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Choivo Capital

Author: Choivo Capital   |   Latest post: Sun, 13 Jan 2019, 02:51 AM

 

(CHOIVO CAPITAL) What is the market value for Sapura Energy Berhad (SAPNRG)?

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If there ever was a company that symbolized the excesses of debt fuelled growth coupled with the sky high price of oil in 2014, it’s this company.

Just 4 years 3 months ago. This company had a Market Capitalization of RM29.72 billion. Just RM4 billion shy of Nestlé’s market capitalization today.

Its founders, were the poster boys of success. Using an insane amount of debt, as well as some level of competence on their end, Shahril and Mokhzani fuelled their incredible ascend to stratospheric levels of wealth.

Which in more ways than one is very similar to incredible rise by real estate companies in China like Country Garden, Longfor Properties and China Evergrande Group.

In terms of debt, Evergrande takes the cake. At one point, it had a debt to equity percentage of more than 432%. Its currently at a slightly less suicidal 232%.

If not for their names or the color of their skin, i might have mistaken them for Chinese!
 

 

 

A very brief valuation

Net Debt: RM 15,382,767 million, or RM15.4 billion. The famous number.

Currently, Sapura has net debt of RM 15.4 billion. Paired against equity of RM12.2 billion, it has a debt to equity percentage of 126%. That does not look too bad. Companies like YTL Power have a higher debt to equity percentage of 149%.

Except, YTL Power have assets that give out recurring income very very very reliably. Even the Chinese property company above, have actual assets that can be sold to meet these obligations.

What does SAPNRG have?

Sapura Energy is the largest provider of tender assist rigs in the world. They also have other assets that are mainly used for upstream drilling.

This is not that bad of a problem, for usage of these rigs may not be that high compared to the capacity they have, oil prices should go up again, in a year, 3 years, or 7 years. (Donald Trump is really expanding shale oil which is based on land, he's likely to maintain this policy untill he is voted out or at the end of his second term).

Also, even if oil prices stay at USD60 per barrel. That is lucrative enough for companies to start drilling again. Capex planning works is very very hot right now for O&G companies.

If they could wait, it’s not that big of a problem. But with RM15.4 billion in debt and RM1 billion a year in interest payments. Time is luxury they do not have.





Also, there's another thing.





Almost RM8.25 billion of their assets, consist of this item call “Goodwill on Consolidation”. What is this?

When a company buys over a company, with Net Assets of say RM100,000 for a price of, let’s say RM200,000. The difference is recognized as “Goodwill on consolidation”. It basically means this is the value of the intangible qualities of the business. That’s the accounting perspective.

From the investors perspective, unless your name is Coca Cola, that is worthless. You’d rather your name be worth zero on paper, but billions in reality, like Coca Cola. Rather than billions on paper but zero in reality.

In my opinion, this RM8.25billion is basically the total amount overpaid by Sapura Energy for the acquisition of the other companies. With the vast majority from the purchase of tender rigs from Seadrill (another oil and gas company that has gone bankrupt). This entire amount should have been impaired in the first place, at least if one was coming from an investor perspective.

But from an accoutning perspective, its a little different. I know how an auditor would justify this figure. Review an acceptable and reasonable (at least on a first level thinking level) DCF from the management about how the companies bought are still worth the price paid, if oil prices go back up. The thing about DCF’s is, it’s a Hubble Telescope, move it a millimetre and you’re looking at a completely different universe.

Which makes it really hard for me to understand why anyone would pay more than RM1 for it, even during the peak. For the record, in my infinite stupidity, for my 2017 stock pick, as well as my personal portfolio then, I actually bought this, without even looking the report because I knew oil prices should be going up, and this name was the first one i thought of. Also, a friend said he likes Sapura’s “courage”. Luckily i sold 3 days later at a small loss the moment i read the accounts.

It’s amazing how courage looks like foolishness when one fails.

If we were impair it. The debt to equity ratio is now 386%. Higher than Evergrande, the most indebted of the Chinese property developers, except, they also own assets that are yielding close to all time low and selling at all time low prices.

If only they could wait it out.

As Kcchongnz have pointed out, a company has value as long as the debt does not exceed the assets. That means even if the goodwill is fully impaired, the company should still be worth around RM4bil or 62 sen, theorectically.

