Threat to Singtel and other Telco Profit Margin- TPG Offering Unlimited Data Roaming in Malaysia and Indonesia

Singapore’s 4th Telco TPG wasted no time in firing a fresh salvo against the telco big boys (Singtel, Starhub, and M1) by offering free unlimited data roaming in Malaysia and Indonesia as part of its many innovative services to its current subscribers. To prevent the potential loss of customers, Singtel and its brethren may very well be forced also to match the new service offering. In 2018, around 10.2Mil Singaporean visits were recorded by the Malaysia Tourism Board. Most Singaporeans would have activated the special promotional package of S$5/GB for such trips across the causeway. There is thus a potential total revenue loss of at least S$51Mil which used to flow directly into the Net Profit Margin of the current 3 telco players that have been dominating the Singapore market for close to two decades.

On the topic of overseas data roaming, many colleagues and friends that I know of, have often found themselves in the predicament of paying for exorbitant data roaming charges while in Malaysia or Indonesia (Batam or Bintan in particularly) as most would have forgotten to activate the promotional package beforehand. A typical situation would be that once you reached Malaysia or Indonesia, one would then switched on the phone or switch off the “Plane mode” and the SMS and emails would then have “flooded” your phone before you can activate the S$5 promotional offer package for the data roaming via SMS. Hence a few dollars would have been wasted and most folks would not have bothered to appeal for a waiver. This is actually quite a common and irritating problem. Hence TPG’s move to implement the free data roaming for Malaysia and Indonesia will definitely be appealing to price-sensitive consumers. 

I do look forward to more innovative products and services offering from TPG to disrupt the local telco market to benefit local consumers. There is no doubt that Singtel, Starhub, and M1 are going to face intense competition and downward pressure on their profit margin over the next 2-3 years. While “market experts” have frequently asserted that the local market cannot sustain more than 3 telco and the industry will eventually consolidate, the fact remains that the telcos still have a fat profit margin and are not in a loss position. I believe that there are still enough fats to be trimmed off and passed on to TPG and consumers. Well, at least this is good news for consumers albeit bad news for investors of Telcos.

Investment Portfolio Updates- 19 June 2019 (Market Rally In the Face of Imminent Global Recession?)

The see-saw ride in the global markets continues since my last portfolio update in April’19 with no clear end in sight. The US levying of tariffs on China and a swift retaliation from China leads to a tumbling of many blue-chip companies listed on the Singapore Stock Exchange. However, over the past 2 weeks, the market had rallied strongly despite weakening macroeconomic fundamentals. “Defensive stocks” such as Singtel and REITs have also seen their prices shooting up like a rocket. The surprising aspect of this is that while the Federal Reserve has given some indication of halting of interest rate increase, this does not mean cutting of interest rates but more of mere hinting. Still, the global market rally on optimism that interest rate cuts are definitely coming which will save the global economies.

One point to note, as per the last global financial crisis in 2008, is that defensive REITS or telecom companies will also be adversely impacted by a global recession and their price will also drop drastically albeit at a slower pace than the blue chip counters. The current trade war has already led to slowing down of trade and also higher goods and services prices in US and China. We are already seeing more and more bad news emerging with regard to the status of the global economies. To side track a bit, this time round, I am not sure whether we can still classify Singtel and Starhub as defensive in nature in view of the declining profit margin of their telecom and Paid TV business segments.   

The bulk of my investment portfolio is held in the form of REITs (approximately 69%). However, I am not particularly excited about the current June’19 general rally in REITs prices. I do not have a crystal ball that can peek into the future to know whether this is the perfect time to sell and then wait for the prices to plunge if the global economies really sink into a global recession in the 2^nd half of 2019 in order to re-enter into the market to exploit market timing. I have seen too many cases over the past few months whereby a lot of enthusiasts exited most of their REITs investments while waiting for the calamity to befall the human race but sadly, they would have missed out on the quarterly dividend stream and also recent rally in prices. My preference would be to collect the dividends and if the market really tanked, to aggressively raise cash level to buy up any undervalued assets.

Also, I decided to put in my small amount of NTUC Income shares- which I kept forgetting previously- into my portfolio tracker to handover to my next of kin for further action if I ever get into an accident. The only regret which I had was not buying more of the NTUC Income shares before the management call for a halt in new shares issuance to policyholders. The bad thing about NTUC Income shares is that its unit price is always fixed at S$10 per share in the event of resales to another party. 

Some quick highlights of the main adjustments I made over the past 2 months:

(1)        Participated in the rights issue of Fraser Centrepoint Trust

Got my 589 units off the non- renounceable preferential rights issue and on top of that, I found myself lucky to be allocated a further excess rights subscription of 1,511 units. Hence total 2,100 units @S$2.35. Compare to the market price of S$2.59, this is an effective S$500 discount to the current market valuation.

(2)        Accumulated additional units of Netlink Trust and Keppel DC REIT

Netlink Trust has shown good earning capability while Keppel DC REIT has very long leases with its tenants (WALE 8 years).

