|Shares Out. (in M):||519||P/E||0||0|
|Market Cap (in $M):||285||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
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When the Chairman and CEO of a listed Singapore company quoted Seth Klarman in his 2014 annual report, we took note. Boustead Singapore (BS) has a 180year history as one of the oldest trading companies in Singapore. The current company is the brainchild of Mr Fong Fui Wong, who paid S$80ml in 1996 for a company, which he thought, had more brandvalue potential than actual bookvalue (S$27ml). At the end of FY2015 and prior to the spin-off of the real estate business the BV was S$ 380m and after-tax profit S$63m.
Boustead Singapore today is a conglomerate of 3 businesses: 1/ geo-spatial technology, 2/ real estate and 3/ energy-related engineering services.
Different headwinds in all 3 businesses have resulted in an impressive decline of the share price to a level where we believe the risk-reward is now very compelling.
An investment in Boustead Singapore buys you, net of excess cash:
1/ a high margin, high return (avg PBT/Net Segment Assets of 72%) geo-software distribution business with a long runway for growth at 6X Normalized After Tax Earnings,
2/ a portfolio of leased industrial real estate in Singapore at a 50% discount to market value and an implied rental yield of 14.8%, with management working towards an exit through a REIT listing,
3/ an energy engineering business at an undemanding 3.5X average historical After Tax Earnings
4/ an owner-operator with an excellent track record for creating shareholder value. Since 2006 BV/Share (incl. Dividends) compounded at 25% p.a. (higher if properties would be marked to market)
Think of this as something like a professional Google Maps on an industry leading software platform with the best interoperability designed for corporate and government critical services. Google actually made an attempt to break into this area, but handed over the space to ESRI in the beginning of 2015. The key companies in this division are the joint ventures with ESRI; ESRI Australia and ESRI South Asia (comprising ESRI Singapore, ESRI Malaysia and ESRI Indonesia) that provide professional services and are exclusive distributors of ESRI geo-spatial technology – the world’s leading geographic information systems (“GIS”) – to major market sectors across the region. The division’s GIS technology platform and professional services are used by over 13,000 government / military / private organisations to effectively plan, deploy and manage key infrastructure and resources. The division is consistently ranked among the top five distributors in ESRI Inc’s global network (#3 currently) and was the fastest growing distributor over the period 2008-2013.
BS 88% owned subsidiaries (Esri owns 12%) have exclusive distribution agreements, which are renewable every 3 years when certain KPI’s are reached. According to IR these KPI’s are easy to reach for BS whose relationship with ESRI extends for over 30 years. US based ESRI only distributes its products locally and works with distributors for the rest of the world. In ESRI’s 40 year history and out of 80 distributors only 2 agreements were ever terminated and in both cases the reason was fraud.
BS describes its products as an operating system for geospatial where clients build their own solution on top of the supplied operating system with software, advice and training provided by BS. Software sales represent 20-30% and recurring revenues 40-45% of total sales. The company claims a retention rate of 99% as a result of very high switching costs, and offering the best-in-class product for decades
BS generates most of its revenues from government entities for whom data protection, support, stability, interoperability and scalability is important. A large diversified user base is also a competitive advantage as government departments are likely to prefer the same software used by other departments they cooperate with.
Demand for geospatial is a function of the size of the country (manage infrastructure, natural resources etc. ) and its economic development stage (internet usage, smartphone penetration etc.). This explains why BS generates approx. 75% of its revenues and profits from Australia. Singapore is developed but small and Indonesia and Malaysia have lots of untapped potential. ESRI generates approx. 60% of its revenues with government entities but this figure is much higher for BS’s ESRI distribution business. BS has some corporate clients in Australia but the business in SE Asia is mainly with government agencies as the governments collect all the data and are reluctant to share it with the private sector. All regions are profitable and profit margins do not change much from region to region.
BS believes that its geospatial business can continue to grow organically at high single digits for many years.
BS geospatial business generated S$110ml in sales in 2015 and has grown sales at 7% p.a. over the last 7 years despite a substantial depreciation of the currencies of their main markets versus SG$ (reporting currency) and the US$ (purchasing currency). It’s a high margin business that generates a high return on capital. PBT margin averages at 25% over the same period and PBT/ Net Assets for the segment averages 72%.
