What Many Tech CEOs are not telling Shareholders- Destroying Shareholder's Value by Paying Workers Shares

As many would know, the Tech industry offers an extremely good pay to its employees. However, to conserve cash as well as they tend to be cash burning in Ops, these companies pay their workers by offering a large amount of share based compensation. This works well when share prices are high but it dosen't work well when share prices are low. 

Let's show this using Twilio as an example. This is undoublty one of the better managed company with a product that is widely used by other businesses. However, it is likely share prices will continue to crater due to their compensation package and high pay to workers.

Twilio's Share Based Compensation Package

To attract talents, Twilio gives them a large number of shares as part of their pay package. At its peak where it had 7,867 staff, Twilio was paying them $650 million in shares as part of their pay package during the last 4 quarters (highlighted in green) ; this works out to an average of US$82,000 per year per employee just on shares based compensations.

Twilio Quarterly Results

As of end March 2022, Twilio's market capitilisation was US$30 billion, hence US$650 million equated to an issuance of 2% of shares or 2% in share dilution.

Fast forward today, Twilio's market capitilisation is US$7.8 billion, a US$650 million compensation package will mean 8% in share dilution every year. Even under the assumption that Twilio has completely retrenched 11% of staff, a revised US$578 million share based compensation equates to an annual 7% dilution in value. 

Twilio (and other Tech companies) cannot sustain such sky high pay packages to its workers  because it will just erode existing shareholders excessively. Its either their tech workers have to take a pay cut or more of their compensation has to be in cash instead of shares. The latter will affect the promises of Non-GAAP EBITDA profits made by CEOs.

Tech Companies Promising Non-GAAP profitability

Due to the downturn, tech companies have promised that they will be non-GAAP profitable; a dangerous promise that has been made by Tech firms both in USA and Singapore. The truth is that fulfilling their promises may mean existing shareholders will suffer a tremendous destruction in their current investments.

As seen in the Twilio example, maintaining the same pay and amount in share based compensation will mean a massive dilution for existing shareholders. Yes, these tech companies can reduce the share based compensation and pay their workers a larger proportion in cash. However, this affects their non-GAAP profits as more cash are expensed. The CEOs will fail to deliver their non-GAAP profitability promises within the target deadlines.

Either way, it is likely Tech companies will be severly diluting shareholders due to them paying their Tech workers too well (in shares) or share prices will crater because the CEOs fail to meet their profitability promises.

CEOs of Tech Companies are making dangerous promises to the market and its shareholders. Either it has to cut the pay of its Tech workers or it has to destroy the value of its existing shareholders.

The Constant Rate Hikes in US is creating a property and insurance problem in Singapore

 That's my thought based on the following facts I have learnt during my time in the market:

(i) A rising interst rate reduces bond prices

(ii) A rising rate reduces share prices due to an increase in discounting rate

(iii) A rising rate increases interest expense

The Property Problem

To summarise, there are many local funds leveraged to the hilt during the era of low interest. A group of them are property workshops that have attracted many "wanna get rich" people. The idea is simple- (a) buy a property, (b) max the leverage pay the low interest of 1.8-2%, (c) get rental yield, pocket the difference of interest (c) and (d) while waiting for your property to appreciate, (e) repeat Step (a) to (d) by buying another property.

Here is the problem, the Fed's hike is creating (b) a higher interest expense while (c) is not rising fast enough. It will come a time where holding a property is loss making and with leverage so high, margin calls may come. A wave of property selling is due and with it a spiral down in housing prices and margin calls. This is why the government has altered the projected interest rates in TDSR projections as they want owners to be prudent.

Singapore has been remarkly resilient. Our risk free rates (SORA) have risen by only 2.0% (from 0.2% to 2.2%), while other countries like US has seen a 3% interest hike. This is not going to hold forever. Globally the risk free rate is 3.25% now and Singapore is an "interest rate taker" due to the economics principle of impossible trinity. T-bills which are more senstive to global movements are now priced at 3.2% which tells you the actual interest rates Singapore should be. Our country's interest rate is growing slower by 1% which defies the logic of being an "interest rate taker".

Eventually Singapore interest rate will catch up with the global rate increase. With US fed rates expected to be at 4.25% at year end. I expect in 2023, we will see SORA rates moving from 2.2% to 4%. With  property owners here on high leverage, a higher interest expense will mean less money in their pockets, reducing their consumptions.

The Insurance Problem

Many of us own whole life, endowment and savings insurance plans. Such policies have a non guranteed annual return which is based on the value of investments in property, bond and shares.

Referencng to the 3 facts, it follows: properties are down, bonds are down, shares are down. This means for this year and probably the next, insurance funds are drawing down on its smoothing reserves to generate returns to policyholders. This is because their investment returns are likely negative. While inflation remains high, insurance returns will be low; indicating the real returns for insurance policy holders are negative. For policy holders holding insurance products, it is a bad time to die or surrender policies during these few years.

Sea Group has a further downside to $30+ unless....

