SilverLake Axis

SilverLake Axis

Links
1) http://www.straitstimes.com/business/companies-markets/silverlake-axis-reports-lacklustre-q4-earnings
2) RHB Investment report 17 May 2017
3) http://www.silverlakeaxis.com/img/pdf/Silverlake%20Axis%20Ltd%20Executive%20Report%206%20Jan%202016.pdf

Decision to Buy - Company is relatively undervalued compared to peers, PE, Free cash flow, P/BV, profit margin perspective. Price is driven down due to speculative attack. There is no consensus to identify how much technology (Cyclical) companies are worth, but using my EPS model, This share intrinsic value is around 1.29701. This is not necessary reliable and I discounted the 2016 sharp increase in assets from disposal of its GIT shares to normal amount.

Untapped Debt Capacity grants greater financial leverage. Good cash flow to support its building up years and acquisitions without heavily resorting to debt, especially in these 2 years of impending interest rate hikes.

Growth company that is expect to benefit from fin-tech drive population in Singapore and Asia.Successful in increasing customer base from 150 to 200 clients. Extends geographical reach to Eastern Europe, Middle East, South Asia while creating a stronger market leadership in South East Asia


From a bottom up perspective, its acquisitions are aligned with the fin-tech developments in the banking sector and it is well positioned to aggressively acquires potential companies and start-ups to grow in the future. Currently sitting on huge pile of cash due to divestment of China listed associate MYR477.7m, which will be paid in instalments from china to company. Looking into acquisitions to hasten growth in insurance sector.

Currently, performance is expected to be poor due to the absence of large scale projects in a tough macroeconomic climate where banks are cutting down on big scale IT spending. Latest earnings is 1% rise in 4th quarter earnings, with lower revenue owning to lower contributions from software licensing, sale of software and hardware, credit and cards processing.Higher revenue in maintenance and enhancement, insurance processing, software project services.  New Vietnam and Thailand small to medium size projects may sustain its earnings in the long run. No large sized projects however, may dampen profitability.

 Company issued  non binding letter stating intention to consolidate its private entities to improve corporate governance and transparency. To mitigate potential speculative attacks in the future


1) Business Outlook

Lines of business + Prospects

2) SWOT

Strengths/ Opportunities
i) Leader in niche market. High switching costs for banks which are subject to heavy regulatory scrutiny and risks of migration to new systems
ii) Long term earnings visibility with 55-60% recurring revenue (maintenance)
iii) Strong fundamentals

iv) Fin-tech wave may spur future IT spending) Strong reputation of High success of implementation rate may drive other banks to switch to existing reliable vendor than to pull out.
v) 40% of leading SE Asian banks use Silver-lake ’s software and services
vi) 25 years track record of successful implementation of Silver-lake ’s enterprise software applications in over 150 customer sites with 100% success rate

Weakness / Threats
i) Highly cyclical company. If company is unable to secure new contracts or key players decide to forsake Silver-lake for other vendors, there will be HUGE decrease in Profits
ii) Technology gets phased out often. Company highly dependent on profitability and acquisition to acquire new technology. New technology / revolutionary can threaten the viability of the entire company.

iii)  Highly Dependent on IT budget of banks. If banks are not doing good, spending will be cut.
iv) There is no guarantee that banks will be continuing to use Silverlake Axis as their vendor if they are successful in finding cheaper vendors or develop in house technology

P
E
S
T
   


Lines of Business (Highly complex)
Application Maintenance (Stable) & Enhancement Services (42%) (Cyclical)
Intellectual Property Licensing (30%) (Stable)
Software Project services (14%) (Cyclical)
Sale of IBM hardware products (6%)
Insurance processing (4%)(Stable)
Credit and card processing (4%) (Stable)


Services
Axis Systems Limited - Delivery Channels & Branch Banking Solutions
SIBS Acquisition 2006 - Core Banking & Payments Solutions
SSB, QR technology (PROFIT), ISIS, Merimem (Insurance Claims & Policies Processing Software as a Service  Platform ), CVSB - Structured Software Maintenance & Project Services, Retail, Logistics, Integration Software, Insurance, Mobility & Internet Solutions

QR Group is highly dependent on certain clients, and the customer was responsible for more than RM13 million of the RM19 million revenue in FY2009

Key Vendors
UOB, Maybank, OCBC, Bank Rakyat, Bank Mandiri, CIMB group
Captured market share in Indonesia, Malaysia, Philippines, Singapore, Thailand, Vietnam
Rivals - SAP, Oracle, Hogan, Temenos, TCS, Infosys, TCS FNS, FIS, Hyundai,

