In earlier post, we showed you how 8I Holdings turned a 1.5m investment into 40m worth in 11 months. This time, again, no surprise, 8I turned a 2.3m investment into a 12m profit in 1 year.
Initial investment: 2.33m
In April 2015, 8I bought 49.9% of Velocity Holdings Pty Ltd (“Velocity”) for A$2.33m. At first, it may sound straight forward. But, the footnote in 8I’s FY16 annual report may confuse you a little.
Its FY16 annual report explained that 8I’s subsidiary acquired 100% equity interest in Fusion 462 Pte Ltd, Oxford Views Pte Ltd and Vue at Red Hill Pte Ltd (the “Velocity Group”) for A$2.33m. The Velocity Group together owns 100% of Fusion 462 Pty Ltd, Oxford Views Pty Ltd and Vue at Red Hill Pty Ltd. Subsequent to the acquisition, 8I swapped all of its interest in Fusion 462 Pty Ltd and Vue at Red Hill Pty Ltd for 49.9% stake in Velocity Holdings Pty Ltd. 8I gained S$1.67m from the share swap.
Note that those companies mentioned above with Pte Ltd are registered companies in Singapore, while those with Pty Ltd are registered in Australia. They are separate entities sharing the same name (e.g. Oxford Views Pte Ltd vs Oxford Views Pty Ltd). These registered companies in Singapore (the “Pte Ltd”) owns 100% of those registered in Australia (the “Pty Ltd”).
What I don’t understand is how the share swap could resulted a gain of S$1.67m. The initial investment was only A$2.33m. Assuming AUD and SGD have exchange rate of 1.0 for simplicity (the actual is really close to 1.0 now), then the gain of S$1.67m is 71% return on investment capital of S$2.33m. This was already highlighted in my earlier post. So, there was nothing new.
What’s new is that 8I sold the stake in these companies for an outsize gains again.
In June 2016, 8I sold 78.6% of its 49.9% stake in Velocity for S$3.085m. The buyer is Labelle Capital Inc, a venture capital company financed by approximately 200 investors, many of whom are minority shareholders in 8I.
Next, 8I also sold 100% of its stake in Oxford Views Pty Ltd (“OVPL”) for S$10.58m. The buyer is Crescenta Investment Ltd, an investment company financed by approximately 360 investors, many of whom are minority shareholders of 8I.
Notice what’s suspicious?
Here, we list them down:
- In April 2015, 8I bought 49.9% stake of Velocity for A$2.33m, valuing Velocity at roughtly A$4.67m. In 15 months, it sold 78.6% of its 49.9% stake (or 39.22% of Velocity) for S$3.085m, valuing Velocity at 7.86m. In 15 months, the value of Velocity rose by 68%.
- OVPL was sold for S$10.58m. Wasn’t OVPL part of the purchase in 8I’s initial investment of 2.33m? Its annual report said so. Sale of OVPL for S$10.58m is a huge gain from the initial investment of 2.33m. If OVPL is not part of this initial investment, then what’s the initial cost of OVPL?
- In 8I’s organization chart, OVPL is separate from Fusion 462 Pte Ltd and Vue at Red Hill Pte Ltd. Therefore, it seems to me that OVPL is not part of Velocity. In a separate document detailing the disposal of OVPL, it mentioned that OVPL operates through joint ventures with subsidiaries of Velocity and is entitled to receive 50% of the profit from the property development projects in which it has invested. It achieved unaudited revenue of S$1.2m for period 1 July 2015 to 31 March 2016 (9 months) with net profit S$0.8m. As at 31 March 2016, in the balance sheet, it has net total assets of S$0.2m. So, after net profit of 0.8m, the net assets is just 0.2m, implying that it was negative before this net profit.
- OVPL, with net assets of just 0.2m, was sold for 10.58m. That’s P/B of 52x!
- OVPL has developing properties with a subsidiary of Velocity in Brisbane with a combined gross development value (GDV) amounting to A$11.3m. If the whole property development has GDV of A$11.3m, how can OVPL be worth 10.58m? GDV describes the estimated value that a property development would fetch on the open market if it were to be sold in the current economic climate. To derive profit, we will take GDV and subtract construction cost, land cost, and other fees, such as marketing, legal, etc. The profit to be derived from GDV of 11.3m will certainly be much lower than 10.58m, which is what OVPL is sold for. OVPL will need other assets to justify its selling price of 10.58m. But its net assets is just 0.2m!
- At first, I thought these real estate companies in Australia were setup first to do business, and 8I came to know them and invested in them. But, I’m surprised that all the three companies in Singapore, Red Hill Pte Ltd, Fusion 462 Pte Ltd and Oxford Views Pte Ltd, were registered in 2013 and 2014. That’s 1-2 years before 8I invested in Velocity. Or these property developments in Brisbane were originated by companies in Singapore? (8I?) and subsequently, 8I swapped the shares in these firms with shares in Velocity, resulting a gain of 1.67m? I don’t have a clue.
- Both of the sale are to investors who are minority shareholders of 8I. Labelle has 200 investors, while Crescenta has 360 investors. I’m not sure if these two groups have any overlap in terms of investors. Which private companies do you know that have this large number of investors (200 or more)? Very likely, I guess, these companies are formed by the participants (students) who have attended 8I’s investment courses. These people are probably willing to buy what (ever) 8I is willing to sell, perhaps, believing that 8I will make them rich. If they have learned value investing properly, they should be able to value companies properly. If not, at least, they should be able to spot overpriced assets and avoid them. Which one is the case for this deal?
