Ipco @ 9 cts ( Investments / Indonesia ) 1 comments

Final Poll Results: 9:0

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Main issues

1.Questionable long-term earnings power of various subsidiaries/associates

2. Lack of synergy between various arms/ Lack of continuity from past expertise

I have vague memories of Ipco. It was one of the first investments I had made when I first started out (see "My Investing Journey: The Construction Stocks") and it was involved then in trenchless construction for Southeast-Asian infrastructure. My investment did not have a happy ending, because I had underestimated the effects of the 1997 financial crisis whose effects eventually filtered down to the order books of construction companies towards the end of the millenium.

Anyway, Ipco today is a totally different beast, and I'm not sure it's the better for it. Over 2004-05 the company restructured under Managing Director Quah, divesting its infrastructure arms and capabilities acquired over the last two decades, to focus on opportunistic investments with near-term potential for listing on regional stock exchanges.

In 2004 Ipco's NTA was $0.20. In 2006 it is still around $0.20 due to negligible profit over the restructuring period, but the composition of assets is totally different. The attraction to many investors is the huge 50% discount to NTA, and I'll approach an assessment from this angle.

First of all, as an investment holding group with no real core business, I would apply a 20% discount to the NTA, similar to the treatment for a closed-end fund. That reduces the attraction a bit, as NTA then becomes $0.16.

Next we take a look at the asset composition under its balance sheet. Singling out the big items on the balance sheet, I can summarise that the assets go into three main categories: 45% intangibles ($80M), 35% other receivables ($60M), 20% net current assets ($40M). Intangibles in this case refers to goodwill, from acquisition of current subsidiaries (mainly ESA, IES and Asian Plan) at above book value; I shall explore these separately below to assess the value of these intangibles. But it is worth noting that Ipco's assessment of the value of the subsidiaries might be skewed in its eagerness to invest; that's why accountants use historical book value for NTA: for conservativeness. The 35% "other receivables" is mainly cash advances to Excellent Empire, a gas supply company in China, which the company is planning to convert to equity. I shall examine the individual main investments below. There are five of them.

ESA: 60% subsidiary, involved in semiconductor backend equipment. Ipco's $9.4M for 60% of ESA in 2004, with ESA promising pre-tax profit of >$7M over two years, suggests a valuation of ~5-6X PE (assuming 20% tax, $3.5M pre-tax profit per year), a fair but not cheap valuation for a private entity. The subsidiary seems to have achieved the target, but semiconductor industry outlook is mixed. Ipco has been talking about a listing for this subsidiary since 2004 but nothing has transpired. It is interesting that goodwill paid for this subsidiary was estimated at $15M. Ipco's valuation for ESA, if extrapolated to 100%, is 9.4/60% = $15.6M. This suggests that ESA's book value assets were negligible! Red alert.

IES: 90% subsidiary, involved in oil and gas engineered products. Ipco's $5.6M for 90% of IES in 2005, with ESA promising pre-tax profit of >$2.5M over two years, suggests a valuation of ~6X PE (assuming 20% tax, $1.25M pre-tax profit per year), again not cheap (we should note that where profit guarantees are given, they tend to be fulfilled, but with poorer results being filtered downstream). Goodwill should be negligible, say ~$3-4M.

CNA (formerly APMI): 40% associate, involved in automotive harnesses and seats. Ipco spent about $11M for a 40% stake in 2004, and its FY06 profit share was $1.3M, giving a PE of 8.5X basing on Ipco's buy-in valuation.... Another investment which has yet to fulfil hopes of a listing.

Asia Plan: 70% subsidiary, residential property development in Washington, USA. I estimate the bulk of goodwill to be in this subsidiary, ~$60M. Although Asia Plan seems to have been able to sell off its plots at significantly higher prices over purchase price, it mystifies me how much premium the original purchase price was over the book value, looking at the goodwill. Note that the company was unable to sell off any plots in FY05. There is widespread opinion that the US property market seems to have peaked as interest rates rise relentlessly, and Norris Homes' purchase recently of 50 lots might be an Indian summer.

Excellent Empire: 20% investment on natural gas supply in China. Ipco does not expect any significant profits in the short term from this investment; indeed further start-up costs might be needed. Hence it is extraordinary that it is willing to inject another $45M into Excellent Empire (through conversion of a previous loan into equity) .... which accounts for about a quarter of Ipco's NTA.

A common thread of my discomfort running through all these investments is the total lack of theme connectivity between the five investments. Electronics, oil and gas, automotive, property, gas supply: Ipco has no prior expertise in all these, with the probable exception of Excellent Empire's gas supply/infrastructure business. Where is the competitive advantage? Where is the synergy? The management would hardly be able to add value even if they owned a majority of the companies. Secondly, the lack of transparency regarding the main investments, as well as the lack of track record, leaves the investor with tremendous risk; and it is not as if Ipco had picked up bargains in the various investments, on retrospect. The ESA, IES and CNA arms seem to be relatively benign, but I do have major doubts about realisable value for Asia Plan's land plots and Excellent Empire's long-term execution risks which still have a long way to go.

On a last note, it is a shame that Ipco exited infrastructure because this is the segment that has shown the most potential for the long-term over the last few years as Asia reflates. If Ipco has persisted, I am sure it would have shown greater prospects, given its incumbent capabilities in various past infrastructure projects.