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Interview With Oliver’s MD Jason Gunn

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Oliver’s real food has had a volatile first couple of months on the ASX. While the share price initially soared to a high of 39 cents, market sentiment cooled when the company announced at the end of July that they would narrowly miss their FY17 earnings and revenue projections. Although missing prospectus projections is never a great look, Oliver’s management stated that this was mainly due to delays in opening new locations and one-off costs rather than lower sales, and have re-committed to meeting their FY18 forecast of $41.9M revenue and 2.37M NPAT.  At time of writing the share price is in the mid-twenties, still comfortably above the initial listing price, and Oliver’s have continued to provide market updates on the roll out of their new stores.

After such a dynamic first few months as a publicly listed company, I reached out to Oliver’s founder Jason Gunn, to see if he would answer some questions over email regarding the strategy of the business and how he felt things were travelling. Jason has kindly provided the below answers to six key questions of mine about the Oliver’s business and other related topics. Jason's answers give great insight into how the business is performing and his vision for Oliver's in the future. In a first for the IPO Review, I present my interview with Jason Gunn.

Oliver’s is obviously a business that has strong values and ideals, but now as a publicly listed company there is more pressure than ever on financial performance. How do you balance your desire to be ethical and responsible with the pressure and scrutiny of being a publicly listed company?

Jason Gunn:
-To me this is simple. To actually be a business we have to make a “Healthy profit” We have always had to do that, just to survive and attract investment. But it is not the main focus of the business; it is just something we have to do, just like we have to comply with the regulations and award rates of pay etc. Our number one goal is to make healthy food choices available to the travellers on the highways of Australia, focussing on providing a great product, in a very clean environment, with fantastic customer service, and we know that we have to do that profitably.

While there has been a revised guidance to your FY17 numbers, you have maintained your forecast for FY18. This now means you are forecasting revenue to grow from 20.436 Million to 41.909 million in one financial year. As an outsider, this seems like a hugely ambitious growth target. Are you able to explain why this is achievable?

Jason Gunn
-It is achievable for a couple of reasons. 1) We have bought back the 8 franchised stores. These stores were the best stores in our network, with significant turnover. As they are the highest turnover stores in the group, they are also the most profitable.  Just buying these stores back will add over $11m to our group TO, and a significant EDBITDA contribution. 2) We are opening another 11 stores in FY18. All of the stores we are opening are expected to be good performers in great locations. Plus, with all of this growth comes scale, and with scale comes efficiencies.

You have gone from being the founder of a small start-up to the Managing Director of a publicly listed company. How do you feel your role has changed over this time, and have you had any challenges adjusting to the realities of running a larger company?

Jason Gunn
-Oh yes, there has been quite a transition. But you know, I love my role, and I absolutely LOVE this business, so I feel that this is what I am destined to do. At the end of the day the role is largely about building a really strong team of motivated and experienced people that are all pulling in the same direction. I have that now, more than ever, and with the support of a very strong board, and an committed investor base, who believe in what we are doing and where we can take this business, I feel more confident and clearer than ever before.

While online reviews of Oliver’s restaurants are generally very positive, one of the criticisms that is made from time to time is that prices are too high. You have said repeatedly that your margins are not excessive and that your prices reflect the costs of providing healthy food. Are you able to provide some detail on the costs of providing fresh, healthy food at highway locations, and do you see potential for your prices to come down as the business grows and economies of scale kick in?

Jason Gunn
-Good question, but realistically no, they wont come down. In fact I do not believe that we are expensive, it just seems that way to some people. It seems that way to some people because we have all been conditioned to think that food is cheap, when it is not. What is cheap, is highly processed food that is full of artificial colouring, flavourings, and preservatives. This is not actually food. We should stop asking why REAL FOOD is so expensive, and start asking, “How can this cheap food be so cheap?” I think it is also worth mentioning, that being the worlds first certified organic fast food chain, we face many challenges around supply chain management that traditional fast food business’s do not have to overcome.

Unlike a lot of food chains, Oliver’s has decided not to pursue a franchise model and is in the process of buying back existing franchises. Are you able to comment on your reasons for avoiding the franchise model? Was this decision at all influenced by recent franchise problems at 7-11 and Dominos?

Jason Gunn
-No, nothing to do with 7-11 and Dominos’.  Like Ray Crock in the movie “The Founder” my first experience of franchising was a disappointing. We are a unique brand in that we have strict nutritional guidelines and we are out to set a new standard when it comes to the quality of the food and the way we do business. I am not saying that we wont have a degree of franchising again at some point in the future, but for now we want to have absolute control over the way our stores are run and retain the profitability in the listed entity, rather than sharing that with franchise partners.

The Oliver’s real food IPO eventually went ahead at a lower than expected price due to what I assume was limited interest from institutional investors, and recent proposed IPO’s from Craveable Brands and Sumo Salad have been cancelled in entirety for the same reason. Is the Australian market too conservative when it comes to new IPO’s from Australian companies? Are you able to comment on the reception you received when promoting the Olivier’s Real Food IPO?

Jason Gunn
-We received a fantastic reception from the institutions we met with, but the feeling was that we were over valuing the business. That said, we had significant applications from our customer base, so they did not think it was too expensive. But there were other factors affecting the overall market, and as a result, we lower the price to meet the institutional market, and thereby achieve our goal of listing.

Croplogic

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When I first saw the Croplogic IPO I was pretty excited. Lately ASX IPOs seem to have been an endless list of speculative mining startups and suspicious Chinese organizations, so its nice to see a company that seems genuinely innovative. Based on technology and crop management techniques developed by the New Zealand government research institute Plant & Food Research, the company is looking to revolutionize the agronomics sector with various technological and modelling-based solutions. This includes both patented electronic monitoring devices that provide live soil moisture levels from the field, as well as sophisticated modelling that allows farmers to predict moisture levels and show optimal times for watering and fertilizer application. The idea is that this technology will allow agronomists to spend less time driving from field to field taking samples, while giving farmers a higher level of service at the same time. The company has been around for five years, and has completed a few trials with large multinationals. While they claim these trials have been promising, they haven’t really amounted to much revenue as can be seen by the meagre profit and loss report.



Croplogic is seeking to raise up to 8 million, with an indicative market capitalization of $23.9 million based on a maximum subscription.

Strategy

One interesting things about Croplogic is that they have decided to grow by acquiring established agronomy businesses rather than organically (if you’ll excuse the pun.) This is based on the idea that the agricultural market is suspicious of new entrants and values existing relationships. Croplogic therefore intends to purchase traditional agronomics businesses then slowly introduce Croplogic’s various innovations to their customers. While I understand the thinking behind this (at a previous role I saw first-hand a European fertilizer company fail spectacularly in their expansion into Australia due to difficulties selling to suspicious Australian farmers), there are a few factors that make me worried this strategy won’t work. Post listing, Croplogic will have only around 8 million dollars with which to buy the very specific type of company they are looking for (they are specifically targeting potato agronomics companies) in the limited amount of time they have before shareholders start getting impatient. With such specific criteria and a limited amount of time, it seems a real risk they will be forced to pay above market prices for the first suitable company they find.

Croplogic’s most recent acquisition doesn’t really inspire confidence either. On the 28thof April 2017 Croplogic acquired a company called Proag services, an agricultural consulting business based in Washington state USA. Croplogic paid $1.4 Million AUD, with another $1.25 million to be paid over the next few years provided Proag’s revenue does not decline sharply. As a test case for Croplogics acquisition model, the Proag purchase does raise a few questions.

While in the financial year ending March 2016 the business made a profit of $140,000 AUD, in 2017 this had reduced to a loss of $24,650 (to make things simpler, I am using AUD for both the revenue and purchase price, despite Proag being an American company). This loss was caused mainly by small a decrease in revenue from 2.24 million to 2.14, and an increase in operating costs from $580,000 to $690,000. To be clear, the FY17 financial year ended before Croplogic bought the business, so these costs cannot be easily attributed to acquisition expenses. While there could potentially be other factors that explain the 2017 loss, 2.65 Million seems hugely unreasonable for a company that lost money last financial year, and even seems on the steep side if you just take the FY16 numbers into account.  Were Croplogic so desperate to secure an acquisition before the IPO that they ended up paying more than they should have for a struggling company? As an outsider it certainly looks like that.

