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Friday, August 12, 2005

Datacraft @ US$1.01 ( Technology / Singapore ) 0 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)

Main issues

1.Thin margins of <5% common in IT industry, suggesting little pricing power and high competition

2.Insider selling

With a record of negative earnings over its last three financial years and stagnant revenue base, it is difficult to see how Datacraft can be valued at 3 times book value.

To me, Datacraft is a stock living on past glory, belonging in the same category of stocks such as Pacific Century, Frontline and Singapore Computer Systems. These were the red-hot stocks during the dot-com boom of 1999-2000 which have dropped off tremendously since the bubble burst. In its heyday, Datacraft, as a leading IT solutions provider in the Asia-Pacific, was worth above US$10.

Its price might have corrected sharply over the last 5 years but in my mind the price has not yet reflected fully the extent to which its fortunes have sunk. Even catering for the fact that the recovering global economy is likely to lead to a rise in IT spending and systems replacement/upgrading by companies, the valuation still does not look attractive.

The 1999-2000 period must surely set an upper limit to the revenue from IT solutions, given the surging optimism leading to companies falling over one another to invest in upgrading their company IT systems in order to chase the productivity enhancement pipe dream; some even created new posts of Chief Information Officer or Chief Technology Officer. At such a peak, Datacraft posted US$45M net profit on revenues of US$670M, in FY01 (Jul 00-Jun 01; legacy optimism still strong during this period); resulting in earnings per share of 10 US cents. That would translate to about 10 times PE at today's price, and that is the most optimistic case.

In reality, I don't think Datacraft will ever approach such strong performances again. The revenue base over these past few years has been US$300-400M, with an inability to overcome overheads resulting in losses. This suggests poor pricing power, even when the economy was recovering in 2004. Now as I look through its latest 3Q05 results today, it appears to have turned around to strong profits of US$8M for the 9 months; however it still does not look in line with valuations of probably 40 times forward PE. Furthermore, the company has projected that it may not be able to keep up with the 3Q strong performance sequentially in 4Q05. Full-year revenue looks possibly in the range of US$400-500M, while for net profit margin to approach the >5% of the tech boom years will be a challenging task.

The reason that margins are likely to remain low is because the systems integration market is highly competitive, with reasonably comparable companies like Frontline and Singapore Computer Systems scraping by with little profits or even losses and large-scale IT distributors like ECS operating on razor-thin margins of 1%. It will be difficult for Datacraft to outperform sector peers, especially when we look at its dismal earnings track record over the past 5 years.

An ultimate test of the value of the stock is what the insiders think of it, and in this aspect things do not look good as well. Directors have been selling recently, according to mandatory SGX announcements. To me it is a clear sign that although the IT market is improving, these guys feel it might be better to sell into strength rather than hold with conviction. And what should we think about that?




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