Monday, May 25, 2020

Silverlake Axis (SGX: 5CP) - Why I Think This Company Is Severely Undervalued

Silverlake Axis (SGX: 5CP) has a rough performance this year so far.

Just by looking at the chart, share price has dropped by almost half since the start of this year from 40 cents to the current 21.5 cents.

If we take its performance from one year back, it has dropped a lot more from 54 cents/share.

For those who does not understand what the company does, one might misunderstood thinking that the company is related to aviation or tourism industry because of the level the share price is descending.

With share price hovering at an all time low valuation (with exception to 2017, I'll explain why), the question is if there is light at the end of the tunnel and if the company represents an opportunity buy to investors.


Business Segment


The company's business segment is divided into two parts: recurring and non-recurring in nature.

The recurring aspect of the business is referring to the maintenance and enhancement services that it provides to banking institutions as well as Software as a service (SaaS) while the rest are more project based related.


Maintenance and Enhancement Services:


The maintenance and enhancement services segment focuses on providing software support to banking institutions.

The company performs maintenance services for the software solutions that they have implemented for their customers. Enhancements are also planned and deployed per the required software release schedule.

From FY2014 to FY2019, the maintenance and enhancement services segment have doubled from Rm 210m to Rm 421m. For the period ending Q3 FY2020, the segment has also outperformed the Q3 FY2019 period by 10%. 

This is what the company described as sticky moat because the digital banking back end are generally complex and contracts procured are generally long term in nature, thus contributing to a high level of retention of the same customers. Margins are also high for this segment as most of the operating costs incurred are human capital in nature, providing round the clock solutions to customers.

This segment will continue to grow as they continued to win small marginal contracts.

Software as a Service (SaaS)

I'm a big fan of SaaS business because of the high profit margins, positive operating cashflow and easy visibility on the revenue.

Providers usually capitalize software and amortize it over a period of time over the length of the useful lives. They would then do a mark-up to charge a subscription fee to customers who depend on these services.

It is great for cashflow because not only will the company be able to generate a positive cashflow from this segment but also easily plan for the next 6 to 12 months with clear visibility.

The insurance processing business, undertaken by Merimem Group, focuses on providing cloud computing SaaS platform for policy claim processing for the insurance industry.

In the past recent years, the Group has established its operations and services in the ASEAN. The next few years the Group will see growth in North Asian countries like Japan.

In FY2019, revenue from this segment grew 10% from Rm30.3m to Rm33.4m with contributions coming from the expansion in Philippines, Vietnam, Thailand, Hongkong and Indonesia from its analytic software suite called Truesight. 

Software Project Services

This is project services which the Group has to bid and tender for implementation or customization of software services.

While 9M FY2020 revenues are down to Rm51m versus Rm67m in the previous year due to completion of projects, the Group is optimistic that the digital banking license assessment, which MAS has delayed to 2H2020 will be a one to watch out for.

Software Licensing

This segment is highly correlated to the software project services.

Software licensing contributed about 15% of the overall Group's revenue.

In 2019, the Group also acquired 80% of SIA X Infotech Group's shares, enabling them to offer Digital Identify and Security Technologies such as biometric verification and enrolment to existing and new customers.

Licensing fee is highly dependent on securing new contracts from existing and new customers so this segment will be lumpy in nature.

For the 9M ending FY2020, this segments were already down to Rm 52m from Rm66 last year for the same period due to completion of projects in Thailand.

Sales of Software and Hardware Products

Although this constitutes a smaller portion of the Group's overall revenue, 9M FY2020 numbers have increased significantly to Rm 21m versus Rm 5m last year due to one sale of high value hardware to support technology advancement for existing customer.

The Group is an authorised reseller of IBM hardware products and system software in Malaysia.

As a reseller of products, this is a lower margin business as compared to the other segments.

Credit Cards Processing

This is one segment that I think the Group is trying to unwind down because it's a low margin business with many competitive areas from other competitors.