Since 2012, adverse currency movements have cancelled the organic growth. 75% of the revenues are in AUD whereas a lot of the costs are in USD.
ESRI ( Environmental Systems Research Institute) is an international supplier of Geographic Information System (GIS) software, web GIS and geo-database management applications. The company is headquartered in Redlands California.
The company was founded as the Environmental Systems Research Institute in 1969 as a land-use consulting firm. ESRI products (particularly ArcGIS Desktop) have a global market share of 40% overall and 60% with government entities. Smallworld, a subdivision of GE Energy, is the largest competitor with a 10% market share.
ESRI has 10 regional offices in the U.S. and a network of over 80 international distributors, with about a 350,000 clients in 200 countries. The firm has 9,000 employees and is still privately held by the founders. In a recent interview ESRI co-Founder Jack Dangermond, said that the company spends 29% of sales on R&D. This datapoint gives us confidence that ESRI is focused on maintaining its market dominance and the quality of its products and services.
ABOUT ENERGY-RELATED ENGINEERING SERVICES
BS Energy provides engineering services mainly to both the upstream and downstream oil & gas industry. The upstream oil & gas sector makes up 15-20% of the division’s revenue and it is where BS is a “regional specialist” for electronic systems such as wellhead control systems; hydraulic power units; emergency shutdown systems; and fire & gas detection systems, among others.
In the downstream oil & gas sector, which makes up 75-80% of the division’s revenue, BS is a “global specialist” for direct-fired process heater systems and waste-heat recovery units. The company provides its engineering services for the downstream oil & gas industry through its subsidiary Boustead International Heaters Ltd and it has installed more than 2000 process heater systems around the world. BS is a specialist supplier to project managers (EPC) for the building of refineries, petrochemical plants, gas processing plants etc..
Process heaters heat crude oil to >700° C to allow distillation into LPG, petroleum diesel etc. and are critical components of refineries, petrochemical plants and gas processing plants. Waste-heat recovery units use the waste-heat from waste gasses (think flaring gasses), which are very polluting to the environment. Increased demand for waste-heat recovery units is driven by global environmental policies.
The Energy-related engineering division has executed more than 1200 projects in 83 different countries. It has served many different oil & gas players of various sizes and that includes giants like ExxonMobil and Chevron.
BS Energy estimates its market share at 5-10% with Heurtey Petrochem S.A. being its largest competitor. Heurtey Petrochem is a French, listed company and other competitors are Foster Wheeler and 1 Italian and 1 Korean company of similar size as BS Energy. The competitive landscape has been stable since the consolidation wave of 1980-2000.
The energy division generated SG$ 190ml in sales in 2015 at a PBT margin of 17.6%. Over the last 7 years revenues grew at 4.8% p.a. and the average PBT margin is 13%. The company reports segment assets for the engineering division, which includes energy and real estate solutions and NOT for the energy business only. Average PBT/Net Assets for engineering is 40% for the period 2009-2015.
In line with the weak environment in the global oil & gas industries, the Energy-Related Engineering Division experienced a drop in revenue and PBT (PBT -50% for 1H FY2016). Low crude oil prices continued to dampen the appetite of global oil & gas corporations to undertake sizeable capital expenditures and investments. BS Energy generates most of its revenues with refineries, which currently operate at high profit margins. However, because most refineries are owned by large oil companies, which are reducing capital expenditure across the board, this affects BS’s energy business.
ABOUT REAL ESTATE
Boustead Projects (BP) is BS’s property arm. BP is a separately listed company after BS spun-off a 48.8% stake in May 2015 (demerger through dividend in specie).
The business consists of a design & build business, and an investment portfolio of self developed leased-out property projects.
Design & Build (D&B):
BP operates a D&B business that is asset light, focused on high value added services such as design, engineering and project management, outsourcing low margin building and construction, all of which help to generate a high return on capital. BP’s customers are generally multi-national industrial / technology companies looking for a one-stop-shop to manage the whole project from purchasing land, permitting and building of a tailor-made factory/office. BP gets paid as the project progresses. Barriers to entry for this business are an efficient design team, the knowledge of local by-laws and a network of good sub-contractors.
The type of properties we are describing here are not your standard logistical box; they are industrial properties designed to high specifications, that generally house local Asian hubs for international companies that can attract highly educated engineers, from e.g. aerospace companies like Bombardier and Safran Electronics Asia Pte, and who are attracted to living in Singapore.
