). Once we drew the shadow for the chicken, then we would be able get the perspective of position. That, in my book, what intrinsic valuation does. It brings perspective to the price of the shares (the picture of the chicken).
So, in the case of a SPAC, that was what was missing. You have a price yet you have no calculation of intrinsic value. That should explain why some people could not grasp with the price of the SPAC - they are unable to get a perspective on the price. There was no reference point.
So then how did they arrive at RM0.75 sen a share or RM0.50 sen a share or even RM1.00 per share? What were the basis?
The only way I was able to put this into perspective was to go back to the most basic of valuation and not rely on the per share valuation techniques available. I looked at the price of equity stake. Meaning I had lumped the entire shareholders together and split them into two groups, original shareholder and IPO shareholders.
The original shareholders and IPO shareholders would make up 100% of the total equity stake in the company, no more, no less (Yes there were warrants but they were almost evenly distributed so we can ignore it for the moment). So, if the IPO shareholders, collectively, held 75% of the SPAC after the IPO, that means the original shareholders, collectively, would have held 25% stake in the company.
To repeat what I wrote in the previous article:
"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."
Therefore, in order words, if I was to compare the three SPACs, the common denominator would be how much were the total value/worth 'given' to the original shareholders for their collective skills and connections. As rough 'ranking' (not to be taken as real valuation) indication for discussion purpose:
Hibiscus: RM78 million ( divided by 24% will give you RM3 million per 1% interest
CLIQ: RM109 million (divided by 25%, RM4.36 million per 1% interest)
SONA: RM155 million (divided by 23%, RM6.74 million per 1% interest)
Whether this is too much or too little is anybody's guess. This is, in my view and please correct me if I am wrong, the 'price' the shareholders paid to the management of the SPAC for creating this opportunity.
Before qualifying acquisition
At this juncture, the shares would be listed and traded on the stock exchange.
But the situation with regards to the intrinsic value remained the same, as there are no business and hard assets to speak of.
But the situation surrounding the shares and their prices have changed. While the IPO price was fixed, the open market price was not and would move depending on the supply and demand for the shares. But again, without the intrinsic valuations, it would be purely supply and demand.
It would be understandable if some investors, who are used to having fundamental valuation to back the price, feeling a bit queasy, almost sea sick. Some of my friends argued that I should anchor the price of SPAC to the 90% of the IPO proceeds as that was hard cash. Indeed that may be the floor IF there was no qualifying acquisition and the SPAC is still under the obligation to return the 90% of the proceeds back to the holders of the IPO shares.
I can buy into this argument at this juncture. As long as I have an unimpeded, unrestricted right, to 90% of the IPO price, the the value 'backing' the shares should be exactly that. I mean cash is cash. If the share price dropped below 90% of the IPO price, I would technically be making an arbitrage on the shares. There would be no risk (with the option to pull out on full receipt of the cash with interest) and I would be making a profit on the difference between the share price and the cash receipt (in case of pull outs).
But if there is any possibility or risk of me not getting the cash receipt in full when I opt out, then this does not work. Also I have to remember that I can only exercise this option during special occasions: when the company is seeking approval for a qualifying acquisition or after 3 years with no qualifying acquisition.
The same friends used this cash return clause to argue that SPAC investment is safe. SPAC ensured that you will get your money back (assuming the 3% annual interest makes up for the 10% of the IPO proceeds that were non-returnable) within 3 years. Well, my answer is that if you wanted risk free investment, then put the money in any (islamic :-) ) bank, you will at least make some profit at the end of the year. In my view, investment in SPAC is an equity investment which must be compared with the opportunity cost of investing in equity, oil and gas companies to be more accurate.
After qualifying acquisition
After a SPAC made its qualifying acquisition, it should now have its intrinsic value brought by the fundamentals of the acquiree company (or part thereof). It is therefore important to note the affect of the qualifying acquisition to the fundamental or intrinsic valuation of the SPAC post acquisition. Would the numbers be able to support the share price (or IPO price) when compared with the rest of the oil and gas players.
Back to the analogy of drawing earlier, the picture of the chicken now has a shadow, a point of reference. And when we put that picture of our chicken to the picture of another chicken, we would get a perspective of scale. In a sense, where did the company rank amongst its peers.
In this situation, the SPAC is no longer a SPAC, but an oil and gas company and could be compared, fundamentally, with other oil and gas companies. And the price will adjust accordingly.
Reminder: The above are my personal views and shared with the intention of creating discussions (and in turn increases [my] understanding) of the SPAC. It is NO WAY a recommendation to buy or sell any SPAC.
Wednesday, June 25, 2014
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
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.
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