Two of the Group's main customers in Japan has decided to terminate and this results in the huge drop from this segment for this year and previous year.

Financials

The Group's financials are healthy and fairly stable over the years, although you could argue that topline doesn't grow by much over the years.

What has really changed for me is that the nature of the revenue has switched from more project work (which tends to be more lumpy) to more on maintenance and enhancement, which are more recurring in nature. 

This provides visibility on financial planning, capex and cashflow needs.

Both GP margins and NP Margins have been fairly healthy over the years, with exception to FY2020 where they lost the tax concession pioneer status due to expiry for the Malaysian subsidiary effective Q1 FY2020. The pioneer status allows for income tax exemption of up to 70% to 100% of statutory income for 5 to 10 years. It also allows any unabsorbed capital allowances and accumulated losses incurred during the pioneer period to be carry-forward. It remains to be seen if the Group can apply for extension on this pioneer status validity for the next 2 to 3 years.


Valuation

Earnings per share for FY2020 annualised looks to be at around SGD 1.88 cents/share, which translates to about 10x PER.

That's the cheapest it has ever been (excluding FY2017 due to one-off disposal of marked to market interests in associates) from a valuation perspective in the last 10 years.

In fact, for a company with a such a predictive and sticky moat, it is hard to imagine that the market is pricing the shares at 10x price to Covid-earnings. There's a lot of bad news that is baked into the current share price and I think what investors need from the company is really just patience, and time for its value to be realized. 

With so much software, tech and SaaS company outside trading at crazy multiples, it is quite a steal to be getting such a valuation for a company that I think we know will be around for a number of years and will prosper as we move towards more digitalization, fintech and banking licensing needs from both banking and non-banking institutions.

Conclusion

I believe why the market is attributing such low valuation right now is because there is currently no catalyst in play.

While management has cited that they are still winning the smaller contracts, larger contracts are harder to come by as most banking institutions are conserving their cash to delay some of the capex projects in hand in view of the economic uncertainty. As a result, this lack of catalysts calls for a drop in the valuation which investors are currently switching their money elsewhere in mind.

Nevertheless, I believe that the market has overly discounted the resilience of the business in mind, the stickiness of the moat and how the business can take advantage of the upcoming digital banking and considering they are trading at a valuation of 10x PER, this will continue to be an accumulation play for me.

Target price would be 32 cents, which represents a 50% upside in the next 12 months with either new contract announcement, or post-covid return to normalcy whichever is earlier. 

Disclaimer: Author is vested in the abovementioned company as of writing

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21 comments:

  1. Silverlake Axis suffered from a short seller's report in Aug 2015. It looks like the stock did not fully recover, having fallen 74% since. But I do agree with you the ROE and margins look incredibly good. The banking software industry is a fragmented market (according to research online), with no clear market leader. I'd like to see Silverlake move beyond regional sales and make a footprint in the Western Hemisphere, but that looks too far fetched. And given recent management's profit warning, I am hesitant to take a stake at this moment.

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    Replies
    1. It's way too far stretched for them to go beyond the Asian Market for now. They can do that with their insurance Saas services but digital core banking would definitely be tough, given there are compliance entries under each regulation.

      Delete
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      Delete
  2. Hi B

    This is a very good summary of the recent history of the company and the breakdown of its cash flows along the years.

    Working backwards, what will be the factors that might result in you assessing the viability / selling of this stock?

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    Replies
    1. Hi INTJ

      I'm not a buyer for sure when the valuation was in the 17x and above like earlier in the year. I knew back then about the risks it imposes, even till now, but I wanted to play out the risk reward and in my opinion, at the current price, a lot of bad news have been baked in.

      Delete
  3. Red flag, I don't see any shares buyback from the management.

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    Replies
    1. They had a two weeks block on the back of quarterly announcement a one week back. Just FYI on some of the rules regarding share buyback on any given company.

      Delete
  4. Hi B,

    This is my highest holding as I buy as it crashes down. It has form 15 percent of my portfolio. I hope we are both wrong.

