#3 Investing Ideas – Why Multi-Chem Limited is Undervalued?(SGX:AWZ)
October 17, 2019
We chat with Phuah Keng Keat, an analyst in a family office based out of Singapore. Keng Keat talked about one of his favourite investment ideas at the moment: Multi-Chem Limited (SGX:AWZ).
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The Transcript of Value Invest Asia, on
Investing Ideas between
The Interviewer: Stanley Lim from
Interviewee: Phuah Keng Keat
is Investing Ideas by ValueInvestAsia.com
Stanley Lim: Hi! Stanley here;
welcome to another episode of Investing Ideas. This week, we are fortunate
enough to have a chat with Mr. Phuah Keng Keat; an analyst from a family office
based in Singapore, and Keng Keat has been a value investor for a long time,
and he basically likes to look at companies within the tech space; both in
Singapore, and also in the US market. This week, he introduced to us a very
small cap company based out of Singapore called Multi-Chem Limited, and this
company has a very simple to understand business, and yet trading at one of the
lowest valuation I have ever come across in a company. So, without further ado,
let’s get started.
Stanley Lim: Hello! Welcome everyone,
to another episode of Investing Ideas. This week, we have a very special guest
who is Keng Keat, a dear friend of mine. Hello! Keng Keat.
Keng Keat: Hi! Hi Stanley, how
Stanley Lim: [Laughs] Very good, how
Keng Keat: Good.
Stanley Lim: Good, okay. Why don’t
you give yourself some introduction to our audience? Can tell us, you know what
do you do in your career?
Keng Keat: Yeah! I’m a buy-side
analyst currently working for a family office. I’ve been there for about five
years, I used to be an IT analyst kind of like doing IT in a semiconductor
industry, but then I have since help to look at the technology portfolio of
family office. So, in the job I cover semiconductor stocks, technology stocks. So,
to utilize some of my past working experience to look at fundamentally technology
Stanley Lim: Wow! Okay. So, you are
the technology expert. You know, just on your own personal investment, how
would you describe yourself as an investor, because we know that in value
investing, there’s a wide range of value investors – if I ask you to describe
your own strategy, how would you describe it?
Keng Keat: Okay! I would think
myself as someone that has tried to learn a lot from different types of
discipline, but then, I think we should not have any constraint on whether to
invest, whether is in a big cap, or small cap, or value, or growth company, or
companies that this on any different geographical location. What I think is
that investors have to be actively searching ideas around the world. So, that
to improve the Alpha of the portfolio, and then for myself, I really focus on
the valuations; let me say basically I use the free cash flow valuation to
determine the intrinsic value of the company. I also actually look at the
underlying growth path of the company to incorporate the growth on the
valuation. So, because I think that growth is a part of the valuation to
determine whether it’s a valued stock or not.
Stanley Lim: Well! Yeah. Fair
enough, I’ve have said before, you know growth is a part of value – but on top
of — you know, which market do you
normally focus on, say in your own portfolio, which market do you mainly focus
Keng Keat: I mainly focus on
the US stocks, because we know that the US stocks is the largest market cap of
the stock market around the world, and then for – especially for technology
stocks, because they are leading in the technology, especially in artificial
intelligence, or even software companies. So, there are lots of potentials to
be found in the US companies.
Stanley Lim: Okay! That’s a very
good introduction. But, today you’re not actually going to share with us a US
company. Interestingly, when you brought this company up, I was quite surprised,
why don’t you introduce this company to our audience. I think they’ll be very
fascinated by it.
Keng Keat: Sure! This company
is listed in Singapore; it is called Multi-Chem Limited. So, it has a market
cap of about SGD 61 million, so it’s considered a very small cap. So, what does
this company do? This company is actually a IT security product distributor. So,
the business is very simple, what they do is to train IT security professionals,
to deploy IT security solutions provided various vendors, and it has been quite
long in the market. That is since 2002, and it has distributor points in 15
countries, and their distributors that they have is – usually they get from the
IT security software from Liposomal, Checkpoint, Cisco, Alto Palo, Carbon Black,
which are quite prominent IT security companies. So, it used to be doing the
PCB drilling for this company, since they divested this business.