Thats a 19% margin of safety at current prices. You can definitely find other investments with higher levels of margin of safety.

But as a bet, its almost incomparable.

 

 

The Gamble

Now, we know from an investor perspective, it’s may be too risky due to the debt, and there are other investments out there with a higher margin of safety.

However, I can see something similar like Airasia in 2001 happening to it. Back when Airasia was sold to Tony for RM1, it had negative equity of roughly RM40 million and the directors had to guarantee 50%. After Tony purchased the company, he found also investors to inject roughly RM123 million into the company.

So, im probably being stupid here. But i can see a very deep pocketed company or individual either buying the company outright for RM2-3 billion and recapitalizing it. 

Either way,  there needs to be a major equity injection via rights issue. Or a debt to equity swap, except at the current market capitalization, I dont think that a debt to equity swap will ever go through, if all the debt is converted to shares, all the shareholders will have their shares reduced by 6.26 times. Shahril will end up holding 2.8% or so of a company from 17.5%.

However, from a gambling perspective, if you think this company won’t go bankrupt while they dig themselves out and that the 2 year forgiveness given by the local banks can be extended.

It’s looks very lucrative. (for more info, please refer to my article “The Art Of Gambling in Speculative Stocks.”

Because in this case, its almost as if the majority of your bet is financed by the banks.

While the upwards movement in price of the company due to increased earnings, belongs to you, the shareholder. Even the profit belongs to you!

In Sapura’s case, the enterprise value of the company consist of 16% market capitalization and 84% borrowings. It’s as if the banks are funding and taking on 84% of the risk for your gamble that Sapura will survive long enough to take advantage of an increase in oil price and drilling activity.

In that situation, as an equity holder, it’s a heads I win, tails you (bank) lose situation.

Your only risk, is that the company goes bankrupt. Or the debt is swapped with equity, making your shares worth 6.26 times less in terms of % ownership of the company.

Personally, i dont think the banks will ever push this company into a position where they need to declare bankruptcy, unlike Toys R Us, as unlike Toys R Us, i dont think its under threat from a fundamental shift in the world, or backed by assets worth far more than the company (alot of great buildings and lands).

So the banks should still allow SAPNRG to live long enough to turnaround. But its a very tenous assumption, relying on the goodwill of others to survive.

 

 

 

Conclusion.

Im almost tempted. But the sheer amount of discounts in the small to mid cap these days is mindboggling and im saving cash for property when if the economy crashes. Stocks, you can always move to a margin account.

So I’ll pass. Im a better investor than trader anyway.

But for those that go for it, or the traders in our midst, do let me know what you think. Im curious about your perspective and i'd like to learn.

====================================================================

Facebook: Choivo Capital
Website: www.choivocapital.com
Email: choivocapital@gmail.com

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  5 people like this.
 
ozzie75 Insightful. Thanks
15/03/2018 14:10
ozzie75 If the same DCF representation is given year after year and those prior representations do not materialise, wouldn't that exception be spotted in the course of a comparative review?

"As an auditor, I also know how we would justify this figure. Review a semi acceptable DCF from the management about how the companies bought are still worth the price paid, if oil prices go back up. The thing about DCF’s is, it’s a Hubble Telescope, move it a millimetre and you’re looking at a completely different universe."
15/03/2018 14:21
qqq3 up 7 sen today...why your timing so accurate one? in a negative way.
15/03/2018 15:14
Choivo Capital Yes, you do a comparative to the previous year budgeted to actual. But you just need to make sure it is reasonable. Which, well... depends on how good you are at arguing your perspective.

Look at it like banks in 2008, they take on all that risk using great calculations and take their fat bonuses. Then when it crash, they say that this is a six sigma event, a one in a million, we could not have possibly predicted, therefore not my fault.

Auditors stay within the lines drawn very well. The problem is where the lines are drawn. And its impossible to get a solution that is 100% true and fair that has no trade offs.


ozzie75 If the same DCF representation is given year after year and those prior representations do not materialise, wouldn't that exception be spotted in the course of a comparative review?

