Description

Zicom Group Limited

Zicom is a small industrial conglomerate (with a few emerging technology businesses) that is traded in Australia and headquartered in Singapore.  The company is run by an owner operator named Giok Lak Sim who owns approximately 36.07%.  Zicom has four primary segments which it will soon be collapsing to two: 1) offshore marine, oil & gas machinery 2) construction equipment 3) precision engineering & automation and 4) industrial & mobile hydraulics.

Current Segments Overview

Offshore Marine, Oil & Gas Machinery – Constructs deck machinery for offshore marine vessels, including, primarily, industrial winches.  The segment is levered generally to offshore oil and gas drilling activity.  Over the last several years it has also begun manufacturing equipment for oil and gas infrastructure projects.

Construction Equipment – Manufacture of transit concrete mixers and foundation equipment.  Zicom is one of the larger cement truck manufacturers in Australia and Southeast Asia.  It has also launched a rental business in this segment (foundation equipment) over the last few years.

Precision Engineering & Automation – Primarily an outsourced manufacturing business with development/design capability.  Primary end markets include semi-conductors, electronics and medical applications.  The disruptive businesses/emerging technology businesses are being launched with the help of this segment.

Industrial & Mobile Hydraulics – This is the smallest segment.  It manufacturers hydraulic equipment used in applications like farming and construction.

As mentioned, Zicom will be collapsing the segments down to two: heavy equipment and precision engineering and technology.  I expect this at the next half year.

Below is a breakdown of the segments over the last five years:

Summary Thesis

An investment in Zicom Group is a cheap opportunity to partner with a committed owner operator.  Shareholders have the opportunity to benefit from a strong balance sheet, a late cycle cyclical upturn in one its primary markets (offshore marine, oil & gas) and perhaps most importantly, the company’s multi-year investments in what it labels “disruptive technologies”.  We view these disruptive technologies as nearly free call options on significant new business opportunities.  The shares trade at less than 80% of tangible book value, 3.5x EV/EBITDA and 7.33x adjusted ’13 net income (of A$7.33 million).  The shares yield 4.3%, which is paid out of conduit foreign income not subject to Australian withholding tax. 

Giok Lak Sim and Family

• Giok Lak Sim founded Zicom Group in 1978 and is the father of Kok Hwee Sim and Kok Yew Sim, both of whom are involved in the business.  Kok Hwee, the eldest son, graduated Magna Cum Laude from the University of Michigan and Kok Yew graduated Summa Cum Laude from the University of Michigan.  Kok Hwee went on to get his masters at Columbia University.

• Since 2008, Mr. Sim has acquired 10.8 million shares in the open market (directly personally and through SNS Holding) for A$2.2 million or about A$.20 per share.  Further, he has, at his election, acquired 4.46 million shares in lieu of cash bonuses over that period.

• As I’ve followed the company for some time, I was a bit surprised by a recent comment in the 2013 annual report.  Giok Lak noted, “The Group has shown great resilience and has been consistently profitable in the last 5 years giving a respectable return on eqity from 8.1% to 19.5%.  However its share value has performed below its NTA of S$0.35 (A$.30) per share in the last 12 months.  With its various growth strategies gaining traction, your directors are confident that shareholders’ value will be accordingly enhanced.”  This was a bit out of the ordinary.

Disruptive Technologies

Since 2010 the company has been investing heavily in what it labels disruptive technologies.  To date, Zicom has invested approximately S$15 million or about A$13 million (approximately 25% of the company’s current market cap) based on fiscal year end exchange rates in the following businesses:

• Orion Systems Integrations (S$3.2 million)
• Biobot Surgical (S$4.3 million)
• Curiox Biosystems (S$5.6 million)
• iPtec (S$2.0 million)

While it has been a long-time coming, it appears that these investments are on the cusp of beginning to generate meaningful revenue and profitability.  Orion, Biobot and Curiox were made in prior years and iPtec is a more recent investment.  Admittedly, these investments are venture capital investments with large potential rewards but certainly potential losses.  Also, a history of comments from the company shows that it just takes longer than expected to meet milestones.  Below are short description and some recent comments on the particular business:

Orion – Orion is developing thermal bonders for flip chip microelectronic assembly…

• July ’13… “a substantial order exceeding US$10 m has been agreed in principle”
• Aug ’13… “finalizing the sale of significant batch orders”
• Aug ’13… “Orion is emerging from its gestation to be revenue generating”

