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Sunday, January 07, 2007

Sapphire @ 5 cts ( Building services / Singapore ) 0 comments

Final Poll Results: 8:0

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

Main issues

1. Declining core business

2. RTO, if any, likely to value shell company at much lower prices

To me, it is one of the symptoms of a peaking market flush with liquidity that a stock like Sapphire can quintuple within the space of several weeks, offering the chance for equity holders arising from a debt restructuring exercise to exit at good profits.

Consider its predecessor IRE Corp, with key shareholder being the Wuthelam Group (via Nippon Paint and Yenom Holdings) at its time of listing in late 1999. It had strong government contacts --- the various town councils, as well as several big private sector developers as customers for its building services, which included maintenance, upgrading and architectural finishes. Its listing price of $0.23 valued it at S$30M market capitalisation based on 128M outstanding shares. It had been enjoying growing profits over 1996-98, the three years before IPO; its revenue base was >S$200M over 1997 and 1998.

Flash forward to the present. The company, after seeing profit decline in 1999 and 2000, bled red from 2001 onwards as construction contracts dried up and effects spread downstream in the sector, leading to a debt restructuring (conversion to equity) having to be undertaken for the company in FY05 that caused outstanding shares to balloon to >3B shares by 2006. Most of the shares were converted in the range of 1-3 cents per share --- maximum. In FY06, Sapphire's revenue base was S$20M; in 1H06, its topline was S$2M. At current price per share of $0.05, based on 4.5B shares (including most recent placement of 500M shares), the market values the new reincarnation of Sapphire at S$225M --- 7 times its IPO market valuation at arguably similar levels of optimism in the construction industry, but where the decline in core business is all too clear.

As a construction recovery play this company is far from the best, in terms of core business and in terms of valuation as described above. The talk, instead, is of another reverse-takeover (RTO) play which has provided the fuel for the stock's upward charge these few weeks. In particular, the interested party is said to be in the oil and gas industry. Some point to Labroy Marine's Tan Boy Tee and ex-KS Tech alumni Tan Kim Seng being participants in the recent private placement as corroboration of this rumour. This is of course a possibility --- but let's examine the numbers.

What is the value of a shell company listed on the SGX? The companies that are targets for RTOs typically have cheap share prices and by themselves do not have any growth potential nor significant corporate value --- essentially shell listings. Wilmar's RTO of Ezyhealth valued Ezyhealth shares at $0.06/share (pre-consolidation), or S$16M for original 262M Ezyhealth outstanding shares. Indofood's imminent RTO of Cityaxis valued Cityaxis shares at $0.04/share, or $5M for original 135M Cityaxis outstanding shares.

An RTO of Sapphire at current market price would imply the acquirer paying >S$200M for the shell that is Sapphire. Forget about the share price surge that has occurred in Ezyhealth and Cityaxis upon announcement of their respective RTOs that took them to way above their RTO prices --- the thing is that firstly, Sapphire as an RTO target is too expensive at current prices, and that secondly for the retail investor, there is very thin margin of safety even considering potential price surge upon actual realisation of RTO, given current lack of information about who might be doing the RTO, the RTO valuation metrics etc. Several debt-restructuring and original shareholders are already taking the chance to exit.

And of course, there might not be any RTO at all. What is the alternative exit strategy for the retail investor then?

Poll(please vote)
I agree that Sapphire is a hot-stock-not: Agree/Disagree




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