SATS is Running the Risk of Overpaying for its WFS Purchase

Recently, in forums, there has been a mockery over Singapore entities (such as Temasek) overpaying for their purchases and then delivering low to negative returns (purchase of FTX, TSMC etc). Unfortunately, it seems another Singapore company, this time SATS, is likely to be overpaying for its purchase

$1.82 billion purchase of WFS

WFS is a air cargo company. Due to the e commerce boom arising from the need to stay at home during COVID,many air cargo firms experienced an increase in profit margins as the boom in e commerce was constrained by airline slots. Even Singapore Airlines (SIA) experienced a boom in air cargo business. However, in recent quarters, SIA is now reporting a decreasing air cargo volume. Given that SATS and SIA are closely linked, I am surprised that SATS still went on for the pruchase of WFS.

From WFS's financial reports, EBITDA profits is falling and this is due to margins reverting to the norm because the COVID boom has declined. I will not be surprised if SATS had waited a little longer, WFS's margin will fall from 13% to even lower in the single digits. Before COVID, its margins were at 5%, so its definite there is a reversion of the mean going on from the highs of 15%. I strongly believe, WFS's EBITDA has plateaued and EURO$200 mil EBITDA is the cap for now. Seen in this light, SATS is paying for 6.5 times EBITDA which is painfully expensive, I am not sure who is adivsing the SATS mangement but they are buying WFS at the wrong cycle.

WFS is coming down from a Peak (Boom) and SATS is recovering from a Bottom

One thing SATS has been touting is that the purchase is EPS accretive. Considering that SATS is recovering from a COVID bottom while WFS is coming down from peak earnings, it is quite stupid to pitch it as EPS accretive. When things normalise, will WFS be accretive? Based on its finanical results and SATS normalcy, I will say it is a definite no

During normalcy, SATS EPS is about 15-20 cents per shares. Assuming WFS is purchased at S$1.82 billion and net profits is approximately EURO$150 million (S$213 million) deriving from its current EBITDA figures, the expected earnings per share of WFS is only about 11.7 cents per share. It is not earnings accretive at all if we assume SATS business as usual scenario In fact, a simple metrics of 15 cents per share (this was when SATS suffered from 3 months of COVID effect in early 2020) indicates that SATS might be paying 25%. 

My gut feel is that SATS should go back to WFS and renegotiate for a lower purchase fee of SGD $1.365-1.4 billion; in terms of Euro coversion, that is about a EURO $1 billion price to acquire WFS. Anything more, it is a bad deal to SATS

From the purchase, my sensing is that the SATS investment team were only looking at recent data and were not considering the changing of trends as the world moves on from COVID. This is pretty poor decision making by the SATS board.

Reaching the point where majority of the United States Tech Sector is 'Defrauding' the World

In recent week, there is one recurring theme among the US Tech companies guidance- they are lowering revenue growth guidance. For example, Twilio/Palantir had been forecasting 25%-30% revenue growth, however due to the expected recession and crypto collapse, forward revenue guidance has been revised downwards.

This means growing their way out of losses into profits have been delayed and share prices have fallen. As these companies pay their Tech employees with a large propotion of share based compensation, the falling share prices means more shares are issued to US Tech workers and existing shareholders worldwide are being diluted faster and faster. For example, Twilio's issuance to its Tech workers for share based compensation is expected to increase to 6% of share base each year. This means for current investors, they are being diluted the worth of their shares 6% each year. 

US Practice of Generous Share Based Compensation will Make Investors Outside US Poorer

It is unlikely US will cut the pay of their tech workers by reducing the share based compensation while maintaining the amount paid in cash. US tech companies are unable to increase the cash payout as their operations are still cash burning and will be prolonged given the weaker economic conditions. Conversely, a lower wages paid to US tech workers will result in reduced consumption and in turn a localised recession to US. This is not palatable.

Therefore, global investors will subsidise the wealth effect of US society by being diluted of their investment values while US tech workers get a larger amount of shares and encash it so as to maintain their pay. Hence US will benefit while the rest of the world suffers.

It has not helped where even the retrenched workers are getting their share vestments and are getting a large amount of retrenchment benefits which are eating into the PnL of US Tech companies.

Growth Story No Longer There

It has not helped where US Tech companies revenue has slowed and they are unable to grow into profits in time. Rightfully, due to the declining share prices, US tech companies should move to paying their workers in cash. In the US property and REIT industries, the remueration of their workers has moved to almost a full cash payment so as not to dilute existing shareholders. This was evident when 2 out of the 3 SGX listed US REITs announced they would not be paid in shares but in cash so as to avoid dilution effect to existing shareholders. It happpened too in US listed REITs.

In short, the US Tech industry are still maintining their share compensation package because their promised growth story has not materialised and they prefer having their cash buffer to continue burning. Their Tech workers are highly paid individuals earning a 6 digit annual package. On average, each Twilio employee earns US$82,000 in shares per year and with part of their salary also paid in cash, it is conceivable that an average Twilio employee is earning a 6 digit USD annual salary.

In a way, the US Tech Industry is like a Ponzi scheme where the wealth/cash pumped in by investors are being dispensed out to its workers and early founders and employees by issuing more shares. These shares are then encashed by their workers and more shares are circulated (evident based on the earnings report of many US tech companies). Unfortuntately, as the world has already plonked the cash into these companies, it is impossible to stop it as Tech companies have an unfair structure where founders are given outsized voting rights relative to their stake. In the end, the world has been defrauded by the US Tech sector and a death spiral is looming with value destruction occuring. It is probably the fraud of the decade which may rival that of cryptos.

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.