"As an auditor, I also know how we would justify this figure. Review a semi acceptable DCF from the management about how the companies bought are still worth the price paid, if oil prices go back up. The thing about DCF’s is, it’s a Hubble Telescope, move it a millimetre and you’re looking at a completely different universe."
15/03/2018 14:21
15/03/2018 15:16
Choivo Capital I dont time price. I estimate intrinsic value.

Where the price want to go, none of my problem.

Let me know if you think i missed out anything fundamental in my analysis.


Posted by qqq3 > Mar 15, 2018 03:14 PM | Report Abuse

up 7 sen today...why your timing so accurate one? in a negative way.
15/03/2018 15:20
angelol I'm an auditor but also a business graduate. What I can say is, if you only look at the account, go to impair everything together with the goodwill, basically the stock you can buy is dividend driven co which would probably give you stable dividend and some capital gain.

You must also understand that on accounting, goodwill should be reviewed on yearly basis? The management in Sapura, a lot of them, carrying ICAEW qualification and the account is audited by KPMG. Are you telling us they have a miss on this and you do it correctly by impair everything?

Most of the auditor, their first job is audit and never go in commercial and look at the business.

We talk about logic now, Petronas just award 5 contracts to Sapura, which you say has an adjusted gearing of 386%. Why Petronas dint consult you first before they award the contract? oh, Maybe Petronas dont have smart people like you.
15/03/2018 15:30
ozzie75 Could have imagine the challenges of the (supposedly independent) auditor, while contesting the assertions they have to think about the client satisfaction and retention factor.

Can't imagine how one would/could establish a nexus connection of the short term share price movement with your write-up, while I am more inclined to associate it with the price trend over the last reasonable 3 years.

Thanks for the critical write-up. It is good to have a balanced view.


Jon Choivo Yes, you do a comparative to the previous year budgeted to actual. But you just need to make sure it is reasonable. Which, well... depends on how good you are at arguing your perspective.

Look at it like banks in 2008, they take on all that risk using great calculations and take their fat bonuses. Then when it crash, they say that this is a six sigma event, a one in a million, we could not have possibly predicted, therefore not my fault.

Auditors stay within the lines drawn very well. The problem is where the lines are drawn. And its impossible to get a solution that is 100% true and fair that has no trade offs.
15/03/2018 15:42
ozzie75 If Arthur Andersen can vapourise because of Enron, it goes to show that things can go wrong when things look alight. Is there this term called professional skepticism, or financial vigilance that needs to be exercised at all times?


angelol I'm an auditor but also a business graduate. What I can say is, if you only look at the account, go to impair everything together with the goodwill, basically the stock you can buy is dividend driven co which would probably give you stable dividend and some capital gain.

You must also understand that on accounting, goodwill should be reviewed on yearly basis? The management in Sapura, a lot of them, carrying ICAEW qualification and the account is audited by KPMG. Are you telling us they have a miss on this and you do it correctly by impair everything?

Most of the auditor, their first job is audit and never go in commercial and look at the business.

We talk about logic now, Petronas just award 5 contracts to Sapura, which you say has an adjusted gearing of 386%. Why Petronas dint consult you first before they award the contract? oh, Maybe Petronas dont have smart people like you.
15/03/2018 15:30
15/03/2018 15:47
Choivo Capital Angelol,

Petronas does not award contract based on whether the accounts leng anot, but whether you can execute or if you can survive long enough to execute. Everyone know Toys R Us got very heavy debt, but only at the end did suppliers etc refuse to do business with them.

In business, economics and investing, what you think will happen, will take longer than you think it would. And when it happens, it will happen faster than you think it ever could.

Yes goodwill is reviewed on a yearly basis. But its very easy to justify pretty much whatever amount you want. Because a very small change in the DCF, which on a surface level is innocuous can give very very different results.

I can't give half a damn about the qualification the people have. If i does not make sense to me, ill try to see their perspective. But if it still does not make sense, too bad, im not buying it.

During the 2008 crisis, so many incredibly brilliant people seem to have severely fucked up their risk management.

Its incredible the kind of stupidity smart people are capable off when you are incentivised to be stupid. If i'm a bank in 2006, well my risk management charts better show that i can buy derivatives on housing loans, cause if it don't, my profit/market share will drop and my share price will drop.