BP has been active in Singapore for many years and has made efforts to expand in bordering Malaysia and more recently China.
A lot of companies in China have the money and expertise to do D&B fast and cheap making it more difficult for BP to compete without gained local knowledge. One way to compete is to buy land in good locations at cheap prices. Even this favorable entry point has been challenging for BP as Chinese land is not cheap. All together, BP’s progress has been slow in China.
Malaysia offers more opportunities because land is cheaper and the catchment area for expanding their Singaporean D & B knowledge works in their favour. The governments of Malaysia and Singapore are pushing to develop the Iskander region, just across the border with Singapore. BP is responding to clients expressing an interest in Iskander. BP acquired land in Iskander through a JV and is building a business park with 100 units. Phase 1 with 50 units has been sold; phase 2 has not launched yet.
In August 2014 BP entered into a S$250ml co-investment partnership with the Abu Dhabi Investment Council ( ADIC) allowing BP to do larger Design & Build to Lease projects without taking concentrated risks because the equity commitment and risk are shared. BP will invoice the JV for D&B services. The focus will be on Singapore and the JV’s goal is an exit through a REIT.
Profit for D&B has been under pressure recently with operating margins dropping to below 7% versus an historical average of 17% as a result of increased competition and increased foreign labor costs in the construction industry.
Starting in 2010 BP moved on from ‘D & B’ to ‘D & B to Lease’ in response to customers requests for alternative financing after the 2008 crisis, and also in order to keep the property off-balance sheet. The properties are leased for 10 to 20 years.
BP owns and leases out 14 industrial properties, 13 in Singapore and 1 in the PRC. GFA is 173,102 m2 for an estimated market value per March 2015 of S$ 372m. Rent is currently S$27.7ml p.a..
BP also partly owns 4 land and/or properties in Singapore, Malaysia and Beijing.
An overview of the property portfolio can be found in the 2015 annual report on pg 25-28.
To manage the risk in case the tenant does not renew the lease at maturity or goes bankrupt BP has the following strategy:
- design & build to lease only for customers / industries that have at least 1 or 2 competitors who might be interested to buy or lease the property
- tenants commit a minimum investment in the property such as machinery, equipment etc..
- BP designs the property taking into account the possibilities to reposition the property
The decision to D & B to Lease has had a negative impact on ROE (more asset heavy, properties at cost or at cost less depreciation) and on profits because the revenues from traditional D&B are now spread out over the term of the lease (as opposed to being received much earlier during the building period ).
BP is working towards an exit of the property portfolio through a REIT. The company believes that an exit through a REIT is possible once a size of at least S$ 800ml has been reached. The JV with ADIC reduces the capital required from BP to reach critical size, and aims to accelerate this IPO timeline.
Mr. FF Wong, Chairman and CEO, and other investors acquired BS in 1996 for S$80 million. The book value at the time was S$27m [NS4] and profits were S$1m on S$60m in sales[NS5] . At the end of FY2015 and prior to the spin-off of the real estate business the BV was S$ 380m, after-tax profit S$63m with sales of S$ 556m.
Mr. Wong focused on high margin and asset light businesses such as engineering services and software distribution. Over the past 10 years BS generated an average ROE of 24% while maintaining a conservative balance sheet and paid out 40% of after-tax profits as dividends.
He’s the largest shareholder with a 33.85% stake in the company and his total compensation for FY 2015 was between S$1.25m and 1.5m of which 21% was salary.
The following quotes give us an idea of how Mr. Wong thinks:
Upon receiving CEO of the Year in 2009 from Singapore Corporate Awards: “Why me? I never considered myself an outstanding CEO. In any case, I could not have achieved anything without my people, shareholders. They are the ones who should get recognition.”
“Never run your company to win approval and popularity from market watchers. At Boustead, we plod along, unmoved by the opinions of analysts or fund managers.”
We have taken a SOTP approach.
