Topic for discussion - Is ARB BERHAD a good or bad company?

Apart from the Serba Dinamik versus auditor saga, ARBB had received quite some attention from investors. However, as all things should be – balanced, there are people that love and hate the company. (No pun intended)

So, I’ve decided to run a neutral standpoint to discuss several key matters of the company raised by investors in order to determine if ARBB is a great company to invest in, or one that you should avoid.

Key Matter # 1 – Irredeemable Convertible Preference Shares (ICPS)

To those who are not familiar with ICPS, the company had on December 2018 executed a rights issue of ICPS at the basis of 15 ICPS to 1 existing ordinary share. Basically, for every 1 share you own, you are entitled to subscribe 15 ICPS at the price of 1 cent per ICPS.

Illustrative example:

John held 10,000 shares at costs of 30 cents of ARBB over 17^th December 2018 (The ex-date) and he was entitled to 150,000 ICPS.

Payable amount: 1 cents * 150,000 units of ICPS = RM1,500.00

However, as the rights issue complete, the share price was adjusted. Did John lose money out of the subscription? Actually, unlike most rights issue case, he did not.

The ICPS is priced at 10.5 cents as at today, representing an exact 10.5 times return for John. The initial RM1,500.00 had rocketed to RM15,750.00 to date, this is what we could classify as supernormal profit!

Anyway, that is for the past shareholders. What about now?

The rights issue had raised a total of RM10.08 million for the company and had continued to raise more funds for the company at zero interest rate. The conversion price or exercise price of ARBB-PA is 20 cents, and to date, 541,009,231 units of ARBB-PA had converted into ordinary shares.  The figure was derived from:

NOSH prior to rights issue: 67,210,000 units

Existing NOSH: 608,219,231 units

Isolated ICPS conversion units: 541,009,231 units

Balance for conversion: 467,140,769 units

From the date of first conversion happened, with 20 cents per conversion, the company had raised a total RM108.20 million in cash. However, this had also caused a dilutive impact on the shareholder’s rights per share. For example, investor’s EPS, DPS and NAPS had been affected by the conversion of ICPS into ordinary shares. The EPS and DPS would decrease, but NAPS would increase due to the cash inflow to the company.

So, yes, the ICPS did cause dilution to the company but at the same time raised quite a substantial amount of cash for their expansion plans. Overall, it is fair for the existing shareholder as the company did grow with the cash they raised.

But the extraordinary growth of the company had also raised eyebrows of some investors. Next, we will also find out more information about the fundamental perspective of the company.

Key Matter # 2 – Legitimacy of ARBB’s account

We all know by now that if the auditor refuses to sign the document, the audited report of a listed entity could never ever reach investors. As for ARBB, so far, they had been able to deliver the annual reports despite a lot of hearsay from the market. I will give a point to them.

Apart from Q1FY21, the company had been delivery some amazing growth. Also, the trade receivables of the company had worried some investors. As you can see, alongside with the growth of the company, the trade receivables increased significantly as well, and caused a lower net cash generated from activities. For technology company, this is rather unusual.

However, the auditor had pointed out the issue and made reasonable forensic studies on the trade receivables accounts, and it would be safe to say that ARBB’s trade receivables are not fraudulent in nature.

At best, the company might be weaker on cash collection!

Key Matter # 3 – Unusually low PER

I’m rather surprised to see that ARBB is only trading at low single digit PER of 3.64 times. This figure is even lower than some cyclical players such as construction, oil and gas, plantation and so forth. What is going on with the valuation?

Before we jump into conclusion, let’s not forget to factor in ICPS as a potential dilution for the company.

The maximum dilutive effect, a.k.a. the maximum conversion of all ICPS into ordinary shares would result in ARBB having a total NOSH of 1,075,360,000. To calculate the trailing maximum dilutive PER of the company, we must first reach the trailing 4 quarters profit after tax of the company, and the total sum is RM56.20 million.

And dividing that with the maximum NOSH, we would reach an EPS of 5.23 cents. The current trading price of ARBB is 26 cents, and using EPS of 5.23 cents, we would reach PER of 4.97 times after maximum dilution.

Why does the market price ARBB at less than 5 times in dilutive PER?

I believe this was caused by lack of understanding on the company’s core business and the recent downturn of the earnings had shaken investor’s confidence. Nevertheless, we are not going to discuss the share price movement but focus on some matter to be clarified for the company.

Conclusion

From what we had really studied, it is without a doubt that ARBB is better than the naysayers in the market. Although the risks are high for ARBB on trade receivables, but they are definitely not a fraud. I think the risks had been over justified by the recent downturn in momentum, and ARBB certainly deserve a better valuation – at least 10 times post dilution for a technology company?