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.

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.