(3)        Sold off part of Starhill Global REIT

Took profit. Orchard Road concentrated malls are exposed to higher recession risk due to dependence on tourists instead of local consumers. This is to reduce my exposure as I already have significant exposure from Paragon via SPH REIT in view of the worsening economic conditions. My preference is on suburban malls due to local high-density living and relatively controlled supply of retail spaces.

(4)        Sold off most of my Perennial Holdings

This is currently my worst performing investment. I think it is severely undervalued as most of its China concentrated projects are still work in progress and the market slapped it with a super high-risk premium. The recent financial results announced in 2019 is also horrendous with high financing cost of City Hall Capitol buyout of stakes from another major shareholder (to end longtime partnership dispute) as well as slow ramp up in occupancy. Redeployed the cash from disposal into the rapid growing SingMedical group.

(5)        Accumulated additional shares in SingMedical Group

Please refer to my recent posting here. In addition, I noticed that a number of directors have either purchased more shares directly or purchase additional shares via exercising their share options.

(6)        Purchased additional units of FIRST REIT

Accumulated additional units of FIRST REIT when its prices dropped below S$1 per unit. Sponsor Lippo Karawaci has already completed rights issue to raise cash. Also, once the divestment of the shopping mall from Lippo Karawaci to Lippo Mall REIT is completed, it should further shore up the financial position of Lippo Karawaci to avert rental default of FIRST REIT at least till end of 2020.

New Lease Accounting Rule Impact On Companies and Investors- Making Something Out of Nothing

The new accounting standard FRS116 on leases came into effect on 1^st Jan 2019. The “right of use” asset model basically attempt to plug the loophole of off-balance sheet liabilities. Basically, for operating lease assets, companies are now required to capitalize the present value of future lease payments of such arrangement as a direct fixed asset and also to recognize a theoretical liability. This gives rise to a strange phenomenon whereby an arbitrary financing cost is also created monthly for the right of use of the asset during the unwinding of the interest component in the lease liability. From the cash flow statement perspective, companies now have to account for the monthly lease payments into (i) repayment of principal portion and (ii) the cost of financing the “right of use” asset. From a retail investor perspective, it does lead to massive confusion over the understanding of the traditional Statement of Comprehensive Income (Profit and Loss statement) as well as cashflow statement.

Majority or only a minority of companies affected?

Majority of companies are being impacted by this change in accounting. For example, most business would definitely have an office lease or industrial premises lease. Since the lease of premises is one of the huge cost components of business, this impact can be very significant on the financials.

To illustrate this, a company may have signed for a 5 year industrial lease for S$120K per month. Total contractual obligation thus amounted to S$7.20Mil over 5 years. Under the new accounting rule, the present value (assuming the benchmark incremental borrowing rate is 3.5% and the landlord requires prepayment on 1^st day of month) of future lease payment will be S$6.62Mil. The differences of S$584K is deemed as the financing cost over the 5 year period.

Key parameters to work out the present value of lease payments

What are the differences between the new profit and loss impact relative to previous method on lease accounting?

Instead of recognizing rental expense in a straight line over 60mths under the old method, the new accounting rules does not have any rental expense for operating lease with the exception of low value or items less than 1 year. The new accounting rules recognizes (i) depreciation and the theoretical (ii) finance cost of liabilities unwinding into the profit and loss consideration.

The mind blogging aspect is that the new rule loads up expenses upfront at the onset of the first few periods of the lease period whereas the previous method has a simpler approach of constant and equal lease expense every month. This is illustrated in the screenshot from period 1 to period 60. The fluctuating figures make it hard to do an accurate forecast of the future business performance with the declining profit and loss impact especially towards the end of the lease whereby the liabilities have been significantly lowered hence very little finance cost at this juncture.

 

Screenshot of monthly profit and loss impact of new recognition method vs previous method

The experts who implemented this new rule rationalize the fluctuation by justifying that this is the realistic application of the time value of money concept.

Further confusing aspects of new accounting rule

1.   As mentioned above, the new accounting rule stipulates the recognition of operating lease has exceptions for low carrying value lease contracts or contracts for less than 1 year. What this meant is that the rules still allow one to use back the old method for such “immaterial” lease contracts to cater to complaints from commercial practitioners on the practicality of implementation for every operating lease in their business which will be too onerous.

2.   If the operating lease contract comes with an option to renew upon the end of the contracted lease (which is actually very common), the new rule requires one to use a judgmental estimation of the probability to decide whether the contract period should take this additional option into consideration to derive the total value of future payments for lease liabilities. Once you leave things to judgment, hell breaks loose eventually and leads to big fluctuation in future financial results.

Summary

I do not like the new accounting rule as it makes an assessment of current potential businesses identified for investment more complex due to the monthly fluctuation and the additional mental acrobatics during analysis. It also makes the overall profit and loss weird with front-loading of expenses and then a favorable impact towards the mid to end point of the lease. But it does have added transparency to potential investment company statement of financial position by bringing in contractual lease obligations into the gearing ratio.

