Now this is contentious topic among value investors. Value investors tend to ask for historical data such as earnings and cashflow to determine the value of a company hence a turnaround company is seldom considered a value investment. Turnaround companies tend to have very poor earnings in the past or experienced corporate mismanagement.

However, in this post, I want to share how you can find value in turnaround companies.

Case Study of S i2i

S i2i Limited is a telecommunication and ICT solutions company. It was incorporated in Singapore in 1993 and subsequently listed on SGX in 1999.

It has three businesses:

Distribution of Operator Products and Services. The company distributes prepaid SIM cards and serves as authorised distributor of telecom operators. A network of more than 30,000 resellers in Indonesia.

ICT Distribution and Managed Services.  The company provides hardware infrastructure and ICT solutions to government and corporate clients such as IBM and HP. It also undertakes projects on networking, data hosting and managed services solutions.

Mobile Devices Distribution and Retail Outlets.  The company procures and sells mobile devices and related services. The company runs a niche retail stores in Indonesia under the “Sellular” brand. However it is moving away from its own brand Mobile Device business, which was not profitable and also taking steps to move away from loss-making retail shops. More on this later.

The primary business, without a doubt, is the Operator Products and Services. In 2015, its revenue was $349m, accounting for over 80% of the total revenue, while ICT and Mobile Devices were $45m and $17m respectively.

Overall, S i2i is not a very exciting business. The industry is highly competitive and future growth is definitely limited. This shaped my investment thesis for the company. It has to be buying scraps at dirt cheap price. Or as we often call it, paying 50cents for a dollar.

History of S i2i

However, when we want to buy scraps at dirt cheap price, we must also ensure that it is worth that dirt! There is no point buying trash at any price because you still end up with trash. Immediately, I went on to search for signs of a “value trap”. But S i2i shows some signs of a turnaround company.

This was not a well-run company. Before 2015, it recorded 3 consecutive years of losses. Even the CEO volunteered to take a pay cut and receive only $1 of annual salary in 2015 for the poor performance (a gesture well-received by many). Shortly after, the CFO resigned citing personal reasons but I think he basically got sacked. While it looked bad when a key management personnel is changed out, it was a step in the correct direction.

However, their problem did not end there. SGX decided to “punish” S i2i further by putting them on a Watchlist on 4 Mar 15. This means the company has 24 months to turnaround before it would be delisted from SGX. S i2i could only be removed from the watchlist if it fulfills any of the following requirement:

1. It must record a profit in the latest year and has a daily market capitalisation of $40m or more over the last 120 days
2. It must record a total profit of at least $7.5m for last 3 years with min. $1m per year
3. It must record a total profit of at least $10m for the last 2 years

Basically, SGX is telling S i2i, “You better start making money and fast!”

The choice is obvious for S i2i, Option 1 is by far the easiest to achieve. They formed a Turnaround Committee and went straight to work.

Cut Off Loss Making Businesses and Lower Operating Cost

S i2i began cutting off the “rotting limbs” of its business, mainly the Mobile Devices business. These include I-Gate, the mobile phone business in Malaysia, and Mediaring, the VOIP business. These divestments helped to unlock over $1.6m of funds. In 2015, the company also underwent a structuring to reduce the overheads and hiring costs before it squeezes out its first profit in years

Seems to be Turning Around

With the divestment of poor businesses and cost reduction effort, it finally managed to show profits in 2015 and continue to do so for the first quarter of 2016.

More Gesture to Shareholder

In May 2016, the company announced a capital reduction plan which will return $10 million cash to the shareholders in June 2016. This will be taken from their cash holding of $39 million. Of course they also announced that the CEO will begin drawing normal salary again in 2016 at $240,000 per year which is reasonable for a company CEO.

Future Direction

The company announced that they will focus on strengthening its main business of Distribution of Operator Products and Services. They aim to secure more clusters to sell more products and services and will continue to move away from the unprofitable business of Mobile Devices Distribution and Retail Outlets

All the above, in my opinion, are signs of a turnaround or at least turning-around company. However, I am super kiasu (scared of losing in Hokkien). I want to know what are the assets that I’m paying for, and it has to be super undervalued!

What Are We Buying Actually?

Looking at the balance sheet, it has $77.9m of Current Assets, and $25.5m of Total Liabilities. That gives us ~$52.4m in Net Current Assets, which translates to a NCAV of $3.82 per share. When I first spotted S i2i in May 2016, it was trading at $1.50. That means it was trading at a 60% discount to NCAV!! *excited*

Now, remember the capital reduction plan of $10 million? That means each share will receive $0.73 of payout. So we need to deduct that from the NCAV as the $10m cash would have been paid out. The new NCAV per share is ~$3, still about a 50% discount, not bad!

Summary

Companies such as S i2i are not very good businesses. However, when it is so undervalued, the risk involved is greatly reduced. Furthermore, we have been very conservative in the valuation as we only considered current assets which are mostly cash and equivalents. Lastly, the management is generally taking steps in the correct direction.

In summary, even in poor performing companies, we can find value too! We just need to look deeper and be more careful. Of course, this kind of companies should not be a huge part of your portfolio too! The old saying goes:

“When you take care of the risk, the rewards will take care of itself.”

Hope you enjoy the post!

See you soon!

Investing Always,

Pete

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