Stanley Kim: Okay! So, now it’s fully
IT security distributor?
Keng Keat: Yeah! Correct.
Stanley Lim: Okay! And for this kind
of distributorship, are they exclusive distributors or you know, they’re just
one of many?
Keng Keat: I think they’re one
of many, but as you know, because it takes time to build the relationship but
with IT distributors, I mean with the clients, as well as the vendors. So, I do
think that they have some kind of like a relationship built in to vary for the cost
of the company.
Stanley Lim: Why do you – you know,
it seems like an interesting business, especially now you know, internet
security is getting more and more prominent, and people are focusing on it. But
why do you like this company?
Keng Keat: Okay! Some of the
investment thesis is that the company currently enjoys a tailwind from the
secular growth in IT security, because I think the business is quite counter
cyclical, because as no matter what happened in the economy; prevention of the
IT security breaches are utmost important policies for the company to maintain.
And the company has been generating a double digits revenue growth for the past
six years. As for the Macro term; the Q1FY19 worldwide IT security is spending
is still growing about 12% year-on-year,
and making it a fifth consecutive quarter of double digit growth. And then, the
thing is that, despite the company is a low moat company, but it earn the spread
between the vendor and customer; meaning that vendor will provide the software,
and the customer will buy from Multi-Chem, and then Multi-Chem will take a
spread from it. But then the other thing of it is that the vendor will need to
work with the distributor, so that companies will use the product, and the
customers will need the training to understand different configurations for on-premises
cyber security. So, I do think it takes time to build the relationship.
Stanley Lim: Right! Okay. So, I have
some questions about how they actually do their business, because if you say
that they are the distributor of all these different solutions or different
products, but all this companies, they actually have presence in say Singapore
as well, or in other 15 countries that they operate. So, it is possible for the
end client to go directly to the main company, instead of going through them. Is
Keng Keat: It might not be that
easy, because – for example, you talk about Checkpoint; Checkpoint is really
focusing on developing the IT security product, they are also improving their
techniques, to different end to end, endpoints. So, they spent a lot of time
and effort in trying to prevent those security intrusions. But when we talk
about distribution, they will let that IT distributor, which is Multi- Chem, to
handle all the client relationship and training. So, I don’t think they really
have to go to Checkpoint directly to buy the software on a company level.
Stanley Lim: Okay! Another concern I
might have you know, listening to you is, maybe in the world of you know, we
are going to cloud computing, and more and more of the servers are becoming
like almost hybrid server, or maybe people might just host everything on AWS. Given
that AWS; they have their own integrated security within it, is there still a
need to ask Multi-Chem to put another security on it, or you know, they can
just go through AWS?
Keng Keat: Yeah! I think the proliferation
of the public cloud is still in its very early stage. Right now, I think not – possible
if we talk about Singapore government’s IT system, will they have put all the
IT system into the AWS? So, I think maybe, well I think it will be very long
term process that still will be another maybe 10 to 15 years of kind of like,
that cycle to go through before you really put all into the public cloud. So, I
do think that companies do have to employ their on-premises database, to host
it like a lot of sensitive data that you are worried that it might be – you’re
not comfortable letting the public cloud to handle it. So, I do think that
there’s still a need for the on-premises security, and then we talk about the
IT security manager. So, let’s say if all the IT securities is moved to the
public cloud, then what is the work of chief security officer? Will be like,
maybe there’s no job for him(/her) anymore. So, they will have this kind of like
incentive, like to make sure that – maybe the strategy is not to move to all to
the public cloud but it’s a mix of hybrid.
Stanley Lim: Right! Yeah, I get a
sense from what you say is, it could be a threat, the cloud computing could be
a threat. but generally, a lot of sensitive data, maybe companies, or the
government would still prefer it to host it on the on-premise lab?
Keng Keat: Right! That’s
Stanley Lim: Yeah! Given that you
say that they have been growing say double digit for many years; past six years,
but why have they remained such a small cap company? Why is that the case?