Revenue Component     Percentage of SAL Group  Revenue     Profit margin per Financial Statements
Licencing     25.5% -30.0%     90.2% -90.7%
Maintainence and enhancement services     42.0% -54.9%     58.1% -62.4%
Software Project services     11.6%  -19.4%     23.2% -27.8%
Sale of hardware and software     1.2% -6.5%                       20.9% -37.8%



2) Porter 5 Forces (Pricing Power)(Franchising)
High barriers of entry (BOE)
i) Highly regulated industries

ii)High initial capital investment

iii) Economies of scale enjoyed by sizeable institutions


Unknown threat of substitutes (TOS)
i) Market entrant of competitors

ii) New technology making Silverlake obselete

Low bargaining power of customers (BPC)
i) Demand of banking technology is always inelastic

Low bargaining power of suppliers (BPS)
i) It is the creator of its own technology


Low intensity of rivalry (ICR)

i) Competition by reputation and quality of service

ii) Dominance in high end market


Organisational Life Cycle

What type of stock it is and what I am looking out for. Growth Cyclical Company. Major emphasis on capital gain. Stable and strong earnings,  but can be made obsolete with new technology.


5 Year forecasted Revenue Growth rate - Impossible to predict,

Beta - 0.80

CAPM (required rate of Return) = 2.18%

Company Geometric Return on Net income (Net Income, 2012 to 2016) =31% (estimated due to highly cyclical nature of company)



2) Financial Ratio Health Analysis with peers

http://quotes.wsj.com/SG/XSES/5CP/financials
http://www.morningstar.com/stocks/XSES/5CP/quote.html

Profitability - Very Healthy, Cash Flow is generally healthy, But may be heavily cyclical. Now most likely riding on the upside.

Gross Margin (TTM) (%)     54.72
Operating Profit Margin (TTM) (%)     189.12
Net Profit Margin (TTM) (%)     167.34
   
Liquidity/ Leverage - Good Cash Flow and liquidity in the short run and long run, Relative low indebtedness considering its Infrastructure, Very Good Free Cash Flow. Will not go bankrupt


    Philips Latest
Current Ratio     5.08
Quick Ratio     -
Long Term Debt to Equity (%)     0.14
Total Debt to Equity (%)     7.85
Interest Coverage Ratio (TTM)     -
Free Cash Flow to Firm (TTM) (SGD 'mln)     30.13
     
Operating cash flow- Cash flow from operations always positive but highly irregular

Investing cash flow - Cash Flow From Investing high irregular from positive and negative

Financing cash flow - Cash flow from Financing is largely negative


Performance - Highly cyclical performance.

Return on Asset - Great, ROA decreasing over the years, removing FY2016

Sales Turnover - Great, ROE consistant ignoring 2016

Earnings Per Share - Earnings per share improving gradually ignoring 2016


Return on Investment -
Tax Retention Rate (tax efficiency, higher better) = (EBIT - tax exp) /EBIT
Interest Expense Rate (lower better)  = int exp / Total asset


Return on Equity
Dupont ROE analysis - Profit Margin x Asset Turnover x Financial Leverage
ROE = Net Income/Net Sales x Net Sales/Total Asset x  Total Asset x Common Equity

Continual Stable profit margin discounting 2016
General improve in Asset turnover, sharp decrease in 2016
General increasing financial leverage, sharp spike in 2016
General improving ROE, sharp spike in 2016, may be due to Increase in financial leverage rather than improve in fundamentals


3) Valuation Models

Compare with Mkt P on fixed date, Over/Under Valued, Buy / sell

EPS Model - 1.297012769 in 5 years (Not Reliable)
DDM MOdel - Not feasible for technology and cyclicals

FCFE -Not feasible for technology and cyclicals

Relative Valuation (Not feasible for technology companies, hybrid of Microsoft)
From Value perspective, incredibly  cheap. But may be due to accounting manipulations and low investor sentiment.

Historical P/E Ratio     5.91
P/E Ratio (TTM)     5.91
P/BV (latest interim)     4.32
BVPS (latest interim) (SGD)     0.139
EPS TTM (SGD)     0.1016


4) Buy / Sell Decision

1) Buy share now because it is at discount.

2) Consider Support Resistance Lines - Buy at 1.297

3) Consider Technical Analysis input by POEMS -Short term bearish signals.