If im an auditor, i am incentivized to be accommodating to management if possible. I will not be accommodating if it is clearly wrong, and i will go to jail if found out by the AOB. And its very very hard to prove that i am clearly wrong or have malice in preparing the DCF. I can always argue that, its easy to say i was clearly wrong in hindsight. But, if placed back in that situation not knowing what i knew now, my assumptions in the DCF were reasonable.

Is it unreasonable to say that oil prices will go back to around USD80 per barrel? I can do a study that shows that it should be at USD80 per barrel, just as easily as i can find a study to show that it will drop to USD40 per barrel. There's a lot of really smart people at both ends of the argument.

Business and valuation is a completely different issue. A good business, given a high enough valuation, can be a bad investment. And a bad business, given a low enough valuation, can be a good investment.

I never said that you must impair all the goodwill of a company. Coca Cola got zero goodwill on their balance sheet, but that does not mean they have no goodwill.

There is a value and a price to be paid for a good business, a good brand, a good team etc and good prospects. And this value is very very very hard to determine. More often than not, people overpay for it. Just look at Tesla.
15/03/2018 15:53
ozzie75 Seems to be suggesting that we should be wary of the unqualified financial statements of Bursa listed companies....oh my god....are those numbers reasonable, really? oh my godlie.

"Most of the auditor, their first job is audit and never go in commercial and look at the business."
15/03/2018 16:02
Choivo Capital No, she's just saying auditors have no business sense.

The numbers are correct. But numbers like goodwill, rely on alot of assumptions. As investors, one must be conservative. And in this case, ill just impair the whole damn thing for my calculation purposes.


Posted by ozzie75 > Mar 15, 2018 04:02 PM | Report Abuse

Seems to be suggesting that we should be wary of the unqualified financial statements of Bursa listed companies....oh my god....are those numbers reasonable, really? oh my godlie.

"Most of the auditor, their first job is audit and never go in commercial and look at the business."
15/03/2018 16:07
Choivo Capital For the record, im not saying that the DCF is prepared with malice.

Im just saying a 1% increase in any of your many assumptions in a DCF can appear reasonable to the management, auditors and Audit Oversight Board. Despite it leading to very very different conclusions and figures.

Therefore as an investor, you need to pay heed to this. Thats why, for the purpose of my calculations for investments, i just impair the entire goodwill (which in this case, is an absolute must) and about half of the PPE (if its a loss making company), unless it consist of lands etc.
15/03/2018 16:10
ozzie75 No worries. Just teasing him/her. Chill.

Jon Choivo No, she's just saying auditors have no business sense.

The numbers are correct. But numbers like goodwill, rely on alot of assumptions. As investors, one must be conservative. And in this case, ill just impair the whole damn thing for my calculation purposes.
15/03/2018 16:13
kcchongnz The market value of a company with liabilities higher than assets is zero, only it is already filed for bankruptcy as common shareholders won’t be able to get anything after everything else is settled.

However, for an ongoing concern such as Sapura Energy, it is not, no matter how high its liabilities over its tangible assets. There is a chance that things may turn better and the business flourish, no matter how slim is the chance. If for example, the O&G industries turns for the better, and Sapura Energy got a lot of good jobs and makes money, it may turnaround.

That is in finance, the option value of a listed entity.
15/03/2018 19:02
sunztzhe Today Oil & Gas stocks turned up. Why is this so?

As the Market price discounts the future, the question that begets one now is as follows:

"Is the Oil & Gas industries turning better???"

We all may have our anchored views but as an investor we must take cognizant of the market and accept the reality that the market is always right.
15/03/2018 19:12
Choivo Capital I suppose even if all the Goodwill is impaired, the company should still be worth 4bil or 60 sen.

Yeah, they definitely have a chance of turning around, but i wonder if they can survive long enough to take advantage of those opportunities.

I don't think any bank would agree to a liquidation (or push it to that level) as this ain't Toys R Us with great land behind it. If its liquidated, the value will be far below what is owed.

The fact the company is still making large PPE purchases, shows that, in a way, the management is still optimistic. But that's a tenous link.