Management

One of the things I look for in an IPO is strong founder with a real passion for the company. Bigtincan’s David Keane and Oliver’s Jason Gunn are two great examples of this. In addition to being good businessmen, both founders seem to have a real passion for their respective companies and expertise in their specific industries. You get the sense with both Jason and David that they have invested personally in their companies, and will stick by them for as long as it takes.
In contrast, the managing director of Croplogic Jamie Cairns has only been with Croplogic for just over a year and has a background in internet companies. The CFO James Jones has been with the company for even less time, and last worked at a private equity firm. While they both seem capable enough, they don’t seem to be experts in agronomics, and it’s hard to imagine either of them sticking around if they were offered a more lucrative role at a different company.
Powerhouse Ventures

The largest Croplogic shareholder is the ASX listed Powerhouse Ventures, owning both directly and through its subsidiaries roughly 20% of the Croplogic stock post listing. I like to think of Powerhouse Ventures a s New Zealand’s answer to Elrich Bachman from Sillicon Valley. The company invests in early stage New Zealand companies, most typically those that use technology developed in connection to New Zealand universities with the hope that these can eventually be sold later for a profit.

To put it mildly, Powerhouse Ventures has not been going that well lately. Listing originally for $1.07 in October 2016, the company now trades at around $0.55, following problems with management, higher than expected expenses, and difficulties with a number of start-up investments. 
This is a concern for any potential Croplogic investor, as one of Powerhouse Ventures easiest ways to lock in some profits and generate cash would be to offload their Croplogic shares. Considering the size of their stake in Croplogic, this would have disastrous effects on the Croplogic share price.

Summary

As you can probably guess if you’ve read this far, I will not be investing in Croplogic. While the shares are undeniably being sold for a pretty cheap price, their chances of success seem so small buying shares would feel more like getting a spin on a roulette wheel than a long-term investment. When you read through the prospectus, you get the feeling that the company is a weird miss-match of various technologies dreamt up in Kiwi research labs that some over-excited public servants felt would be a commercial success. Considering the minimal progress that has been made in the last five years, they probably should have stuck to writing journal articles. 

Sienna Cancer Diagnostics

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Overview


Sienna Cancer Diagnostics are seeking to raise 6 million dollars, with an indicative market capitalization based on full subscription of just under 37.5 million. Shares are being offered at 20 cents each.

Sienna was originally founded in 2002. The company’s focus is the development of diagnostic tools for cancer, and more specifically using tests that look at levels of Telomarese in the body to aid in diagnosis. I spent around 10 minutes clicking on links on Wikipedia trying to understand what exactly Telomarese is, but I quickly realised it goes well beyond whatever I can remember from year 10 science. Instead, as usual I will do my best to evaluate the Sienna IPO using the tools available to an average investor.

IPO’s in the biotechnology space can be broadly broken down into two categories: Pre-revenue, where all the company has is an idea and maybe some patents, and post-revenue, where the company has a proven method of generating revenue, and is now looking to ramp things up. Sienna Cancer Diagnostics falls awkwardly somewhere in the middle. While technically Sienna has been receiving revenue from product sales since 2015, if you exclude research and development expenses, revenue for the first six months of FY2017 was $291,588. There are small café’s that turn over more money than that. It’s an unusual time to list, as the immediate question is why Sienna didn’t hold off until the listing until they had demonstrated their growth potential.

Background


Like many companies, Sienna’s past does not seem to be as straightforward and linear as the Prospectus would like you to believe.

In January 2015, Sienna Cancer Diagnostics announced their first sales agreements with a Major American pathology company. Kerry Hegarty, the CEO at the time gave an interview to The Age, where she explained that “ …Sienna has succeeded where other cancer diagnostic ventures have failed because it has been able to stay an unlisted company so far.” Hegarty goes on to talk about the flexibility of being an unlisted company when you are still in a pre-revenue stage.

4 months after giving this interview Hegarty left Sienna Cancer Diagnostics.  Later that same year in September, Street Talk reported the company was planning a 10 million-dollar IPO with Pac Partners as lead manager. Did Hegarty leave because she felt that the company’s decision to list was premature? I have no idea.


For whatever reason, the 10 million-dollar IPO with Pac Partners did not eventuate, and the company is now listing 18 months later raising only 6 million with the much smaller lead manager Sequoia Corporate Finance.  A CEO leaving a company and an IPO being delayed aren’t exactly unusual occurences, but it would be interesting to get some background on why both these events happened.

Financials


As mentioned earlier, Sienna has largely relied on government rebates and Australia’s very generous research and development tax incentive program for revenue. I take the view that if the company is going to achieve long term success, it will need to eventually stop relying on government handouts and therefore these revenue streams should be excluded from any analysis.

 The worrying thing is though, once you take this money out revenue has gone backwards from 2016 to 2017. In 2016, Sienna’s first full year of receiving product revenue, the company had annual revenue of $640,664 excluding government rebates, or $320,332 every six months. The first six months of FY17 saw revenue of only $291,588, a pretty sizeable decrease at a time you would naturally expect revenue to grow.

While there may be legitimate reasons for the decline in revenue, it is not addressed anywhere in the Prospectus that I could find. The decline in revenue also puts into question Sienna’s chosen listing date. August is an interesting time to list, as it means the prospectus does not include the full FY17 numbers, even though the financial year is over by the time the offer closes. The cynic in me says that if the FY17 numbers were any good the IPO would be delayed a couple of months, as strong FY17 numbers would make the IPO a much more straightforward process.

To further illustrate the odd timing of the listing, the balance sheet as of January 2017 showed over 1.5 million dollars in cash, vs annual expenses of around $570,000. Whatever was behind the decision to list before FY17 numbers were available, it wasn’t because the company was about to run out of money.

Shareholders


Sienna have not put any voluntary escrow arrangements in place, so a key question for any potential investor is who the existing shareholders are, and how likely they would be to dump their shares as soon as the company lists.

Earlier articles about Sienna mention the ex-CEO of Macquarie Allan Moss as one of the main shareholders and backers. Interestingly enough, his name does not appear in the current prospectus, so either he has sold out completely, or now holds less than 5% of the company. Why a shrewd investor like Moss would sell-out before an IPO is another question a prospective investor should probably think about.

Instead, the current largest shareholder is now someone called David Neate, who owns just over 10% of the company. I was immediately curious about who this person was, as I could not find him listed on the board or the senior management team of the company. After digging around online, the only information I could find on him was in regards to Essential Petroleum Resources Limited, a now delisted oil and gas exploration company that someone called David Neate (and I’m aware it might not be the same guy) held 12.6% of in October 2007. 

There is an October 2008 Hot Copper thread where someone wondered why Neate was unloading so many shares in Petroleum Resources Limited. A few months after the post in January 2009, shares fell to below 1 cent following unfavourable drilling announcements  and the company delisted later that year.

Of course, there are perfectly reasonable explanations for a major investor deciding to offload shares, but it’s not really the sort of information you want to find when you start googling the major shareholder of a potential investment.

Verdict


As this is an IPO in an area where I have no technical knowledge, I am acutely aware that I could be completely off the mark with my analysis. If using Telomarese to diagnose cancer proves to be the next big breakthrough, this could easily be the IPO of the year. However, if I’m going to invest in a company that’s actual product revenue is less than one fiftieth of the indicative market capitalisation, I would at least want to see revenue growth, not revenue going backwards. Furthermore, the small amount being raised does make me wonder if the IPO is more about existing shareholders unloading stock than actually raising capital. Contributed equity is listed on the balance sheet as only 16.6 million, which means at least some initial investors would still be making significant profits if they unload their shares well below the initial listing price.

While I may well live to regret it, this is one IPO I will not be taking part in.

Oliver’s Real Food

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I've changed jobs recently which has kept me busy, and with the Oliver’s Real Food IPO only open for two weeks I thought I would have to publish my review after the offer closed. It was with some relief then that I checked my email Friday night and saw they had decided to push things out by a week and reduced the share price from 30 to 20 cents in response to limited interest from institutional investors. The reduction in the share price isn’t as dramatic as it initially looks. Oliver’s has increased the number of shares at the same time, so while under the original offer the maximum subscription was to sell 30% of the company for 15 million at 30 cents per share, this has now been adjusted to 35.8% for 15 million at 20 cents a share. Although the share price has gone down by a third, the actual reduction in pre-offer valuation has only gone down by 25% thanks to the increase in the number of shares.