4)Consider Analyst consensus opinion - Contrarian View -


5) Buffet Valuation Checklist

Business Tenets

1) Is business simple and understandable? (choose companies within your circle of competence, not the size of the circle but rather how defined are its parameters) - Yes from the application user perspective, IT company are complex and cyclical in nature and difficult to evaluate

2) Does Business have consistent operating history? (Operating performance, Cash Flow especially for SME) - Yes compared to other Fintech companies.

3) Does business have favourable Long term Prospects? (American Steel industries decline, avoid commodities) - Yes in SEA Singapore and ASEAN


Porter's 5 forces - choose franchises that products are needed and desired, with no close substitutes, highly regulated posing high barriers to entry, market leader, high switching costs,  strong reputation allowing company to retain market and pricing power to pass on costs to users, Highly cyclical and dependent on if it can continue acquiring new technology and clients.


Management Tenets

4) Is management rational and track record of competence? (Beware SMRT clowns) - Yes

5) Does business have strong track record and consistent good leadership and management (management changes, adopting of technology, recognition of fundamental changes in economy) - Yes

6) Does management resist institutional imperative? (Manager Mismanagement and inertia to change) - No. Cautious and well thought out acquisitions.

    The organisation resists any change whatsoever in its current direction, and will seize upon any evidence that they are doing the right thing while fastidiously ignoring evidence to the contrary.
    Just as work expands to fill time, and waistlines expand to fill belts, projects and acquisitions will materialise to soak up all available capital.
    Any business plan of the CEO, however stupid it may be, will receive immediate support from a legion of lackeys who will produce copious data and detailed rate of return and strategic studies to support the boss's thesis.
    The behaviour of peer companies, irrespective of differences in circumstances, whether they are acquiring, expanding, setting dividend policy, downsizing, putting the troops through customer service training or setting executive compensation will be immediately and thoughtlessly copied.
    Poor capital management skills. Buffet buying over entire companies to decide financing policy )


Financial Tenets

7) What is the ROE? (Revenue, Expenses, Cash Flow, Labour relations, pricing flexibility, capital allocation needs). Look out for cash flow, indebtness  and changes in interest rates - Great

8) What is the company's owner earnings? -Great

9) What are the operating margins? - Fantastic

10) Has company created at least 1 dollar of market value for every dollar retained? - Not sure


Value Tenets

11) What is the value of the company (Intrinsic, Book, Market).  Buy a good company at an undervalued Price. Buy a very good company at a fair price as good companies are closely monitored

Buy Great company at undervalued Price, Projecting that market overreacted negatively due to short seller report.

12) Can it be purchased as significant discount to its value? (undervalued, Very good prospects / projects) - YES

Summary of the Audit findings for related party transactions
As of now, Silverlake is found to be compliant with SGX listing news and there is no evidence of fraud. There is no evidence of Silverlake artificially buying companies at inflated prices (think SingPost, China companies) The  majority  (77%)  of IPT revenue transactions  with  Silverlake  Private  Entities  were with respect to Licensing with the SPEs acquiring licences for either long term disruptive research and development purposes(“R&D”)or for transactions with financial institutions in which an SPE was primary contracting partyas reseller or as system integrator using SAL software. The  percentage  contribution  of  IPT  revenue to  other  revenue  sources was relatively low at below 10% for the Review Period

There is use of special entity vehicles to conduct research objectives, to isolate the risks away from the company if the research fails. (Think Google / Alphabet) However, there is a risk of fraud and related party transactions. Its growth is partially organic and partially through continual acquisitions, some of which is its special entity vehicles. However, even the auditors cannot come to a definitive conclusion that whether the acquisitions are priced too high, given the nature of technology companies. There is sharing of resources by various businesses within the Silverlake Private Entities group, leading to economies of scales and general low overheads.
Revenue Component     Percentage of SAL Group  Revenue     Profit margin per Financial Statements
Licensing     25.5% -30.0%     90.2% -90.7%
Maintained and enhancement services     42.0% -54.9%     58.1% -62.4%
Software Project services     11.6%  -19.4%     23.2% -27.8%
Sale of hardware and software     1.2% -6.5%     20.9% -37.8%




Despite being in the clear, there is clear evidence of the complexity of the agreements and corporate structure. The conclusion is that the special purpose entities overall has no book value loss for Silver-lake. Technically speaking, the company has profited from its acquisitions and it is only investor sentiment that drove down the share price of the company. The underlying fundamentals of the company remain unaffected. If I should ever enter into a position at Silver-lake, it MUST be a small position due to the immensely complex structure of the company.

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