Still, a very interesting and potentially lucrative gamble.


kcchongnz The market value of a company with liabilities higher than assets is zero, only it is already filed for bankruptcy as common shareholders won’t be able to get anything after everything else is settled.

However, for an ongoing concern such as Sapura Energy, it is not, no matter how high its liabilities over its tangible assets. There is a chance that things may turn better and the business flourish, no matter how slim is the chance. If for example, the O&G industries turns for the better, and Sapura Energy got a lot of good jobs and makes money, it may turnaround.

That is in finance, the option value of a listed entity.
15/03/2018 19:02





If that is the case, why even bother investing. The market is efficient, not accurate. Very big difference.

The market is only right over the very long term. SAPNRG can definitely revert back to the mean, if they survive long enough.


sunztzhe Today all Oil & Gas stocks turned up. Why is this so?

As the Market price discounts the future and the question that begets one now is.."Is the Oil & Gas industries turning better???"

We all may have our views but the market is always right.
15/03/2018 19:09
15/03/2018 19:21
zero Jon, always a joy to hear your voice - a beacon of reason in the swamp of i3's mangled logic - and english.

I'll be the devil's advocate here - to list E&P, they may even have 'persuaded' the auditors to write-back some impairments. We shall see ;)

Anyway, they have good cash flow, so this is my moonshot stock for now. To slightly paraphrase what you said, if I owe the bank RM1m, it's my problem. If I owe the bank RM10b, then it's the bank's problem.

And as far as I know, nobody gets a moratorium on billions of debt by being an idiot. Remember, banks only lend to you, when you don't need the money.
16/03/2018 01:31
Choivo Capital Haha, you flatter me. Thank you. As always let me know if i miss something.

That quote about owing 10 billion is one of my favorites haha.

My problem with the cash flow is that its only 1x interest cover or so. Though tbf, there's alot of PPE purchases.

If they list the EP at RM5 billion, they might be able to raise some cash. But how much debt can you allocate to the EP?

That division only makes 70M or so per year. How fast can you ramp up the extraction? And do it fast enough to justify that RM5 billion figure being thrown about? That's 70 PE.

But as a gamble. Looks good.

I think the banks just didnt have a choice. Although tbf, the moratorium started in 2014, so it looked better then.

Feel free to find and add me on fb, we could talk privately.




Posted by zero > Mar 16, 2018 01:31 AM | Report Abuse

Jon, always a joy to hear your voice - a beacon of reason in the swamp of i3's mangled logic - and english.

I'll be the devil's advocate here - to list E&P, they may even have 'persuaded' the auditors to write-back some impairments. We shall see ;)

Anyway, they have good cash flow, so this is my moonshot stock for now. To slightly paraphrase what you said, if I owe the bank RM1m, it's my problem. If I owe the bank RM10b, then it's the bank's problem.

And as far as I know, nobody gets a moratorium on billions of debt by being an idiot. Remember, banks only lend to you, when you don't need the money.
16/03/2018 01:52
SarifahSelinder Jon

Financial modelling so common nowadays

Tak dpt ke sapnrg dan auditors bikin sensitivity studies on all scenarios utk taksir goodwill and use yg most reasonable?

U sendiri pun ada byk bikin assumptions projections in u punya share valuations

So org lain bikin assumptions projections valuations tak tepat no reliable u seorg jer punya assumptions projections dan valuations yg bolih pakai?

Hebat!
16/03/2018 07:41
Choivo Capital Sarifah,

I don't do multi varied assumptions in DCF. If i do use assumptions, they are very conservative.

Look at my WCE one. More than half is all extracted form the contract. Not pulled out of my ass.
16/03/2018 10:37
cckkpr Trying to turnaround a company mired in debts will only work with a new management team in most cases. I am not confident it will work in this case, I will take my money and put in elsewhere hoping to get better returns or to recoup whatever losses incurred.
Lets not placed too much emphasis on the responsibilities on the Auditors.Don't tell us they will be subjected to penalties for any wrongdoing discovered later. Most of us know that the Auditors are NOT independent and is actually dependent on their clients for their source of income and future growth. Where they have to compromise, they will with a calculated risk. 1MDB will give you a clear cut idea of how Auditors work.
16/03/2018 15:06


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