Keng Keat: I guess it’s because
the owner and his wife actually own about eighty percent of the company. So,
the top three shareholders actually have about eighty percent of the company,
and the stock is currently illiquid, but maybe I will just go through some of
the – highlight of the company, the revenue as I mentioned has been growing at
double digit, and then operating profit is actually even more impressive, it’s
actually a double digit for the past six years, and then margin, of course you
look at the margin, I expected it to be very low around 3 to 4 percent, but
then – but the problem is that actually there’s not much R&D to carry out
for this company because it’s just mainly a distributor. So, wherever you
observe the top line that is a double digit, I mean the growth of the revenue will
fall to the bottom line. Now you talk about on the net cash basis, because Multi-Chem
is currently sitting on forty four million net cash, and if you compare the
market cap of it, is about 62 million. So, this implies our EV/EBIT multiply by
1.7 times, which is extremely low.
Stanley Lim: Okay! Or if you are looking
in the other way, maybe a net cash of – if you minus half the net cash, the PE
is roughly about two times that.
Keng Keat: Yes! Correct. So, I
don’t think you can find any other companies that trade at good multi-part …
Stanley Lim: Okay! But! Of course, I
think for a lot of small cap companies, especially you say that the main
shareholder owns 80% of the company; it goes back to the point of you know, how
do you see the management. Are they fair to shareholders? Because they are a
huge risk to minority shareholders, how do you see…?
Keng Keat: So far, I see that
dividend payout, although it’s about 30%, but it’s still below the operating profit
that you can generate, but nevertheless, the current dividend yield is still
about 6%, and because they are the majority owners of the company. So, they
will like continue to distribute out this dividend to back to the shareholders,
which as a minority shareholder, you can benefit from the dividend as well. Yeah!
So, the reason why the EV/EBIT is treated as such a low level, is because the
cash build up over the years, because operating profit that the company is generating
on a yearly basis is about 13 to 14 million per year. That means it’s actually
earning on an EBIT of 30 million over the EV of about forty four million. Okay,
which means it’s actually has a earning yield of 64 percent per year. So, within
two years if you have two years, you buy the stock for two years, you could
have your stock price back.
Stanley Lim: It always sounds to be
too good to be true, so if they are so you know, cash flow rich, cash rich, and
the business is almost anti-cyclical, why is it listed in the first place, why
do you think they need to list the company in the first place?
Keng Keat: I think previously
they are doing the PCB drilling in China, but then because I think this is a
business with a lot of competition, so they kind of divested the business, and
the listing of the business is actually –when they are still doing the PCB drilling
business. So, since 2002, I think the owners had made effort to switch to this
IT security company, and of course, the company continued to be listed, but I
actually, either I would not foresee that the company continues to be listed in
the market, because eventually, I was hoping this eventually there’s
privatization going on, because the owners might pick some like loans from the
banks, and then try to privatize the company, because he already owns that like
80% of the company.
Stanley Lim: So, to you, even
privatization could be another out for investors.
Keng Keat: Yeah! That’s correct.
Stanley Lim: I guess for yourself that
have invested in this company. Okay! So, it seems like you know, it’s almost
too good to be true company, like everything’s looks good, but I have to ask
you, what could be the risks what could be the downside for such an investment?
Keng Keat: I think that risk
would be — like what you have mentioned, because there’s a public cloud threat
that can handle end to end security. So, people will move their IT applications
to be hosted in the public cloud, which makes the on-premise society security
products obsolete. But I think as I say, we still have a long way to go,
because of we are at a very early stage our public cloud, If I look at it, this
company actually, just as a distributor, another distributor may come out, to like
cut the business of from Multi-Chem. So, this might be a risk, but I see that –
because the company has been around for about twenty, almost twenty years
really. So, it does have some relationship with the vendors, relationship with
clients, I do think that this kind of relationship is very hard to replicate,
and it’s also kind of like offset by the industry tailwind, because industry tailwind
is that the IT security spending is still going strong at about double digit.
Stanley: Okay! But given,
you say that the company has a history of twenty years, but they you mean that
right at the beginning, they are already doing this IT distributorship together
with the PCB drilling?
Keng Keat: That’s correct.
Stanley Lim: Okay! In a sense, I
quite agree with you maybe the relationship that they have built over the years
that could be quite sticky, as long as they don’t screw up anything, but having
said that, when they distribute the product, is it recurring revenue or you
know, or it’s one-time revenue plus platform training, how does that work?
