I recently made a purchase of Neratel of 13,000 shares at a price of $0.55.
This was not a company I was unfamiliar with as I have previously been vested with them in 2011 before a couple of takeover saga takes place and I divested the share thereafter at 76 cents early last year.
In this post, I will not be writing about their fundamentals as much as I have done in the past as the purchase was made on a bet that if the share price drops low enough, a potential takeover bet might be in the offspring. In the meantime, I do still take a look at their fundamentals and assess their ability to pay 3 cents dividend (conservative estimate) while waiting, which represents a 5.5% yield at current price.
In Feb 2012, ST Electronics, a wholly owned subsidiary of ST Engineering, has proposed to acquire Neratel to complement their infocom business offering terrestrial and wireless broadband networks. The consideration for each Neratel share was proposed at $0.45 (comprising $0.39 in cash and $0.06 in dividends paid by Neratel to shareholders). Eltek ASA, which is the majority owner of Neratel at 50.1% holdings at that point in time, has given an irrevocable undertaking to vote in favour of the transaction, though it ultimately failed and did not go through at the end as most of the minority shareholders rejected the offer and it did not get through the required 75% approval from shareholders.
The consideration at that time implies a PER of 12.1x of Neratel’s FY11 earnings of 3.7 cents/share, which coincidentally implies about the same FY15 earnings of 3.8 cents/share recently announced. Since the share price of 45 cents was strongly rejected back then, of course we can imply that no one was going to bid 45 cents again for another takeover bid, especially since the company has expanded much of their business since 2011.
9 months later, Northstar Group, a Jakarta based equity fund, comes in and agreed to buy a controlling 50.1% stake in Neratel from the previous owner Eltek ASA. As a result of the deal, Northstar is launching a mandatory unconditional offer for all the remaining shares at $0.49/share. At the time, shares of Neratel traded above $0.49 after the announcement was made, again indicating that the offer was low ball and market suggesting that it expects a higher valuation than that. The privatization offer was not successful at the end, though what we do get is a change in a controlling shareholder from Eltek to Northstar and this is a big change in the future direction Neratel was going to go from there.
The consideration offer of $0.49 at that time implies a PER of 13.2x of Neratel’s FY11 earnings of 3.7 cents/share and 9.1x FY12 earnings of 5.4 cents.
Northstar’s ambition after taking control of Neratel was to expand into the different markets and double their earnings in 3 years. This aggressive growth since then implies tapping into markets of unchartered territories but with promising rewards and expanding their balance sheet by taking on more debt and incurring higher capex. We knew from then on Neratel was not going to be the same company in the past which has a nice offspring of free cash flow, stable dividends but with little growth in it. I don’t think that was the intention of them taking over Neratel. They want to grow this young company into a monster of the future.
In Jul 2013, there was panics in the market when news came out that the CEO, Mr. Samuel Ang sold out his direct stake of 1m shares, leaving him with little stake in the company. The market sees this as negative as a sale from the Director probably means that something isn’t going right. Thereafter, there were further clarifications that came out indicating that the selling was misconstrued. Apparently, Mr. Ang exchanged his shares by selling and increasing his stakes in Canopus Asia, the company used by Northstar to hold its stake in Neratel. Effectively speaking, the transaction was done to align his interests that of Northstar.
Being in the service oriented business, Neratel faces many competitions especially smaller retailers who are offering lower margins. The good thing about Neratel however is that they require little capital to operate and has generated significant amount of free cash flow until the decision in recent times to venture and expand. With these growth and expansion on the back of the mind, it is not difficult to think that dividends may be compromised in the short term, unlike in the past where they can generate high FCF, pay high dividends but with little growth element in it.
My intended margin of safety comes from the fact that the company is still expanding well into different geographical areas and yet still able to pay an estimated 3 cents/share as dividends which would require them $10.8m at this point in time. Their cash equivalent, as of 31 Dec 2015, are still at $20.8m while net cash (after deducting all short and long term borrowings) are at $4.5m. The FCF is a bit struggling at the moment, but that’s because a lot of the money are pumped into working capital needs and those WIP receivables which they can only get once they have completed their service.
Also, I think with the previous 2 failed takeover bids at $0.45 and $0.49, it gives an indication to potential offeror that the company is worth a lot more than what it used to be. Even though they may somewhat struggle to keep their margins due to smaller competitors, I do believe that the company has grown and expanded and they will be worth a lot more should there be any takeover bid in the future.
Meanwhile, I’ll continue to receive dividends in the pocket while waiting for someone to offer a suitable price to takeover Neratel one day.