Biobot – Biobot is developing a surgical robot focusing on prostate biopsy

• July ’13… “we have secured an order from a leading German hospital with more than 1000 beds for our first unit”
• July ’13… “we are also finalizing negotiations with a leading USA University Hospital in New York as a center of excellence and point of reference for our robot in USA”
• Aug ’13… “Biobot aims to realize its first sales of the robot in the first half of next financial year”

Curiox – Curiox is developing bioinstrumentation microplates and washing stations that utilize its DropArray methodology

• July ’13… “we foresee that another 6 months is required for these top users for further validation”
• Aug ’13… “DropArray technology has achieved break-through acceptance by 10 of the top 25 pharmaceutical companies in the USA and Europe”… “the technology is now at a critical stage of validation by various pharmaceutical companies”

iPtec – investing in intellectual property translation services (in partnership with Singapore Health Services)

• Oct ’13… “has received a cash grant of S$4.5 m from a Singapore government agency responsible for enterprise development in Singapore to set up the medtech IP translation services”

While it is hard to judge the value of these investments or their ultimate potential, if we assume that the total investment in start-ups returns just 20% after-tax, the increment profit potential is A$2.6 million plus the current losses running through the income statement, which I conservatively estimate at A$0.85 million after tax (Curiox which is accounted for as an associate appears to have produced A$.6 mm in trailing losses and I assume the other two business lost at least A$.4 mm pre-tax).  That would result in total incremental profit potential of A$3.45 million.

Cyclical Tailwind

Zicom’s marine offshore, oil & gas segment primarily supplies large industrial winches for offshore oil rigs and supply vessels.  This business has tended to lag by 18-24 months or more (as can be seen on the prior peak in the business) orders for offshore oil rigs.  It is important to take note of the following chart showing the resurgence of the offshore market following the financial crisis:

http://www.offshore-mag.com/articles/print/volume-73/issue-7/rig-report/rig-construction-continues-to-focus-on-higher-spec-units.html

I believe based on company commentary and backlog reports that this is beginning to impact the Zicom business in a positive manner.  Below is the recent trend in backlog, which shows the offshore marine backlog up 42.8% from the end of 2012.  The prior peak in offshore was about $100 million.

Additional Items of Note

• It is important to note that the company tends to report financials in S$, not A$.

• Zicom has an enviable balance sheet that I believe it will use to its advantage over time.  With A$19 million in cash and A$13 million of consolidated debt, the company is well positioned to invest further in its businesses or make further acquisitions.

• Over the last five years ROE has averaged 15.75% and tangible book value has compounded at 13.9% over the period.  The last couple years have been a bit softer as the balance sheet has become less levered, the company has invested in the disruptive businesses and its two core businesses have been softer.

• Approximately 50% of the company’s business in FY ’13 was from Singapore and the US.  Additional countries of note include Australia, Malaysia, China and Thailand.

• The prior peak offshore marine, oil & gas segment EBITDA was A$16.6 million in 2009 versus $7.2 million in ’13.

• Construction equipment has been the weakest segment as of late.  I believe this segment has a fair bit of exposure to Australian construction.  Australian business declined 29.3% in ’13 and construction revenue was down 30.8%.

• Precision engineering has been one area of growth over the last five years, as revenue has grown from A$8.1 mm in ’09 to $35.2 mm in ’13.  The segment produced $2.2 mm in income in ’13 versus a loss in ’09.

• Working capital flows in H2 ’13 were a bit more punitive than normal in the half.  I would expect this to reverse a bit in H1 ’13, with a better net cash number at the end of the year.

• While traded in Australia, a relatively small portion of the business is from Australia.  Also, dividends are paid out of foreign conduit income and are not subject to withhold.  While the A$ has weakened against the US$ and could be a risk going forward, the A$ has also been weak against the S$ which provides some benefit in terms of translation.

• Given the increased volatility in exchange rates in ’13, the company recorded an exchange loss of A$2.7 million for the year.

• While the company was repurchasing shares a few years ago, the company, unfortunately, began to be frustrated that the market didn’t really respond to the repurchases and so it has failed to continue to repurchase shares at what I deem, and even management seems to deem, as attractive prices.

Risks

• The late cyclical pick-up in marine offshore, oil & gas orders does not materialize or materialize to the degree hoped.

• Exchange rate volatility continues to hamper the business.

• The investments in disruptive technologies do not begin to bear fruit and/or they become a further drag on profitability.

• Management knows something we don’t… the insider purchases have tended to come after the announcement of earnings in two time periods each year.  This year, insiders have been noticeably silent in terms of purchases after the release of full year ’13 results.

Catalyst

• Acceleration of marine offshore, oil & gas business.
• Contribution from disruptive investments.
• Additional acquisitions