Sing Medical Group Déjà Vu- Undervalued Stock Price Increased 20% But Price Collapsed Again Recently

Since my last posting on the “The Enigmatic Case of Sing MedicalGroup- More Money Earned Lead to Lower Share Price” on 8 January 2019, the price of Sing Medical Group has shot up by 20% from S$0.400 to S$0.485 within 2 months. However, its share price has since plunged by 22% to a low of S$0.380 on 7 June 2019. If one had the ability to see the future using a magical crystal ball, then one would have sold off in Feb’19 at S$0.485 and then buy again when it hit S$0.380 recently and locked into the profit. If it can recover to S$0.480 level, one would have made a staggering 40% profits. Of course, I am saying this with the benefit of hindsight. I know of a retail investor who subscribed to value investing sinking in up to S$100K over the past few months into Sing Medical Group (“SMG”) and the recent plunge in stock price would have been disastrous. So, what exactly happened here for the price to have plunged so dramatically again and most importantly, the key question is whether the share price of SMG is severely undervalued again?

The very peculiar nature of Sing Medical Group share price

The strange thing is that whenever the financial results showed improvement or if it issued rights to raise funds for M&A opportunities, the share price will go the other way. The recent sharp drop in share prices maybe also due to existing shareholders punishing the management team for selling off part of their shares at SGD 0.605 to CHA, the Korean Medical Group and existing investor.

1. Excellent Q1 2019 financial results but share price tanked

The recently announced results of Sing Medical Group is excellent. Revenue increased to SGD21.6Mil  relative to SGD19.2Mil (+12.3%) on a year to year basis due mainly to growth in its Diagnostic & Aesthetics segment while Net Profit After Tax dropped <3%> in view of lower tax exemptions and lesser carried forward tax benefits. Since we cannot control statutory taxation, a better gauge would be to look at the Net Profit Before Tax which increased by 0.9% (the increased revenue is being offset by increase in marketing expenses). Despite the wonderful Q1 2019 results, the share price of Sing Medical Group tanked.

Many shareholders have been extremely disappointed with the lack of dividends being declared. Last year, the management did raise the possibility of a formal dividend policy in the new financial year but have since remained silent on this issue. Despite the high profits made, SMG has been aggressively reinvesting the proceeds into opening new clinics. A new pediatric clinic in Punggol has just been opened recently this year. A new Breast clinic and its specialist has also just come on board SMG. There are other plans to increase the number of specialists by another 7 to 8 which means revenue topline is going to continue to expand rapidly but profitability may be hit in the short term while ramping up patient loading.

2. Punishment by investors in retribution against the management for selling their shares at S$0.605 to CHA Medical Group without a general offer to other shareholders and proposed S$10Mil convertible loan to shares at a low conversion price of only S$0.423 per share.

Many existing shareholders in investment forum have been upset by the existing management selling off part of their shareholdings in SMG. CHA Medical Group has valued the shares at S$0.605. This exercise was just recently concluded. Compare S$0.605 independent valuation against the current price of S$0.380. This represented a 59% discount of the independent share valuation should the price hits S$0.605 in future.

Even for the S$10Mil convertible loan by shareholder CHA, the price of S$0.423 against the current market price of S$0.380 represented close to 10% discount for new investors entering at the current market price. This means that your investment automatically gain a 10% discount premium of S$1Mil out of S$10Mil cash injection by CHA medical group- free hard cash put in by the other shareholder to increase your margin of safety.  

3.Jinxed Fund Raising Exercises

Whenever there are rights issues or offer of convertible loans to shares, this always spell bad news for existing retail shareholders albeit improving revenue and future profits. This is because the share price will most likely plunge after this exercise. This has a lot to do with the lack of tangible returns to shareholders as alluded to point 1 above. There is thus currently an unhealthy downward spiraling cycle in its share price whenever SMG raised funds for expansion as the market seems overly risk-averse to the business of SMG. This is clearly a stark contrast to the industry PE average based on S$0.380 per share being traded.

Parting Thoughts

SMG management needs to seriously look into immediate actions to revive the share price. This is paramount as SMG will always need to give an increasingly huge discount of its intrinsic value to fund its aggressive growth initiatives which resulted in a perpetual downward cycle. I maintain my view that the share price will grow 20% by end of this year and with a potential for 50% growth in share price over the next 2-3 years if the management continued with SMG expansion. The increase in share price by 20% and then a decline of more than 20% represents good buying opportunity. I have accumulated extra SMG shares as I think that the management has been delivering and executing well on its expansion plan. The strategic partnership with CHA Korean Medical Group will also strengthen SMG.

Last but not least, at the current low share price of S$0.380, there is a probability that some existing corporate shareholders or perhaps Dr Beng himself may buy out the other shareholders and delist the undervalued SMG. After building up the medical group over the next few years, the controlling shareholders can easily go for IPO again at a better valuation to realise their investments. This is also the strategy employed by our local billionaire and business tycoon Peter Lim on Thomson Medical Group.

Pls also see my previous postings:
(i) Hidden Gem with Explosive Growth- Potential Further Upside of 25% to 50% (Part 1);

(ii) Hidden Gem with Explosive Growth- Singapore Medical Group S$10Mil Shareholder's Loan for M&A (Part 2)