For the past 2 weeks, Sea Group has made headlines by retrenching and closing down operations. The press release/letters by the CEO is the goal of "self sufficiency".

Weirdly, based on information, it seems Sea is not cutting or downsizing at the right places to be self sufficient. In fact, without doing this, it is likely shareholders will face a further 50% losses.

The Main Problem to Self Sufficiency

Shopee Brazil is the problem. Without it, Sea Group will be self sufficient. This is derived from CIMB's report

                                                                 Shopee Results

To clarify the terminology of EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation), EBITDA is one of the closest guage of cashflow generation. A positive EBITDA means a company is generating cash and self sufficient. An important point is that a positive EBITDA may mean the company is reporting accounting losses. So a positive EBITDA is a bare minimum to being self suffiicient and what Sea Group CEO, Forrest Li, is alluding to.

For year 2021 and 2022, the biggest cash burner (excluding HQ) is Shopee Brazil at about US$1 billion per year. Without Shopee Brazil, it is definite Sea Group on a whole can be self suffiicent by 2023, generating positive cash. 

The 2025 Time Bomb

Sea Group has US$7.8 billion in cash and short term investments currently. By 2025, it has about US$2-3 billion in maturing covnertible bonds, without a share price of US$90, it is definite bond holders will ask for cash instead of shares.

With about a cash needs of US$1-2 billion to sustain its main 3 segments, the continous burning of cash by Shopee Brazil from there to now of US$3 billion is putting Sea Group on a whole in danger of having to raise cash in 2025 to save itself. 

Conclusion

Without closing Shopee Brazil, Sea Group is going to find it difficult to achieve self sufficiency by 2025 and investors will be in a world of pain. I expect a collapse of share price until $30+ as long as Shopee Brazil remains in operations.

The closure of Shopee Brazil will save at least $1 billion in cash each year and enable Sea Group's survivial from 2023 onwards.

Putting Deposits with Singapore Banks will Make You Relatively Poorer

Recently, there were 2 hour long queues to place fixed deposits with Singapore banks. To me, it is not financially wise as there are two Singapore Financial Products available to all Singaporeans and are providing higher rates - (i) Singapore Savings Bonds (SSB) and (ii) 6-month Treasury T bills issued by Singapore.

Both are yielding more than 2.6%. In short, if you are placing Fixed Deposits (FD) with banks, you are becoming relatively poorer to others who put in SSB and T bills.

Higher Rate better Credit Rating than Singapore Banks

Below are the current rates for SSB and T-bills.

SSB- 2.6% for first year and eventually rises to 2.99%. Can be applied at any ATM as long as you have a CDP. 

T-bills: Shorter duration than SSB or FDs (about 6 months). Current rate is about 3.3% per annum, which is the highest. Only downside is that you will need to hold to maturity about 6 months to a year. Individuals can approach a bank manager to enquire on how to apply. My advice will be to select the non competitive tranche to get allocation. T-bills are subject to institutional investors bidding and given the high interest rate environment, they are bidding around 3% for Singapore T-bills.

What's even better is that SSB and T-bills are issued and backed by the Singapore government that has higher credit rating than our banks. A higher interest rate, better credit rating, short duration or no locking you up- what better way there is than to invest in our government's SSB and T-bills

Do not be Tricked by Bank Staff

Unfortunately in Singapore, most bank staff are sales driven and will peddle you products that are not in your best interest. Forget about their talks of saving investment products. While they are higher rates (in the T-bills interest range), they lock you up for a longer duration than T-bills and early redemption results in penalties. SSB has no penalty for early redemption and T-bills while they lock you up, are at most a 1-year duration.

If you want higher rates, go for Singapore T-bills they are as good as investment products and lock you up for less than 1 year. The products being marketed by banks lock you up for a longer period and have financial penalties for early redemption.

Right now as interest rates rises likely to 4-5% level, you do not want to to be locked at such low rates. SSB and T bills offered by the Singapore government is currently one of the best ways to grow your wealth at close to risk free, as opposed to the Singapore banks.

This article is not a sponsored post from the Government of Singapore, but to remind individuals that investing in Singapore banks are making you relatively poorer. The author believes in writing neutral articles with no financial motives. 

Portfolio Update Sep 2022

As mentioned in my older posts, I have planned to sell my SOE & other investments and shift the proceeds to Yangzijiang Financial Holdings (YZJFH). I have completed this.

This is because with the clarity of its debt investments provided by YZJFH, it indicates a deep discount which will make the investment worthwhile. The company has followed up on their thoughts that the market is undervaluing their business by doing large share buybacks. You can read my thoughts of YZJFH fair value here.

I have also bought a few Alibaba shares due to the recent sell down. 

The current portfolio composition is as follows:

I don't foresee any more significant portfolio changes unless such a deep discount situation re-occur.