1/ Boustead Projects
1a/ The IPO documents for the spin-off include property valuations by CBRE, DTZ and Knight Frank from September 2014. The notes in the 2015 Annual Report include an independent appraisal of the properties, which we have used in our valuation (quasi unchanged from the 09-2014 valuation)
2a/ The tax treatment depends on the tax regime at the time the properties will be sold, the time the properties have been in the portfolio before sale and the way BP organizes the sale. We understand that under the current tax regime a 3% tax on the value of the sale is due plus an additional amount if the properties are sold within 3 years. Although we cannot determine the tax liability we have applied a tax of 5% of the value of the sale for valuation purposes.
3a/ We have valued the Design & Build business at 8X run-rate after-tax earnings. We believe this is reasonable because the current operating margin of 6.7% is far below the historical average margin of 17%. Revenues from design & build are realized as the project progresses. When BP started to design & build to lease the revenues for design & build were reflected in the lease payments. Most of the new design & build to lease projects will be undertaken by the JV with Abu Dhabi. BP will invoice the JV for design & build services thereby increasing the revenues for this segment. Operating margins will depend on competitive pressure and government policy on foreign labor cost.
In May 2015, BS decided to spin-off a 48,8% stake in BP through a dividend in species and to separately list BP.
The reasons given for the spin-off were:
a) increase transparency and highlight the undervaluation
b) reduce the weight of real estate in the business-mix of BS and thereby improve diversification
c) facilitate the search of a new CEO as Mr. Wong is 72 years. (CEO with the skills to manage the 3 businesses appears [NS6] hard to find)
BP shares were IPO’d at 0.88 and after an initial increase fell as market sentiment towards emerging markets and real estate in Singapore in particular, worsened. Recently, most sectors of the property market in Singapore have been under pressure as a result of a weakening economy and an increase in supply. But a recent research report (Q3 2015) from Colliers states that rents for higher-specification industrial space have been stable.
The shares currently trade at S$ 0.7, approx. 50% of our estimate of intrinsic value.
The 50% discount to market prices, an implied rental yield of 14.8% and a management working towards an exit to maximize shareholder value makes this a compelling investment.
2/ Geo-Spatial and Energy-related engineering
We value the geo-spatial business on TTM revenues and using the average operating margin of the last 7 years. On that basis the implied valuation is 6X after-tax normalized earnings. This is clearly very cheap for a high margin, high return on capital business if you are confident that BS is unlikely to lose the ESRI distribution rights and the revenues have the potential to grow for a long time as the use of geo-spatial software increases.
A further depreciation of the AUD and to a lesser extent the IDR and MYR against the S$ and the US$ is a risk as BS pays ESRI a license fee in US$ and financial reporting is in S$.
The competitive position of BS’s energy-related engineering business is not so strong as its geo-spatial business. This business is also vulnerable to the capex-cycle of the large oil&gas companies. However, the business is a nice asset-light niche-business that has been very profitable in the past. An implied valuation of 3.5X average after-tax earnings of the last 7 years seems an attractive risk reward.
All of Boustead’s businesses are currently facing headwinds and this might continue for a while. The AUD can depreciate further against the US$ and the S$. In Singapore, property prices can fall and landlords might have to accept lower rents. The oil & gas companies’ capital expenditures could further depress sales of heater and waste-heat recovery systems. We believe that the current share price already discounts such a negative scenario that the risk-reward has become very attractive. The geo-spatial software distribution business is a high margin, high return business with a durable competitive advantage and a long runway for growth currently valued at 6X after tax earnings. At this valuation geo-spatial represents 25% of the SOTP valuation. We do not consider the energy engineering business of the same quality and it represents only 12,5% of our SOTP. It’s a high margin, high return business valued at an undemanding 3,5X average historical after-tax earnings. The property business represents 28% of our SOTP at a 50% discount to current market value; has an implied rental yield of 14.8% and a catalyst if management successfully executes its strategy to exit through a REIT.
Our downside is protected by the quality of the assets and the businesses, the diversification across unrelated businesses, the low valuation, a strong balance sheet and a superior management aligned with shareholders and working towards a catalyst to release value.
1- AUD depreciates against the US$ and the S$
2- a decline in rental income and property prices for high specification industrial properties in Singapore
3- capital expenditure from oil & gas companies on heater and waste-heat recovery systems remains long term depressed
1- Stable currencies allow organic growth of the geo-spatial business to be reflected in the financial results
2- BP’s property portfolio reaches the critical size to allow a potential exit through a REIT
3- Normalization of the capital expenditure from oil & gas companies on heater and waste heat recovery systems
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