200 and 360 Investors
If you are in the shoes of these 200 & 360 investors, why would you buy these companies from 8I and pay at much higher price than 8I did just one year earlier?
Possible answer is to sell them at even higher price. 8I intends to list Velocity in the stock exchange. If Velocity turns out to do as well as Digimatic (formerly CPA Academy, see this post), then these investors would have reaped high rewards. This is just what I conjecture. I know nothing about these companies and these investors and no one at 8I.
But if what I guess is correct, then these investors have to see what happened to Digimatic after listing. Digimatic’s share price has fallen from 0.395 at IPO to 0.12 today, nearly 70% loss. The investors who sold earlier would get the rewards, while those who sold late would be penalized with losses. If you think you can sell earlier, then you have to see if everyone else (those investors in your group) is thinking the same. Because if they do, then the share price will plunge quickly. This is an illiquid stock. Even if you just want to sell shares worth $50k, you can cause the price to fall by 10%.
Is Velocity worth 7.86m? Looking at its summarised financial statements, it’s still making loss of 1.2m on revenue of 14.9m. It has net assets of 5.7m but with 6.58m goodwill. Excluding the goodwill, the net assets is negative 1.57m. I don’t have experience valuing property developer and don’t have details about Velocity’s business. But given the negative net assets, it’s likely that Velocity is still early in its development process.
Source: 8I Holdings’ FY16 Annual Report
Is OVPL really worth 10.58m? If yes, then it’s fair deal for all parties. If it’s underpriced, then 8I is doing its shareholders disservice by selling it cheaper to some of the minority shareholders. If it’s overpriced and some of the 360 buyers are participants who attended 8I’s investment course, then 8I is selling overpriced assets to its own students. This is ethically wrong.
What do you think about this OVPL deal? Is it fair, overpriced or underpriced? Well, we are all outsiders to this deal. So, in the end, the 360 investors have to be responsible for their own action.
My word of caution is that if you buy something without knowing its actual value, and intend to profit by selling it at a higher price, then you have to rely on finding a buyer who is willing to pay more than you did. This is speculating, not investing. Stock market bubble is formed by this reasoning. If you buy something expensive and want to sell it for profit, then there must a greater fool out there for you to do so. On the other hand, if you buy something at bargain and want to sell it for profit, you don’t need to rely on finding the greater fool. Sooner or later, someone will want to buy it, at least, at fair price.
Both the sale of stake in Velocity and OVPL provided 8I with profit of S$11.96m. This gain is achieved in less than 2 years of investment. Given my observation of how 8I operates, I think, it will sell stake in other companies that it invested in again, probably in the next 9 months. It reported 18.6m profit for FY16, which included 18.6m gain from the sale of CPA Academy. Coincidentally, both figures are around 18.6m. Therefore, in order to grow its profit for FY17, it will likely need another outsize gain from its private equity business because the combined recurring profits from its education business and investment gains from listed securities are not likely to surpass FY16’s total profit. Without another outsize gain, there could be a substantial drop if profit for FY17.
Acquisition of 8 MAD Group Sdn Bhd
In July 2016, 8I bought 51% equity stake in 8 MAD Group Sdn Bhd (“8MG”) for RM 430k. This values 8MG at RM843k. 8MG provides integrated branding and marketing communications consultancy and customized training and performance coaching solutions to learning institutions and corporations.
It has unaudited revenue of RM 4.1m and net profit after tax (NPAT) of RM 260k for financial year ended 31 December 2015 (FY15).
The interesting part of the acquisition is that 8MG have guaranteed a minimum NPAT of RM 244k for FY15 and minimum NPAT of RM 250k for every subsequent financial year. In the event that the NPAT for the financial year falls below the minimum NPAT, 8I shall have the right to decide on the dividend payable to the Company by 8MG.
This acquisition implies that 8MG is worth RM 843k. Assuming the NPAT for FY15 and subsequent years are RM 250k, then the P/E is just ~3.4x! This deal is a steal for 8I. And if it’s a steal for 8I, it’s a loss for 8MG’s original owners. Why on earth would they be willing to sell 51% of the Company for just 843k when it can guarantee NPAT of 250k per year?
They lost the controlling stake after selling 51% of the Company. Also, the RM 430k that they receive from selling the 51% stake can be earned in just 1 year 9 months, assuming NPAT of 250k, which they guaranteed. If they have such a confidence to guarantee the NPAT, then why sell it cheap? A rational owner, who is also an entrepreneur, will check how to value his company properly after all the hard work he put in to build the company. Even if he doesn’t know how to value his company, he will know that in stock markets, many companies are valued at 10 – 20x P/E. Why would he value his own company at rock bottom P/E of 3.4x?
In any way, this seems like a very attractive deal to 8I. Given 8I’s operation of flipping companies, 8MG can be the next target for flipping. Perhaps, this time, 8MG could be sold to the Malaysian students of 8I’s investment course in KL for another outsize gains. Perhaps, 8MG could also be listed some time later, giving its original owners large rewards. Maybe that’s why they are willing to sell it cheap in the first place to 8I. Maybe. It’s all just my maybe. All my guesses only.