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    Replies
    1. I mean I hope we are both correct hahaha.

      I have a much higher AV. Price.

      There might be a catalyst coming soon, the write back of current liabilities as contingent for Goh purchases of his 3 companies.

      With NP and GP flat, I hardly think their profits is above 25 percent, let alone 50 percent.

      So, SAL balance sheet is stronger than it seems and we will.most properly know come october

      Delete
    2. I think you are too optimistic. I have bought massively into this... Really massively, but I bought it at average price of 23c... so breakeven today as of time of writing. It is severely undervalued based on forward earnings yes. But I dont think it's fair value is more than 35-40c unless management is able to present us with solid growth plans ahead. I think best case scenario will be a buyout from Temenos or infosys which is actually quite possible with a price tag of around 650-750m (25-29c a share)

      Delete
    3. I hope you are right.

      The moment banks hits its high again is probably the moment they will be back. I do think the 2H with the digital banking license they can surprise us with new avenues of revenue. Already they did try something out with Dreams Ab on personal finance software infra.

      Delete
    4. Hi SI

      I think I computed their net cash less borrowing and it was like closer to 3.8 cents. They are unlikely to use cash for any acquisition. They probably did the cross placement thing like they did with infotech in the early part of 2019.

      Well, let's cross finger and hopefully we are right.

      Delete
  5. I have some small holdings in Silverlake Axis. As someone mention, they never really recovered from the short seller report and at the AGM, some of us pressured the management to settle the interested party transactions. It took them a few years before they release a proposal this month to shareholders to close this by buying over the IPTs from senior Goh.

    From a valuation perspective, looks cheap for sure at 10x PE, high profit margins and ROE.

    From a business side, they are definitely sticky as quite a number of banks in this region use them for their systems so there is definitely some moat.

    However, there is currently no catalyst as their fortunes are tied to the banks and insurance companies to a small extent in this region. If u see their revenue and profit, it has been quite flat in recent years.

    You may need to be patient to wait for market to rate this fairly again while collecting dividends during this wait.

    ReplyDelete
    Replies
    1. Hi Kay

      Thanks for sharing your perspective.

      I don't usually look at silverlake when their valuation was still at the 15x and above but the past recent days of drop have given me a more in depth look at the companies.

      Barring a complete manipulation of the stock, I believe the market is mispricing its fundamentals and stickiness of the ongoing profits. Its also an industry which I think is not as obsolete as some other industries like transportation and aviation during Covid or news advertising.

      I think its a great opportunity to accumulate during this Covid period.

      Delete
  6. Thank you for sharing your thoughts and analysis.

    I noticed the CEO bought 250K shares at $0.225
    https://links.sgx.com/FileOpen/_eFORM1V2_KYS.ashx?App=Announcement&FileID=612079

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    Replies
    1. Shouldn't be anything significant and nothing out of the blue that they've been buying all these while.

      Delete
  7. Hi Brian,

    I've nimble a small amount in the stock as well as it's puzzling why Mr. market is not rewarding the stock when the revenue mix has changed from fluctuation to more certainty with similar margins (excluding income tax exemption). Like you said, at PE 10x, it's a steal based on its business nature, risk profile, margin and just need a tiny spark for the stock price to explode and rise exponentially! :)

    ReplyDelete
  8. They still have RM200m worth of investment in Global Infortech. Its an insinificant stake, wondering why they are still keeping it.

    ReplyDelete
  9. Hi Brian,

    Thanks for sharing great analysis. It is well said about Silverlake, every part just ticks the check box. I am more worried about future growth of this company. With the rise of digital banking, definitely the demand for software system and maintenance will increase too. However, the competitors are mainly bigger companies like Finastra, TCS, ACI which are global companies offering SaaS or even BaaS. It's not clear to me how Silverlake is planning to grow in the long run. For now, it's a good company. Looking forward to your thoughts. Thanks.

    ReplyDelete
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