This last-minute drop in price and wrangling of share numbers puts you more in mind of a fishmonger trying to move some dodgy prawns than a multi-million dollar IPO offering. Pricing an IPO is meant to be a precise and scientific exercise, developed through numerous meetings with fund managers and other institutional investors to accurately gauge the market. Wesfarmers recently put a pin in their Officeworks IPO plans precisely because they failed to hear much enthusiasm from institutional investors at this stage of the process. For Oliver’s to be forced to drop their price at the last minute suggests that they either their fund manager skipped this step, or that Oliver's management didn't listen to the advice that was given to them.

Overview

Putting this last-minute price drop aside, Oliver’s Real Food is one of the more interesting IPO’s of 2017. The business runs a chain of healthy fast food options on major arterial roads on Australia’s eastern seaboard. While healthier fast food chains have been around for a while (Sumo Salad are rumoured to be planning an IPO of their own), Oliver’s is the first healthy fast food business that is targeting the highway service station market. As anyone who has ever tried to get a meal on a freeway can tell you, your meal choices are typically restricted to KFC, Mcdonalds, or a dodgy cafe with burgers and chicken wings sitting in bain-maries, so there does seem to be an opening for a healthier and more expensive alternative. 

Management

Jason Gunn, the main founder of Oliver’s is your classic new age guru. You can watch videos of him online talking earnestly about his love of transcendental meditation (17% of Oliver’s staff apparently are now practising transcendental meditation thanks to Jason, one statistic that was left out of the prospectus) and one of his go-to quotes is that Oliver’s is the first business that he has run that “satisfies his soul.” He also seems to have gone all-out on the photo shop options for his Prospectus photo.



While it might be tempting to dismiss Jason as some snake oil peddling charlatan, he does seem to genuinely believe in the stuff he talks about, and he has successfully built a business around a set of values that seem to work for him. He also is balanced out by his co-founder Kathy Hatzis, who has held senior marketing positions in the finance sector and seems to the more down-to-earth of the duo. The only thing I could find by her online was a much more mundane article about managing brands that manages to not mention meditation, vaccines or enlightenment. Overall, they seem like a good pair of founders, and exactly the sort of people you would want to be leading a health food chain with a new age vibe.

Growth plans

One potential cause for concern is that growth has been slower than originally planned. In March 2015, Jason Gunn told The Australianthat he expected revenue to grow to 30 million per year within 12 months, yet even the projected figures for the 2017 financial year show revenue of only 21 million. More interesting still, is that in the same article Jason stated that he was aiming for an annual revenue of 30 million before proceeding with the IPO. I’m not really as concerned about this as I perhaps would be in other cases. After reading and watching a few videos on or by Jason, overestimating growth rates in a conversation with a journalist seems to be exactly the sort of thing he would do. As long as there are more sober minds around him this potential character flaw shouldn’t really be a problem. What’s more, Oliver’s growth is largely a factor of the number of stores they open, and this seems to be pretty reliant on when the big petrol stations have leases coming up. Store growth seems to have stagnated somewhat in late 2015/early 2016 with the number of company owned stores going backwards in the first half of FY2016 from 8 to 7. However, more recently things seem to have gotten going again, with 12 company owned stores at the time of the prospectus, and firm plans to increase this to 1 9 by the end of FY2017.
Longer term, Oliver’s have 60 sites in total they have identified for potential store locations in Australia for the next 4 years, which indicates the business has a lot of room to grow.

Financials

One of the things I like about the Oliver’s prospectus is the lack of massive pro forma adjustments to the financials. Too often, you flick through pages of rosy pro forma figures in the financial section of a prospectus only to find a few brief lines of statutory figures that show the company has actually been making massive losses. With Oliver’s the first figures presented in the financial section are the statutory profit and loss statements, and the only pro forma figures I could find were in the balance sheet. The numbers also seem to stack up pretty well. Margin over cost of sales has been steadily in the mid-thirties, and margin plus labour expenses has been consistently around 75%. While Oliver’s did make a small loss in the first half of 2017, for a company going through an IPO and growing this quickly it’s actually impressive the loss is this small.

In order to get a sense of what Oliver’s could look like as a more mature business, I projected two scenarios of a future Oliver’s profit and loss based on 40 stores here. In the first more conservative scenario, I projected that Oliver’s revenue per store would be the same as in 2015 at just under 1.6 million per year (I didn’t want to use the 2016 numbers as I wasn’t sure who store openings affected the figures), and that labour and cost of sales would stay steady at 75% of revenue. I increased the head office and general administration budget to what I feel is a generous 4 million and all other costs were simply based on the 2015 figures increased to reflect the higher number of stores. With these rather conservative estimates, the business would make just over 2.6 million per year after tax.

In the second more optimistic forecast, I projected a growth in sales per store by 20% to just over 1.75 million based on the assumption that increased brand recognition and familiarity would lead to more customers per store (Mcdonalds in Australia apparently averages over $5 million in sales per store so this is far from being unrealistic). I also used a lower cost of sales + labour to revenue ratio of 65% on the assumption that the higher revenue per store and supply chain efficiencies of having a larger business would help drive these costs down. With a slightly more optimistic leaner head office budget of £3.5 million, this shows a projected profit after tax of just under 9 million.

The indicative market capitalization based on a maximum subscription is $41.9 million at the revised offer price. The fact that a business like this has such a clear path to a profit of 9 million, while at the same time a more pessimistic model still shows profitability is a promising sign.

Food

You can pore over the financials until you are the blue in the face, but at the end of the day if you are thinking of investing in a restaurant chain It probably makes sense to actually eat in the place. For this reason, I drove down to the nearest Oliver’s to me in the Melbourne outer suburb of Scoresby last Sunday afternoon. The Oliver’s was located in a BP service station on a freeway next to an business park, with a KFC and Mcdonalds for competition. At 3:50pm on a Sunday Trade wasn’t exactly brisk. In the 20 minutes or so I was there only three other customers came into Oliver’s while the other two fast food restaurants probably served around 12 people each.

My meal of a chicken pizza pocket, one of Oliver’s trademark cups of green beans with salt and an Oliver’s brand non-alcoholic Organic Tumeric Beer came to a pricey $22.75 (the organic turmeric beer was an amazing $6.95 for 350mls, if Oliver’s can sell enough of them they should have no issues hitting their profit margins).
Pricing aside, I was pleasantly surprised with the food, the Pita wrap was fresh and tasty, and a cup of green beans flavoured with nothing but a little bit of salt is less boring than you’d think. I wouldn’t get the turmeric beer again, but I’m sure it is to some people’s taste.

Conclusion

Overall, there’s a lot to like about the Oliver’s IPO. While the last minute price change does potentially reflect badly on management, the rare opportunity of listing in a business that has both a proven track record of achieving profitability and great growth potential is too good for me to give this one a miss.





Moelis Australia

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Overview

Moelis Australia is the Australian offshoot of Moelis & Company, an American investment bank founded in 2007. Moelis and Company have made a name for themselves as one of the leading “Boutique investment banks,” smaller specialised investment banks that have become increasingly popular since the GFC largely thanks to their perceived ability to give more independent advice. In one of their most impressive wins to date, Moelis and Co was recently announced as the sole lead on what will probably be the biggest IPO in history, the giant Saudi state owned oil company Aramco.

In Australia, Moelis has been similarly successful, though not without controversy. While they have been involved in numerous successful IPO’s, they were also the lead manager for the botched Simonds Group IPO in late 2014, with shares now trading at less than a quarter of their floating price. More recently they have made the news for apparently buying up Slater and Gordon debt at significant discounts, supposedly for some debt for equity scheme they are planning.

After the IPO, Moelis & Co will retain a 40% stake in Moelis Australia and a partnership between the two entities will remain with Ken Moelis himself, the founder of Moelis and Co taking a seat on the board.

IPO details

25 million of a total 125 million shares will be sold through the IPO at $2.35 per share, raising $53.8 Million once the costs of the offer have been taken into account. The Market capitalisation at listing price is $293.8 million, making it one of the biggest Australian IPO’s this year to date.

