Swing Media Technology Group

I spend my days looking at companies and their annual reports. And what I do on a daily basis is to try and understand the businesses of these companies from these annual reports. The annual reports, the financial statements and the notes to the financial statements can give you an understanding into the operations of the company that one is researching. Amongst my favourite places to search for undervalued securities are stocks which are trading below book value.

According to tweedy browne’s “What has worked in investing”, companies which trade at a low price to book value on the whole tend to do well. Portfolios created out of low price to book entities normally have market beating performances over the long run. So this is one of those places where I’d like to start the research process. Businesses are incredibly diverse and everyday is part of a meandering learning journey which should be accretive to our knowledge base. And this happens, when one reads annual reports every single day. How did you think Warren Buffet get so good at what he does?

Swing Media Technology Group was one of those companies which I awoke to one morning.

The company  in question has been listed on SGX since 2002. It describes its business as one of Hong Kong’s leading manufacturers in DVD-R, CD-R, chemical dyes and stampers. What comes to my mind immediately is that the company is surely in a sunset industry. I mean how could they compete with thumb drives and flash drives?

But let us look at the annual revenues of the company.

At a glance, the company seems to be doing well. If one were to analyse its reported after tax earnings, it also seems that the company is doing well.

The net income for the last 10 years grew from 33.5 million to close to 70 million . If I may add, very simply looking at it that way, the company is impressive to say the least. The revenues and income attributable to shareholders are on an uptrend.

It only becomes apparent that the company is burning cash when one analyses the  free cash flow figures over the years. For the years 2007 to 2016, its free cash flow figures were negative according to morningstar.Look at the table below.

So investors look upon earnings as a measure of economic performance of the company and often times, they are wrong about the true earnings of the company. One of the best metrics to get a good gauge of a company’s economic performance is the free cash flow metric.

If the free cash flow is positive, there is much that the management can do to maximize the intrinsic value of the company. The company can perform a share buy back, give a special or hiked dividend to reward shareholders, pay down debt and even use it to help grow the business.

So as it stands, free cash flow is negative for the last 10 years. What can the reason(s) be? One of the reasons is that Swing Media operates in a capital intensive business. And that being the case, the capital expenditures of the company are hefty just on maintenance alone. Now in the case of Swing Media, we did see revenue growth over the years, albeit, a gradual one. So it appears that part of that budgeted capital expenditures were also allocated to grow the company.

In the case of Swing Media Technology Group, we see a classic example of a company earning a positive after tax earnings due to accounting convention but generating negative free cash flows over its operating life from 2007. Now that is a long time coming. And I think astute investors know that. The markets knows that. The markets also do know that the company has a chest of cash within its balance sheet  and that its dividends paid have fallen over time. Apparently, management has other plans with the cash and there may be no plans to hike dividends. They can’t anyway! Free cash flow is negative! They need the cash to be invested in a low return business that produces a facade of growing revenues and profits. They also need to be in the stock market to raise money, just in case, they are short of cash. And if I may add, investors have been fairly generous with the company.

Capital Raising

These are the instances that I can find that Swing Media has raised cash.

  • 2010, Swing Media proposes renounceable non-underwritten rights issue of 483307883 new ordinary shares
  • 2013, Swing Media proposes rights issue of 73.9 mill new ordinary shares
  • In 2014, the company proposed 1 rights share for every 2 ordinary shares held.
  • 2017 , Swing Media raises $5.1 million through a share placement to 7 investors, including 2 clients managed by Look’s Asset Management.

Now, do you see a pattern of over reliance on capital markets. Time and time again, Swing Media Technology Group has looked towards its investors for cash. And time and time again, investors have willingly parted with their hard earned money.

This is also the reason why the debt of Swing Media Technology Group is only 17% of the company’s equity. Without the  capital raising through rights issue and share placements over the years, you would have seen a balance sheet with a lot more debt than what we currently see. Why? The reason is that the company can either fund its operations through debt or equity. In a low return business, insufficient free cash flow forces the company to raise debt or equity. Swing Media has opted to raise cash from equity instead, on the part of management, a wise move. But how beneficial is it from an investors point of view?

If  a company is in a high return business with low capital intensity, the capital raised from investors could very well increase the intrinsic value of the company. But if a company is in a low return business, the cash that investors provide to the company will not lead to payoffs that the investor wants – Increased earnings per share and dividends. Of course, this is an oversimplification of the matter above and can be rather subjective from investor to investor.

As it stands, this is the earnings per share record of Swing Media Technology Group on a diluted basis.

That does not look pretty. Earnings per share have been on a decline for 3 years. And the charts look like this:

Source : www.ftmarkets.com

But what I am going to say next is going to sound contradictory. I can’t proclaim to love Swing Media Technology Group as an investment. But what I do see here is a possible play on assymetry.

The price to book ratio is only 10%. And what we see currently is a pattern of insider purchases. Management is also planning to embark on a diversification of businesses into farming in Australia. I am not sure about the economics of the farming business but I do see an attempt being made at carving out something new from its filings. This remains to be seen of course and it is at best speculative on my part. What I would like to see is a transition to a less capital intensive business and a liquidation of its dvd and cd manufacturing business thereafter. From there the business could take a life of its own again, hopefully, with a more positive slant to it.

Clearly, this company is not for everybody. Do your own due diligence and if anything at all, treat this as an educative article(but not a recommendation to buy or sell) on how management can use excessive capital raising to run its operations and by  doing so, dilute shareholder wealth to a large extent.

 

 

 


kingsley

I have been an investor for 15 years now and my journey has meandered from Warren Buffett to Ben Graham. My start, like many, really was the naive idea that Buffett's skills could be replicated in some fashion. I was proven wrong when some of the supposed stock picks that I chose had dismal performances. Then, I learnt that it is no point trying to be someone I am not. Gradually, through failure and some success in deep value investing, my approach towards stocks gradually shifted to an approach based around Graham's techniques. So, I give credit where credit is due and to Ben Graham, I and many other investors around the world, owe him a great deal. So, if you want to read up on biographies, read about Ben Graham. His seminal work, Security Analysis is a gem. My books are just rich interpretations of what he has taught.

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