Stanley Lim: I think it would be
some recurring revenue, but I’m not so sure about why is that, because the
contract detail might be quite sensitive to disclose, but I do think it’s a
recurring kind of business way, because if a new feature is being, like you
know the IT security is always changing, because hackers may have developed a
new way of hacking. So, the IT security company do have to spend a lot R&D
on researching what is the best way to protect IT security, therefore I do
think there’s a pricing mechanism to actually renew the contract, such that you
continue to get a protection, but Multi-Chem can continue to be the IT Security
distributor company to distribute the products.
Stanley Lim: Okay! I guess that’s
fair. Now you know, talking about valuation, you know for such a company, of
course you’re talking about the EV/EBIT you know what 1.7 times, or a PE over 2
times net cash, seems unreasonable, seems undervalue. In your opinion, what
should be a fair value for such a company?
Keng Keat: I think if you –
because since it’s a small cap company. So, if you let’s say you incorporate a
small cap illiquidity premium inside, and then you also demand for a double
digit 12 percent yield per year. So, you have to multiply it’s not easy to EV/EBIT
multiplied by 8x, because you invert the required return of 12%, you get the 8x
multiple, well I’m sure you will still come close to $1.60 which is 125 percent
return compared to the current price of like 73 cents now. So, that means that
I think this companies like is really undervalued, because based on the revenue
growth, and operating income growth but it’s trading below price to book value
of 0.6 times, so it’s actually a kind of like neglected small cap in Singapore.
Stanley Lim: Yeah! It seems that it
is undervalued, but okay, let me be the devil’s advocate here, because a lot of
small cap companies we see right, they seem cheap, but due to the illiquidity,
and due to the huge stakes of their major shareholders, it is almost very hard
for them to get out of – and become fairly valued, and you know, what could be
the catalyst for such a company, apart from you said privatization right, if
that doesn’t pan out, you know what other catalysts are you looking at?
Keng Keat: Because this refer
to the kind of portfolio allocation of the stocks, because for my side, because
I do have some CPF, stock investment to invest. And some CPF’s will give you
like about 3%. So, if I have a CPF fund, and then if I ever see this company,
I’m getting about six percent dividend yield, at the same time I’m waiting for
the privatization to happen. So, it’s like a call option for me to have inside
my CPF stocks. So, I do think that I kind of like, I just put a small
allocation inside, because as you are right to correctly say that because the stocks
are illiquid, then it’s not warrant to have a big position inside, because you
might not be able to get out. So, by just putting a small portion of your CPF
inside, I think it is quite okay to do that. So, it depends on what is your
cash allocation versus whether you want to use you CPF to invest in it.
I see! It’s very
smart. So, in a way I guess what you’re saying is due to the it’s already so
low valuation, and quite simple to understand business, you feel that the
downside risk is not too much as long as the company maintains the business,
they don’t even have to grow, they just need to at least maintain the business,
you should still be continuing enjoying that six percent dividend, and if it
privatizes, it is good, if not, you just enjoy the six percent.
Keng Keat: Yes.
Stanley Lim: Okay! Interesting, I
quite agree with you on this one, seems like a very undervalued stock, and
definitely I am yet to study deeply into it, but you definitely have peeked my
interests. So, once again this is Keng Keat; a great investor, and a personal
friend of mine, who is an analyst for family office, and I look up to him in
many of his thesis, and I always learn a lot from him. So, thank you so much
again Keng Keat.
Keng Keat: Thank You Stanley.
Stanley Lim: Thank you, I hope to
see again soon. Bye
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****Disclaimer: The show is for entertainment purposes only, and should not be taken as investment advice. Please seek professional advice or do your own research when making any investment decision. Disclosure: Stanley owns Amazon.com. Keng Keat owns Multi-Chem Limited
Stanley Lim has spent the last decade in the investment industry. Over the course of his career, he has kick-started a few businesses, worked in the family office industry and most recently in the investment advisory industry. He has been a writer and analyst for The Motley Fool Singapore from 2013 to 2017. He has written close to 2000 articles online, on investment education and market analysis. He is the co-writer of the investment book: “Value Investing In Asia”, published in 2018. Stanley is currently the chief editor of Value Invest Asia.