CEO

The CEO of Moelis Australia is Andrew Pridham, more famous for his role as Chairman of the Sydney Swans and his occasional spats with Eddie Mcguire than for his career as an investment banker. Pridham’s career has been impressive; he was appointed the Managing Director of Investment Banking Australasia for UBS at only 28 and has also held senior roles at JP Morgan before helping start Moelis Australia in 2009. He has been less successful in his ventures into the art collecting world though, making headlines a couple of years back when he purchased what turned out to be a forged painting for 2.5 million dollars. When Melbourne radio hosts started making fun of him about this, Pridham’s response somehow managed to go from victimhood to snobbery in one sentence.

“It’s extremely disappointing but notsurprising these radio jockeys find it appropriate to make fun of any victim ofcrime — me or anyone else. It is of some comfort to me that it is highlyimplausible anyone will ever have the opportunity to defraud any of them of$2.5 million.”


However, as long as Pridham doesn’t decide to turn Moelis Australia into an art gallery, his dubious taste in Australian art shouldn’t trouble potential investors, and overall he seems like a pretty capable and intelligent guy. Also, for the CEO of an investment bank worth nearly three hundred million dollars his salary is quite reasonable, at only $450,000 a year plus bonuses. That he is looking to make most of his money through performance bonuses and increases in the share price is a positive for investors, and something that other recent listings (Wattle Health anyone?) Could learn from.

Expansion plans.

One of the things that worries me about the Moelis Australia IPO is the 44.2 million of the total 58.8 million raised  that will be set aside for the vague purpose of “growth capital.” This is expanded upon in another section of the Prospectus with the below statement:

"Moelis Australia is actively assessing a number of strategic asset and business acquisitions. None of these opportunities are certain of proceeding at the date of this Prospectus. Any one of, or a combination of, these acquisitions could result in Moelis Australia applying a substantial part of the Offer proceeds to fund the acquisitions of potential assets or businesses being assessed."

While some investors will see this as a growth opportunity, something about the combination of a CEO with no shortage of self-confidence, a professional services business and statements like this make me a little nervous. As any financial academic or Slate and Gordon stockholder will tell you, business acquisitions by listed companies have a tendency to destroy rather than create shareholder value, and I doubt Pridham is going to be able to sit on his hands for long with $54 million in his pocket. While it’s possible he might make the deal of the century, it’s also possible he might end up biting off more than he can chew.

Significant Investor Visa Funds Program

Another thing that concerns me with the Moelis IPO is its involvement in the Significant Investor Visa Funds Program. This is a program the federal government introduced a while back where Investors who invest over 5 million dollars in approved Australian investments are able to gain an Australian Visa.
These sorts of visa programs have come under a lot of criticism both in Australia and internationally, and in the USA in particular have become a target for fraudulent activities.

Canada cancelled their own program after finding it delivered little benefit and an Australian productivity commission report in 2015 advocated scrapping the program as well, arguing that it led to too many visas being granted to elderly people with limited English skills.

 While the current Liberal government appears to be committed to the scheme, you would imagine that all it would take is a change of government or a few highly-publicised scandals for things to change. Moelis themselves appear to be well aware of the risks this would pose to their business, as evidenced by this detailed response of theirs to the 2015 productivity commissions report.

Moelis does not break down the revenue for each separate sector, though the prospectus does state that average assets under management grew from 161 million to 624 million in 2017 largely thanks to this program, so we can assume that if this program was to be cancelled it would have a significant impact on the business.

Valuation

Looking around at most investment banks, they seem to cluster around a P/E of just under 15. Goldman Sachs is currently at 13.96, JP Morgan Chase is at 14.1, and Morgan Stanley is at 14.53. The big four Australian banks have similar P/E ratios. Moelis Australia are no doubt aware of this, and have presented an “adjusted” Price to Earnings ratio of 14.6 in the prospectus. On the surface this makes the valuation seem like a pretty good deal. As a relatively small player, their growth prospects are more significant than the larger banks, so to be priced at the same discount rate would represent a great opportunity. However, this is a good example of when it pays to do your own research before trusting adjusted ratios cooked up by investment bankers. When I divide Moelis Australia’s profit from the 2016 calendar year (9.8 million) by the post-listing market capitalisation of 293.8 million I get a price to earnings ratio of 29.97, more than double the ratio quoted in the prospectus. Although you might think this is because my calculator isn’t as fancy as the ones used at Moelis Australia’s head office, Moelis have actually made two rather questionable adjustments to get this lower ratio.

To start with, while P/E ratios are almost always calculated using previous earnings (trailing twelve months). in Moelis Australia’s adjusted P/E ratio, they have instead used their forecasted Pro Forma earnings for the 2017 calendar year of 16.8 million. While for a small growing company it may make sense to use forecasted earnings in a P/E ratio if the business is just starting, I fail to see how it is justified for an established investment bank with a proposed market capitalisation in the hundreds of millions. Moelis Australia are not planning to change their operations significantly in the next twelve months, so their reason to use forecasted earnings simply seems to be so they can get a more attractive P/E ratio.

The other adjustment they have made is to the price side of the P/E formula. Moelis Australia have taken the odd approach of subtracting the net offer proceeds of 57 million from the market capitalisation for the adjusted formula. This is supposedly justified because their acquisition plans are not included in their projected earnings, though as a potential shareholder, the actual market capitalisation is how the market will evaluate the stock, and the total shares outstanding will determine your share in any future earnings. While P/E ratios are based on earnings from the past and the market value today, by some odd form of wormhole accounting Moelis have ended up presenting a ratio based on future earnings and a market value from the past. 

Of course, I’m sure Moelis Australia could wheel out to a batch of highly paid accountants who would explain why the adjustments they made are reasonable and their P/E ratio is accurate, but then again Goldman Sachs had maths PHDs that could explain how CDOs were a great idea in 2006 and we all know how that ended up. I would argue that any future investor would be much better served using the 29.97 figure I calculated when deciding if Moelis Australia is a good investment, as this is how P/E ratios for other companies are quoted.

Verdict

When you use the actual P/E ratio of 29.97 to evaluate the deal, the Moelis Australia IPO looks reasonable, but hardly exciting. If you think that Moelis Australia is a great up and coming Corporate Investment Bank with a proven track record and that Pridham is a genius who will be given the new freedom of 50 odd million dollars in free cash to launch some amazing acquisition, then a P/E ratio double that of the larger investment banks is perhaps reasonable. From my perspective though, the Significant Investor Visa Program is not something I would want any investment of mine relying on long term, and with what I know about the track record of acquisitions, I would probably rather have the cash on the balance sheet invested in an index fund than whatever plan Pridham has cooking up.

BigTinCan

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Overview

As someone working in business development, I’m used to being called into a room by an executive or manager for a presentation of the new sales tool that is going to reduce our admin/allow us to accurately forecast sales/provide quality leads. 9 times out of 10 it’s a bit of a let down. The tools are rarely demonstrated in a live environment, the data is often inaccurate, and the supposed insights with “machine learning” seems to be nothing more complex than a couple of if arguments in an excel cell. It is for this reason that I was a little sceptical when picking up the prospectus for Bigtincan, a content platform for sales people on mobile devices.

The Bigtincan hub allows companies to selectively push sales content to the mobiles and tablets of sales staff. The idea is that instead of sales people having to hunt through different emails or folders for the presentation or collateral that they need, all content can be accessed from the one hub, with both offline and online capabilities. Bigtincan is seeking to raise 26 million for a fully diluted market capitalisation of 52.34 million once all the various options and are taken into account.

Financials

BigTinCan is currently burning through a lot of money. The total loss in 2016 was nearly 8 million, and based on their own forecast figures they will lose another 5.2 milllion in 2017. In any other sector, trying to argue a company with these sorts of losses is worth over 50 million dollars would be ridiculous but in the tech space this is pretty standard. Any successful tech company you can think of lost huge amounts of money during their growth phase, sometimes for a long time. To use the most recent example, Snapchat’s market capitalisation post listing was around 29 billion dollars, despite losing over 500 million dollars last year.

