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 ValueInvestAsia.com
Interviewee: Phuah Keng Keat
Intro: This 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 are you?
Stanley Lim: [Laughs] Very good, how are you?
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 stocks
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 on?
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 that right?
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 correct.
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.
Stanley Lim: 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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Disclosure: Stanley owns Amazon.com. Keng Keat owns Multi-Chem Limited