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Monday, July 31, 2006

Enviro-Hub @ 36.5 cts ( Recycling / Singapore ) 0 comments

Final Poll Results: 1:1

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

Main issues

1.Questionable acquisition valuations

2. Benefits of Citiraya contacts may be overstated

3. Some concerns over medium-term outlook for electronics recycling

Enviro-Hub was formerly known as Leong Hin, and it is ironic that after suffering a terrible fate at the stock market following CAD investigations, it was acquired by Raymond Ng who is now trying to turn it into another Citiraya, a former market hotshot also now under CAD investigations. Of course, Raymond Ng is trying to replicate Citiraya's early success, not the scandals :-)

The acquisition of 65% majority stakes in two recycling firms has formed the basis for the restructuring: Cimelia, specialising in e-waste and platinum metals refining, and HLS Electronics, specialising in plastics recovery for IC trays manufacturing. Given that the previous operations of Leong Hin were slightly loss-making/breaking even, and that Raymond Ng is actively divesting these previous arms, it makes sense that a study of Enviro-hub's future prospects lie in these two new acquisitions (a third recycling-related arm, E-Hub Metals, generates insignificant revenue and is loss-making).

How profitable are these two arms? Looking at segmental results for FY05, Cimelia achieved $3.3M pre-tax profit on $17M revenue, while HLS contributed $1.9M pre-tax profit on $5.5M revenue. Relating to their part-cash/part-shares (of Enviro-Hub) acquisition values of $20M for 65% of Cimelia (hence valuing 100% at $31M) and $23M for 65% of HLS (hence valuing 100% at $35M), the effective FY05 PEs are 9X and 18X respectively. For private acquisitions, these are rather high acquisition multiples to pay (especially for HLS). If one were to examine the latest 1Q06 results, he would have found that subtracting the impact of an extraordinary gain on asset disposal of $2M, the newly-restructured Enviro-Hub's pre-tax profit would merely be $0.9M. Even allowing for seasonality (electronics industry is busier in 2H.... though even that is in question for this year), it is clear that annualised FY06 profit based on 1Q06 results may not justify the acquisition valuations paid out.

Going back to the acquisitions, the new shares issued by Enviro-Hub in part-payment were valued at ~$0.35/share. It would have been equivalent to $0.26 today, because there was a 1-for-3 bonus in mid-2006. So those shares paid out to the former Cimelia and HLS owners had actually appreciated in value (to current $0.365). That of course means that (1)the part-share deal actually turned out stupendously for those former owners; (2)buyers of Enviro-Hub shares today are hence supporting a valuation of >9X PE for the Cimelia acquisition and >18X PE for the HLS acquisition; (3)a possible share overhang? Already we see the former HLS owners cashing out in late July 06 through private placements.

By the way, if anybody is looking at Enviro-Hub's NTA and thinking $0.25 NTA backing sounds quite attractive, note that acquisition goodwill comprises nearly half of that. The acquisition of the two recycling subsidiaries was done at a heavy 3X premium to their book value.

It is clear what the market is pricing in. Recycling looks to be a good business to be in right now given high metal prices. Raymond Ng brings with him a string of connections from Citiraya. While I won't deny that it looks like a sunrise industry, the execution risks must not be underestimated --- here I play the devil's advocate and list down potential pitfalls/concerns:
(1)Raymond Ng's undoubted linkages to Citiraya might mitigate any contacts that he has in the industry which could have helped Enviro-Hub secure waste collection clients (ie. the electronics industry players). Already there have been several corruption lawsuits implicating staff of these companies in their dealings with Citiraya.
(2)The sweet spot may not be as sweet given growing realisation of the value of electronic waste. Pricing pressure by the electronics company suppliers is likely to increase, as they press for better prices for their waste.
(3)A downturn for the electronics industry would hit these recyclers badly because they depend on electronic waste volume from the MNCs; a downturn seems probable, from anecdotal evidence. Singapore, Enviro-Hub's main operation centre, would be hit by an electronics slump if it does transpire (not to mention the migration of low-end electronics manufacturers)
(4)There is fierce competition. Remember that Citiraya's high profit margins must be doubted because of all the accounting liberties it took, which have since been revealed. Consider a peer, Greenworld, which collects waste and recycles ferrous and non-ferrous metals from them --- it is only able to reap 2-3% net profit margin on its turnover, and its FY05 profit had fallen from FY04.

Given such considerable execution risk and valuation risk, it just doesn't make sense now to buy in and end up holding the baby for directors possibly cashing out. A good time to keep watch for signs of a strong business turnaround would be 4Q06, where the electronics industry is traditionally busiest and provides the most e-waste to recyclers like Enviro-Hub. If the company churns out great results during this busiest season, then it may then be time to look again.




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