Taking a closer look at the numbers, the extent of the loses seem more strategic than involuntary. In FY 2016, BigTinCan spent just under 9.5 million on product development and marketing, or 135% of their total revenue, and they plan to spend another 12 million in FY 2017. They could have easily reduced their loses by cutting back in these areas, but as every other tech company knows, the real key to success when you are selling software is scale. It costs nearly the same amount of money to sell a product to a million-people compared to a thousand, and you only get to sell to a million people if you have a great product. The key metric for any young software company is growth, and here Bigtincan does not disappoint. Total revenue was 5.17 million in 2016 and grew 35% to 7.04 million in 2016, with projected revenues of 9.7 million for FY2017.

The one potential problem I found regarding Bigtincan’s financials is whether there is enough available cash to sustain the future losses the business might make. BigTinCan will have 14.421 million dollars cash immediately after the IPO. Given their current and projected loses, there is a reasonable risk that they may need to refinance before they get into the black, which needs to be taken into account when deciding if purchasing these shares make sense.

Product

As someone who is often on the road presenting to customers in my day job, I get the appeal of the Bigtincan Hub. In sales, you are constantly searching through folders and emails for the right presentation or tool that suits the customer you are dealing with, and when you have to do it all on an Ipad it becomes even harder. A centralised hub that can deal with a range of different file types, allow commentary and collaboration, and let managers push files to different users has definite appeal.

What’s more, from all the research I have done, it seems the BigtinCan Hub has delivered as well. Most reviews they have received are pretty positive, and they have received some impressive testimonials from large customers.

Perhaps the most impressive write-up comes from Bowery Capital, a venture capitalist firm that publishes an exhaustive summary of all software tools for start-up sales organizations every year. In their latest piece, Bigtincan receives the best rating out of the 13 other companies in the “content sharing space.”

The only reservation I have with the Bigtincan hub is that it is targeted to address a very specific need. What happens if in a couple of years’ time, Google, Apple or Microsoft release something that can do everything that Bigtincan can do and more? Given the natural advantages these larger companies have, it would probably be the end of Bigtincan. Of course, the more palatable outcome is one of these companies deciding they want to acquire Bigtincan by buying out shareholders at a healthy premium over market price, so there is upside to this possibility as well.

Past court cases

Buried in the financial section of the prospectus is a small note that there were two court cases that had an impact on the Statutory profit and loss for the last two years. As investing in a company with a troubled legal history is an alarming prospect, I decided to do some digging to see if I could find out more about this.
The first court case was a dispute with an early director called David Ramsay. From what I can understand from Bigtinc an’s version of events, David Ramsey was given money to develop software for Bigtincan which he then used instead to develop an app for his own company. It appears Bigtincan won this case and Ramsey had to pay $300,000 in damages as a result. While Ramsey has tried to appeal this, it looks like his appeal to the high court was rejected. so it seems this chapter at least is closed.

The second case was with an American Software company called Artifex, which filled a lawsuit against Bigtincan over the use of technology that let users edit Microsoft office documents on their smart phone. Bigtincan reached a confidential settlement with Artifex over this matter, so we do not know the exact outcome, but as Bigtincan has continued to grow since then we can assume that whatever concessions were made did not have a major impact on the Bigtincan business.

I don’t really see any major cause for concern with either of these court cases. Given the potential money at stake, it seems inevitable that software companies get into squabbles about proprietary technology, and most successful tech companies have a story of some estranged director or other in their past, if only to give Aaron Sorkin and Ashton Kutcher material.

Price

Evaluating Bigtincan’s listing price is a more complex than for most companies, as I was unable to rely on a basic Price to Earnings ratio to get a feel for what would be reasonable. Instead, I decided to use price to revenue as an alternative as nearly all software companies list at a loss.

Based on these figures, the Bigtincan valuation seems pretty reasonable. Total revenue from the 2016 calendar year was 7.934 million vs a fully diluted market cap of 52.34 million, giving a Price to Revenue ration of 6.6. Linkedin’s initial listing was at a Price to Revenue ratio of 56 and Salesforce’s was around 11 (this was back in 2004 when internet companies were viewed with suspicion). Closer to home, Xero the New Zealand based accounting software company listed on the ASX in 2012 with a price to revenue ratio of 25.

In addition to comparing Bigtincan to other technology IPOs, I have modelled the next five years after 2017 to try and get an idea of where Bigtincan could end up, assigning different growth rates to their main revenue and expense areas.

Based on the assumptions I have made (and I accept that many will disagree with a lot of these) the company will have an EBITDA of 4.4 million in 2022. To me this is very compelling. I do not think I have been overly optimistic with the growth rates I have used, and you do not have to be Warren Buffett to know that a fast growing SaaS company earning 4.4 million dollars a year will be closer in market capitalisation to 150 million than 50 million.

Verdict

There are significant risks with this IPO. Bigtincan is still a young company operating in a competitive environment, and all it would take is a change in industry direction or a better product from a larger tech company to end their prospects completely. However, the potential upside if things go to plan is pretty substantial, and for me the price is low enough to justify getting involved.

The Fat Prophets Global Contrarian Fund

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 Overview
If you’ve heard of one hedge fund manager from the last ten years there is a good chance it’s Michael Burry. The eccentric investor made millions on his bets against the housing market during the Global Financial Crisis and was immortalized in the book and later film The Big Short. What is less well remembered about Burry’s story is that before the housing market blew up countless panicked investors withdrew their money from his fund, worried by Burry gambling so much money betting against a housing market in the middle of a boom. While Burry still made millions from his bet, it was less than it could have been, and the stress and frustration of the whole process led to him deciding to close his hedge fund.

Burry’s story highlights a fundamental issue with hedge funds: investors in hedge funds can withdraw their money whenever they like. It is often precisely when a hedge fund manager sees the most opportunity, for instance when the market is falling or in Burry’s case when a bubble is about to burst, that investors want their money back.

It is for this reason amongst others that Listed Investment Companies (LICs) have gained in popularity in Australia over the last decade or so. LICs are basically a hedge fund or managed portfolio that is publicly traded on the ASX. Unlike a hedge fund though, when investors decide to they want their money back from an LIC they simply sell their shares, which doesn’t reduce the money available to the manager of the LIC. This means that LIC managers are less beholden to their investors, and, the theory goes, therefore more able to concentrate on maximising returns.

The Fat Prophets Global Contrarian fund is the latest such LIC to list on the ASX, with their 33 million dollar IPO at $1.10 a share expected to close on the 10th of March. Fat Prophets was started in the year 2000 by their founder Angus Geddes as a subscription based investment advice and funds management company. Investors who sign up to their service are given access to a daily newsletter, as well as reports on certain stocks with buy and sell recommendations. Since inception the organisation has grown to over 75 employees and 25,000 subscribers, and now provides stock picks for a range of different markets and sectors. The Fat Prophets Global Contrarian fund is the first time Fat Prophets has branched out into the LIC world, and it will be run by Angus Geddes and his team using the same contrarian investing principals that has made Fat Prophets a success.

Pros

The Fat Prophets track record
Fat Prophets impressive growth over the last 16 years has been largely due to a record of stock picks which would be the envy of most fund managers. Since their inception in 2000 until the end of 2016, the annual return of an investor who followed all their Australian equities stock tips would have been 18.49%, against an All Ordinaries return of only 7.96%. They have had similarly impressive success in their other sectors. On the Fat Prophets website all of their past stock tips from 2006 to 2016 are publicly available, and reading these you get a good sense of the company and how they have achieved this level of success.

Each stock tip is thoughtfully written, with impressive amounts of detail about each company and its market outlook.  If you want to gain an understanding of their investing rationale and style, have a look at their buy recommendation for Qantas shares in August 2014.
                                                                               
The post goes to painstaking lengths to break down Qantas’s market position, their recent challenges, and why the Fat Prophets team felt the struggling airline could turn things around. Not only did the recommendation prove to be spot on, with the share price more than doubling over the next twelve months, but they were even correct about how it happened. They correctly predicted that a decrease in flight volumes along with the cost savings of Alan Joyce’s restructures would help bring the company back into profitability. Of course, not all their recommendations ended up being as spectacular as this one, but in all their tips they display a similar level of knowledge, discipline and intelligence. The opportunity of being able to get in on the ground floor with a team like this as they embark on a new venture is definitely an appealing prospect.