Yangzijiang Financial: High Returns and Clarity on its Investments

Yangzijiang Financial (YZJFH) had released an announcement clarifying its assets and its composition. Below are the key points:

1. Investment Portfolio: 57% in Debt Investments, 14% in PRC equity, 11% in Singapore as Cash, approx. 12% in China in cash after receiving proceeds from short-term investments (see Question 25), approx. 6% in microfinancing

2. Clarity on its Debt Investments: YZJFH lends it to companies via a close loop system and it is secured against the joint venture's assets and land which are about twice the amount of the loan it gives out (see Question 3) and PowerPoint on its collateral held. 

Valuation of YZJFH

Using a Sum of Parts valuation, we will ascribe a discounting factor for each portion of YZJFH portfolio.

For cash, we can set it as 100% because this is cash held in bank. For debts, given that YZJFH has clarified they are collateralized with a high amount of security such that a default by its loanees will not result in large impairments, a 90% factoring is sound.

For equity, to be safe, it will be set at 50% of its value. This is similar to the book value of Hotung Investments and TIH which are listed on SGX.

This means a fair value of YZJFH is $0.890.

		Reported Assets	$4,450,000,000
		Discount Factor	Value
Debt	0.57	0.9	0.51
Cash	0.23	1	0.23
Equity	0.14	0.5	0.07
Microfinance	0.06	0.5	0.03
		Implicit Value:	0.84
		Implied Asset Value	$3,751,350,000
		Liabilities	$281,466,000.00
		Value to Shareholders	$3,469,884,000
		Outstanding Shares after share buyback	3,850,000,000
		Value per share	$0.890

Summary

Given the company has clarified on the components of its investments, been aggressively doing share buybacks for two weeks and clarified on its 40% dividend policy, YZJFH is undervalued and has a potential to provide a 130% return at the current price of 0.38. The company is a 6% dividend yielder.

To me, this is a strong buy and I will start re allocating my China Investments in Tencent Music and various SOEs to YZJFH. This is because I want to cap my allocation to China. It is good to know YZJFH provides the same dividend rates as my current China stock holdings but with added knowledge that I am investing in a company with a Singapore presence.

Yangzijiang Financial Holding Review- a 6% Dividend Company in Singapore

Yangzijiang Financial Holding (YZJFH) results are relatively muted- interest income was slightly lower due to the shifting of cash from China to Singapore rendering it not invested. Earning per share wise- the first half saw 3.45 cents earnings. I foresee the full year earnings to be 7 cents.

Based on its dividend policy, this means at the end of the year, an investor should expect a 2.5-2.8 cents dividends. At current share price of 39 cents, this means a 6.7% dividend yield

Risk- High exposure to China Real Estate Sector 

From its PowerPoint briefing (pages 24-27), YZJFH has about 43% of its $2.5 billion PRC debts in China's real estate and construction sectors. This works out to $1.07 billion exposure to China's property sector.

As a proportion to its s$4.5 billion asset, YZJFH has a 23.7% exposure to this sector. This is quite a large exposure to the declining property sector that China is trying to rescue.

However, one positive is that most of the debts mature in a year time. I hope YZJFH is prudent and not renew such debts to China's property sector. Given that YZJFH has a high collateral to the sector where the companies pledge two time the loan amount; if the China's companies are unable to pay up, I hope YZJFH will force sell these companies' assets. There is just too much exposure 

Explains the High Dividends

Given the high exposure to China's property sector, I think this explains why its dividend yield is at 6.7%. China's national bank, ICBC, has about 31% in loan exposure to China's property sector and yields 7.4% in dividends. 

Company Share Buyback

Despite the approval by shareholders for YZJFH to have a s$200 million share buyback this FY. The company has been very slow in executing it. In fact, YZJFH has only utilized $9 million in share buyback.

On 12 Aug, the company has hastened its share buyback and bought $1.5 million worth of shares. From now to the end of April 2023, YZJFH has the capabilities to make $1.3 million in share repurchases each trading day under its mandate. CEO Mr Toe has been highlighting in presentations how the market has been undervaluing YZJFH. 

As an investor, I will be judging him based on his management team's execution in their share buyback. Shareholders have approved the mandate for him to do a large amount of buybacks; however the management has been extremely slow to deploy. As seen in the slides, YZJFH has s$480 million in cash in Singapore, it is definitely able to execute a buyback of s$200 million anytime as its fund management business requires only s$250 million this year.

The share buyback execution from now to the end of this FY will be key to show if Mr Toe does mean his words. As the trading volume is 4-5 times its buy back volume, there is no reason for YZJFH not to do buybacks if their CEO does feel the company is undervalued.

My Action

I have started switching some of my funds from Sinopec and Tencent Music to YZJFH. This is to maintain my exposure to China at a limited proportion. To me as a financial company, I do feel YZJFH is undervalued as well. Basing on comparable to ICBC and CCB, YZJFH smaller exposure to the China property sector and that its results are audited in Singapore should lend credibility to the company's assets. 

I am valuing it to be a 5% dividend company and have an internal price target 60 cents at a future dividend of 3 cents. Hence explaining my reallocation.