Minimal Restrictions
Reading through the prospectus, one of the things that jumps out at you is the loose rein Angus Geddes has given himself. While most LICs typically restrict themselves to certain sectors, areas or assets types, the prospectus makes it clear that Angus Geddes and his team are going to invest in whatever they feel like. They reserve the right to trade in everything from equities to derivatives, debt products and foreign currencies, and to go from 100% cash holdings all the way to 250% leverage. While some might see this as a risk, to me this makes a lot of sense. If you believe that Geddes and his team are worth the roughly $400,000 annual fees plus bonuses they are charging to run the fund, it makes little sen se to restrict them to a sector or investment type. With this level of freedom, Geddes can go after whatever he feels will give the most value, and there will be no excuses should the fund not perform.

Cons
Listing price
As a new entrant with a smaller Market Capitalisation than the established LICS, fees are inevitably higher than some of the more established listed investment companies. The Fat Prophets Global Contrarian Fund will charge 1.25% per annum of their net assets in fees. In addition, a quarterly bonus will be paid each time the portfolio ends a quarter on a historical high of 20% of the difference between the current portfolio value and the next highest historical portfolio value. By contrast, Argo and AFIC, two of the largest Australian Listed Investment Companies charge fees of under 0.2% of their net assets per annum. It should be pointed out though that both Argo and AFIC regularly underperform their benchmark indexes, so perhaps in the LIC world you get what you pay for.

Net Tangible Assets
After the costs of the offer are paid for, the Net Tangible Assets of the Fat Prophets Global Contrarian Fund based on a maximum subscription will be somewhere around $1.08 per share. Listed Investment Companies usually trade at a relatively small discount to the net value of their portfolio, as the market prices in the fees an LIC charge. This means we can assume the shares actual market value will be somewhere around $1.05 to $1.07 after listing, versus a purchase price of $1.10. While this is the same for every newly listed LIC, it does mean that any investor thinking of participating in this offering needs to be in it for the long haul, as there is a good chance the shares will likely trade at below listing price for at least the first couple of months.

Wildcard

Loyalty options
Every investor who participates in the Fat Prophets IPO is issued with a loyalty option for each share purchased. From 12 to 18 months after the listing date, shareholders will have the option to buy an extra share in Fat Prophets for $1.10 for each share they own, regardless of what the actual stock price is. These loyalty options are forfeited if an investor sells their shares in the first year and are not transferred to the new owner. Initially this seems like a great deal, as you can double your holding at the listing price if the fund performs well, however the fact that everyone participating in the IPO is issued with the same loyalty options negates most of the benefit. In fact, in a simplified world where the stock price equals the net assets and no one sells their shares in the first 12 months, the loyalty option provides no benefit at all.  
To understand this, imagine that based on these assumptions the shares are trading at $2.20 after 12 months. Initially you might say the loyalty options now give each shareholder a bonus of $1.10 per share, as they could buy shares for $1.10 then immediately sell them for $2.20. However, this overlooks the fact that every other investor would also be exercising their options, doubling the number of shares on offer. At the same time, the company assets would only increase by a third from the sale of the loyalty options, from $66 to $99 million. With $99 million of net assets and now 60 million shares on issue, the share price would now be $99,000,000/$60,000,000 = $1.65. This means that not only would shareholders only make 55 cents per loyalty option, their original shares would have also lost 55 cents in value at the same time, giving a net benefit of zero for the option.
Of course, the real world never plays out like the textbook. Some shares will inevitably change hands in the first 12 months, reducing the number of options available and therefore providing some value to those who still have their loyalty options. However, any investor thinking of participating in this offering should make sure they have the funds available to exercise their options after 12 months if the share price is trading above $1.10, as otherwise they risk seeing the value of their shares reduced by other investors cashing in their options without being able to benefit themselves.

Summary
If you are looking to for an IPO that is going to double your money in six months, this isn’t the one for you. Any gains here are likely to be in the long term. Nor is this an IPO in which to invest your life savings, as the freedom Geddes and his team have given themselves mean that the risks could be considerable. However, if you are looking for a good long term investment opportunity for a portion of your portfolio, investing in this IPO could make a lot of sense. The Fat Prophets team have proven they know what they are talking about when it comes to investing, and if they can get anywhere close to their previous success the fund will do very well.

Personally, Geddes track record is too good to pass up, and I will be making a small investment.

ReTech Technology

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Overview

ReTech provides online learning and educational services to companies in China. They plan to raise 22.5 million through the prospectus by selling 20% of the company via the IPO, giving a total post IPO market capitalization of 112.5 million. The business has three main arms, an E-learning business where they provide training courses to businesses for staff, a newer e-training partnership area where they will partner with established education entities (they have a memorandum of understanding with Queensland TAFE) and a proposed e-course direct area where they intend to sell courses direct to companies and individuals. According to the prospectus, e-learning is a rapidly growing industry, with a growth rate of 32.9% between 2010 and 2015. While this seems high, service and knowledge based jobs are exploding in China, and online education is one of the fastest and cheapest ways to train staff. Having had the misfortune to complete a few work-mandated e-learning courses in my career myself, it’s not exactly an exciting industry, but the benefits they offer companies are clear. The prospectus lists a few of the courses which ReTech owns the intellectual property rights to and looking at names like “how to introduce the gear box” and “how to recommend vehicle insurance for clients,” you can almost imagine a bunch of bored car salesmen sitting in an office somewhere in China clicking through multiple choice questions.
The IPO funds will be used, amongst other things, to set up an office in Hong Kong. This means that unlike Tianmei, the IPO I reviewed most recently of another Chinese company, the final parent company isn’t located in Australia. While I’m no expert on Hong Kong company law, I think this is a mark against ReTech. With an Australian company, shareholders have the recourse of class actions or potential moves against the board if things go wrong. I’m not sure how easy those things would be to organize against a Honk Kong based company.

Company background

According to ReTech’s website, ReTech was originally founded as a website development company in 2000 by a guy called Ai Shugang while he was still a university student. Since then it has grown and expanded into several different technology and internet related areas. Instead of just listing as the original entity, the founders decided to create a newly incorporated company called ReTech Technology to list on the ASX. They injected their own capital into the business, and then sold/transferred significant amounts of the intellectual property and existing E-Learning contracts to the newly created company. To make things more complicated, at the same time the founders also created another company called Shanghai ReTech Information Technology (SHR) which as far as I can understand will remain wholly owned by Ai Shungang. SHR has also had a significant number of E-Learning contracts assigned to it from the original ReTech entity. SHR has signed an agreement with ReTech regarding these contracts where ReTech will provide the services on SHR’s behalf, in exchange for 95% of the resulting fees. If this all sounds a bit confusing you’re not the only one.
My concern with all of this is that ReTech is in the sort of industry where a founder siphoning off business is a major threat, meaning another business still operating owned by the original founder is a big risk. In the prospectus, ReTech list expertise and their existing client list as two of their four main competitive advantages, two things that would be easy for the founder Ai Shungang to poach to SHR. Although Ai Shungang does own a significant stake in ReTech, he owns 100% of SHR’s parent company, so the motivation for him to do this is there. The prospectus points out that both Ai Shungang and his companies have signed non-compete contracts, guaranteeing they will not operate in the same sector as ReTech, but I know how hard to enforce these contracts are in Australia, and can only imagine what the process would be like in China.  
Finding out what exactly this separate company will be doing given they have committed to not entering the online education sector proved difficult. I eventually found a legal document on ReTech’s website that states Shaghai ReTech Information Technology is going to focus on software and technology development and technical management consulting. To make things even more confusing, they also seem to be still using identical branding to ReTech, based on what I found on a management consulting website. If you trust the founders of the company, probably none of this would bother you but for me these are considerable issues.

Valuation

Before looking at any of the financial information for ReTech it is important to remember that the company was incorporated in its current form in May 2016, and the final part of the restructure was only completed in November. This means that all historical profit and loss figures are pro forma only, estimates of what the contracts, intellectual property and assets now owned by the ReTech Group earnt before the company was split. This is a massive red flag for me. I’m sceptical of pro forma figures at the best of times, and when they are used by an unknown company in a prospectus where the unadjusted figures are not even provided it’s a massive concern. To give just one example of how these figures could potentially be distorted, education software development costs could be written off as not part of the business, while the associated revenue is counted towards ReTech’s bottom line. Examining the pro forma figures doesn’t exactly assuage my concerns either. Have a look at the below table taken from the prospectus, in particular the profit before tax to revenue ratio. In 2015 off revenue of just 6.9 million the profit before tax is listed as 4.2 million, meaning for every dollar of revenue the company made 61 cents of profit. Of course, I understand that profits can be high in the technology sector, but a profit to revenue ratio of .61 is extraordinary, especially when you consider that this is a young company in a growth phase.

Most young companies with growth rates this large are running at deficits as they re-invest into the business, not earning profit margins that would be the envy of booming mining companies.


Even with these relatively major concerns put aside, the valuation appears expensive. The pro forma Net Profit after Tax for FY 2015 was only 3.6 million, which against a valuation of 112.5 million is a Price/Earnings of just over 31 (annualizing the profits from the first half of 2016 doesn’t give you much better numbers). Full year profits for FY2016 are expected to be 5.8 million, a P/E of 20, but if there is one thing I am more suspicious of than Pro forma historical accounts it’s prospectus profit forecasts, so I have little inclination to use these numbers to try and justify the valuation.

Management personnel

When I started digging around on the management personnel, one of the first things I noticed was the strong link to Investorlink, a Sydney based financial firm that seems to specialize in assisting Chinese companies list on the ASX. In addition to being the corporate advisors to this listing (for which they will be paid $380,000), Chris Ryan, an executive from Investorlink is one of the five board members of ReTech. I was already sceptical of this IPO at this stage, but this was the final nail in the coffin. Chris Ryan’s CV is like a checklist of bad Chinese IPOs. Ryan was and apparently continues to be the chairman of Chinese Waste Corporation Limited, a Chinese company that reverse listed in 2015 and was suspended from the ASX in mid-2016 for not having “sufficient operations to warrant the continued quotation.” He is currently the chairman of TTG Fintech Limited, a company that listed on the stock exchange at 60 cents in late 2012, inexplicably reached as high as 4 dollars in mid 2014, and is now trading at 7 cents and he has been on the board of ECargo Holdings, a company that listed at 40 cents in late 2014 and is now trading at 20 cents. I spent some time looking at the various Chinese IPO’s that Investorlink has advised on, and was unable to find a single IPO whose shares aren’t now trading significantly below their listing price. If ReTech are indeed a legitimate company, it’s hard to understand why they would seek to list through Investorlink given this track record.

Verdict

To put it bluntly, I wouldn’t buy shares in ReTech if I could get them half price. Everything from the odd restructure to the lack of statutory accounting figures, the high valuation and the awful track record of the Corporate Advisor makes me want to put all my money in treasury bonds and never invest in anything speculative again. Of course, it’s possible that Ai Shungang is going to turn out to be the next Mark Zuckerberg and I’m going to end up looking like an idiot (to the handful of people who read this blog at least), but that is one risk I am happy to take.

 The offer closes on the 9th March.

Tianmei Beverage Group Corporation Limited

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Overview

Tianmei Beverage Group Corporation Limited is a Chinese company based in Guangzhou with two arms to the business. The first is as a distributor and promoter of packaged food products, placing different suppliers’ goods at convenience stores and supermarkets. The second is a bottled water company that sells water produced by a Chinese water processing plant they have a contract with. They are using the Prospectus to raise 10 million dollars, selling 25% of the company in the process. The money will be used to buy the water bottling plant they currently source their water from and to start importing Australian food products to China and promoting it at their contracted stores.

Valuation

From a pure valuation perspective, Tianmei China is a fantastic deal. According to the Prospectus they made a profit of over 4.3 million dollars in the first half of 2016, and the IPO values the company at 34 million, meaning the Price to Earnings (P/E) ratio is well under five if you annualised those earnings. On top of this, both arms of the business are in massive growth areas: The bottled water market in China has seen double digit annual growth due to pollution concerns and the growth in demand for Australian food and health products in China has been astronomical. You can see this in the impressive premiums that the market places on any Australian company that is exposed to Chinese consumers: Bellamy’s was trading at a P/E of 40 a little while ago, and even after sacking their CEO and concerns about their accounting, the share price has only shrunk to a P/E of 10. The A2 Milk company is trading at a massive P/E ratio of 68 and Blackmores is trading at a P/E of 20 largely thanks to growth potential in China.

It’s basically impossible to come up with a valuation that isn’t higher than Tianmei’s listing price using a discounted cash flow analysis. Even if you put a ridiculously high discount rate of 20% and assume a conservative growth rate of 6% for the next 8 years before levelling off to 1%, you still end up with a company value of over $40 million. The way I see it then, if you are evaluating this stock, investigating the exact growth rate of the bottled water market or Chinese supermarket conditions is a waste of time, as whatever you come up with is going to show the stock is a good buy. Instead, the simple question for any potential investor is can we trust this company? As a relatively unknown company operating in a country that doesn’t exactly have a spotless reputation for good corporate governance, it is hard not to be suspicious. The story they are selling through their accounts is one that anyone would want to invest in. The question is, is this story true?

Personnel

According to John Hempton, a role model of mine and someone who inspired me to start this blog, the best way to find out if a company is dodgy is to look at the history of the key management personnel. Hempton’s hedge fund Bronte Capital does just that, following people who they believe have been involved with companies that were fraudulent for potential targets to short sell.


Unfortunately, it’s hard to find nearly any English information on most of the key people in the company and I don’t speak Mandarin, so the only person I can really look into is the chairman, an Australian guy called Tony Sherlock. Tony Sherlock has been around for a long time in the M & A and finance world. He was the chairman of Australian Wool Corporation, worked at PWC in the risk division for ten years and co-founded Bennelong capital, a boutique corporate advisory firm. Judging by his Linkedin profile he looks like he is in his late sixties at the youngest, as he finished a Bachelor of Economics in 1969. Would a guy nearing the end of a successful career working risk his reputation promoting a company that wasn’t above board? It seems unlikely. He’s built up a solid reputation for himself over the years and it would be strange for him to risk it that late in his career. Of course nothing is certain, and it’s possible he’s got some secret gambling condition that makes him desperate for cash or simply doesn’t know that the company is fraudulent, but overall it seems like a positive sign that he is the Chairman.

History

One of the initial things that made me suspicious of Tianmei is its age, as according to the prospectus the company only started in 2013. Trying to unpick the exact history of Tianmei China is a painstaking undertaking, as there are a ridiculous amount of holding companies that have been created along with business name changes. As far as I can understand it though, it looks like the Tianmei business was created in 2013 by Guangdong Gewang, a Guangzhou based business started in 2010 that sells supplements of selenium, a chemical element that Guangdong Gewang claim is vital to human health. While I was initially suspicious of a company selling a supplement that I’d never heard of, after doing some research it actually looks legitimate. Although selenium deficiency is very rare in the West, apparently it is a problem in some parts of China due to crops being grown in selenium deficient soil. During a restructure in 2015 Guangdong Gewang separated the selenium supplement business from the water and FMCG businesses, and as a result created Tianmei. Interestingly enough, Guangdong Gewang is applying for admission to the Nasdaq for their own IPO currently. Guangdong Gewang still hold 22.5% of Tianmei through Biotechnlogy Holding Ltd, a company incorporated in the British Virgin Islands. (Both these companies seem to have a real love of the British Virgin Islands, Tianmei’s ownership also is funnelled through a British Virgin Islands company.) While the history isn’t exactly stable, there are no obvious red flags I could find to turn me off investing in Tianmei.

Ownership

One of the things I like about this IPO is that the initial listing at least isn’t just a way for the owners to cash in. As a jaded, though still cautious believer in the theoretical benefits of capitalism, it’s nice to see an IPO doing what a stock market is meant to do; allocating capital to a business that wants to grow.
A strange thing about the ownership structure is that the equal largest shareholder with 22.5% ownership is a woman called Han Xu, an Executive Director who from her photo looks to be in her mid-twenties. How does someone who finished their bachelor’s degree in 2011 and a Masters of International Finance in 2013, afford 7.2 million dollars’ worth of shares in the company? Perhaps a more basic question is how can someone who left university three years ago and never studied law end up as the ‘legal expert’ and executive director of a soon to be publicly listed entity, when fully qualified lawyers of her age are still working 70 hour weeks as Junior Associates? The most obvious explanation would be she is the daughter of someone important. After doing some digging around I found that one of the co-founders of the original Selenium supplement company was a guy called Wei Xu. While I don’t know how common the Xu last name is in China, it seems reasonable to assume that they could be related.
Is this potential Nepotism enough to be a concern? I don’t really think so. While she might not be the most qualified person for the job, If anything it’s reassuring that the co-founders of the company are maintaining their holdings. The third largest shareholder of Tianmei is a guy called Mengdi Zhang, whose father Shili Zhang was another initial co-founder of the Selenium business according to Guangdong Gewang’s filings for their Nasdaq IPO.

Verdict

Overall I think this looks to be a pretty good IPO. While of course there are always risks with investing in a company this young and especially one operating in a foreign country, the price is low enough to make it worthwhile. It seems the listing is about both raising capital as well as creating a link with Australia so they can start importing Australian foods, which perhaps explains why they have listed at such a low price; the benefits for them isn’t just the capital they intend to raise. If the market gains confidence that Tianmei is legitimate, the company could well double its market capitalization in the next 12 months and I will definitely be along for the ride. 


Eildon Capital

SPACS

Overview

Eildon Capital is currently a subsidiary of the publicly listed investment company CVC Limited.  The company focuses on high yield debt and investments in the property sector. They plan to raise between 2 and 10 million dollars via the IPO, with a market capitalisation on completion between 24 and 32 million. In the prospectus, they state that their goal for debt yields on property are between 12 and 18 percent before management fees and taxes. As a Mezzanine finance company, security on these loans will usually be equity in the ventures themselves.
There’s a lot of things to like about this prospectus; an experienced and stable management team, a good track record and at least on the surface a reasonable price, with every one dollars’ worth of shares bought giving you $1.01 of net assets in the newly created company. I’ve got a few misgivings though, and there are three main reasons I won’t be taking part.

The property sector 

As a long term believer in the idea that the housing market is overdue a downward correction, it’s hard to think of who would be more exposed to this than a company specialising in high yield property development loans. A substantial portion of their current assets are mezzanine loans to apartment developments in Melbourne, the Gold Coast and Brisbane. When I think “housing bubble,’ an apartment development in the Gold Coast is probably one of the first things that comes to mind. While Eildon stress in the prospectus that they have ways to mitigate their risk, if they are getting double digit yields on loans it’s hard to believe they are able to protect themselves that well.

Vanda Gould

Another thing that makes me a little suspicious of this listing is a controversy that has been hanging around Eildon capital’s current parent company, CVC Limited. Founded in 1985, one of CVC Limited’s founding directors and chairman for many years was a guy called Vanda Gould. Vanda Gould resigned in 2014 after becoming embroiled in a lengthy dispute over tax avoidance with the ATO. He recently lost an appeal to the high court over a tax bill of more than $300 million for companies he owns and advises, and is also facing criminal charges relating to tax avoidance that could potentially land him in jail. The guy seems like one of the real characters of Australian investing, his chairman’s letters for CVC would regularly get pretty philosophical, quoting Shakespeare and referencing interest rates from ancient Rome and Babylonia. While these days he holds no position at CVC and you won’t even find his name on the website, it’s hard to believe he is completely disentangled from all of CVC’s various affairs. To give an example of a potential continuing connection, over 10% of the shares of Eildon capital will be held by a company called Chemical Trustees Limited on listing, a company that had its assets frozen in 2010 due to alleged tax avoidance in relation to Vanda Gould. I have no idea if there is still any connection between Chemical Trustees and Vanda Gould, but if they end up having to sell their holding in a hurry or the shares are seized it could have a significant effect on the share price.

Pricing concerns

The last thing going against this prospectus is CVC Limited’s current share price. With net assets of $214 million as of the end of the last financial year, CVC’s market capitalisation has hovered around the 196 million dollar mark for the last couple of months. This means every 1 dollar you invest in CVC Limited buys you $1.09 of net equity on CVC’s balance sheet. That’s 8 cents more than you will get of Eildon Capital’s equity if you take part in the IPO. As CVC currently owns Eildon capital, this could mean that the IPO is priced above the current market price. Of course, it’s impossible to know for sure what assets exactly on CVC’s balance sheet the market is undervaluing, but it could just as well be the Eildon capital assets as anything else. If this is the case, there is a real danger the share price will drop by around 6% or 7% upon listing. If you are a long term believer in the company this may not bother you, but it does mean you may need to commit to holding these shares for quite a while if you want to make money.

Verdict

Despite all these issues, the target returns will no doubt be enticing for some investors, and if you have an appetite for a bit of risk and are not currently that exposed to the housing industry taking part in this IPO could make sense. For me though, my scepticism of the housing market along with concerns about the Vanda Gould connection makes me happy to give this one a miss.

The offer closes on the 24th of January.

Ardrea Resources

SPACS

Overview

It’s hard not to be charmed by the prospectus of Ardea resources. Something about the long term consultant getting his first shot at a Managing Director role, the all or nothing plan of investing all money raised into exploratory digging in the next few years and the hopeful and earnest pictures of gold nuggets, abandoned mine sites and old letters makes it feel like something out of a Poldark episode.
The whole project seems to be a creative way Heron Resources management have dreamt up to finance exploration of some of their existing tenements they think look promising without annoying their shareholders who would rather they focused on their existing mine. Ardrea resources will be given the tenements and in exchange Heron Resource shareholders will be given over half of the shares in Ardrea Resources. Ardrea will then raise 6 million dollars through the IPO selling off the other shares
While it's an elegant solution, it is a rather expensive way of doing things. The IPO will apparently cost $900,000, or 15% of the money raised and that’s before the additional salaries of board members and directors that will need to be paid each year are factored in. The cynic in me thinks that if those gold nugget pictures that are talked about so excitedly in the prospectus where compelling enough Heron Resources management would have convinced shareholders to let the company do the drilling themselves, though perhaps that's unfair.

Analysis

The payoff tree for Ardrea is pretty simple: The two year exploration will either turn up something that warrants a mine, or the company will have burnt through nearly all its money on the exploration drilling and the shares will be close to worthless. This means that in order to evaluate this deal we need to decide on two things: how much the share price will be if the drilling turns up something, and the likelihood of that happening.
To try and quantify what the Ardrea share price would be if the drilling work uncovers a feasible mine site we can use the share price of Heron Resources itself. As it stands currently, Heron Resources has had the Woodlawn mine approved as economically feasible with works due to start early next year. With this information supposedly factored into the share price, the company has a market cap of just under 52 million dollars. If you subtract the net cash the mine has of around 24 million dollars, it means the market value of the Heron Resources mining site plus any other remaining tenements is around 28 million dollars. The market cap on listing of Ardrea Resources will be 14.3 million if fully subscribed, meaning that if Ardrea was to find a mine site that a feasibility report showed was worth developing, the market cap and share price doubling to 28.6 million and 40 cents respectively may be a reasonable assumption. I know this may be overly simplistic, but there seem to be so many unknowns in regards to what could be found that trying to be more specific seems futile.
Trying to assign a percentage to the drilling finding anything is harder still. I’m not going to even pretend that phrases like “’wallaby style magnetite epidote alteration’’ mean anything to me, so the Prospectus isn’t really much help in this regard. There are a couple of things though that make me feel this percentage isn’t that great. Firstly, these tenements are not exactly new, with the Prospectus mentioning they have been looked at by previous miner’s numerous times, which can hardly be a good sign. Secondly, I keep coming back to the idea that if this really was a great opportunity, there must be easier ways to raise 6 million than through an IPO. Surely there would be private investors who would jump at the chance to put up money if they thought this opportunity was worthwhile. With all this in mind, I find it hard to be confident that the drilling prospects are above 50%.
With that low of a chance of a payoff, the deal doesn't seem that enticing.
There’s one more reason I’m reluctant to invest in this Prospectus. One of the conditions of the prospectus is that Heron Resources shareholders get priority if the IPO is oversubscribed. This means that for the average non-Heron Resources holding investor you are in a catch 22 situation: If the Heron Resources shareholders know this is a good deal, all or most of the shares will be snapped up before reaching the general public, and you will be left out. If, on the other hand, Heron Resources Shareholders think that this drilling project isn’t worth it, your bid will probably be filled.

Verdict

This one is a pass for me. If I had shares in Heron Resources it might make more sense, but as it stands there are too many potential downsides to make the potential payoff worthwhile.


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