Encorp (2)

Dawn Of A New Era

Publish date: Wed, 7 May 2014, 07:33 PM 

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When I first wrote about Encorp few weeks ago, I didn't buy a single share. That was because I noticed that the historical PE multiple is approximately 11 times. According to back of envelope calculation, earnings might go up next year as Strand Mall will start contributing soon and PE multiple might drop to 7.5 times.

For a small cap stock, 7.5 times is not expensive. However, there are many other property stocks that are trading at that kind of multiples. I simply cannot convince myself to give Encorp preferential treatment.


1. My Investment Philosophy

I notice that many investors are deeply influenced by investment gurus such as Warren Buffet, Peter Lynch, etc. I have read some of their books. Most of the time I am fine with their views and proposed methodologies.

However, I would say that my investment style was not most deeply influenced by them. If there is one book that influences me most, it would be Steven Covey's "7 Habits of Highly Effective People". I found its Habit 3 "To Begin With The End In Mind" extremely relevant for investment.

Every time before I buy a stock, I ask myself "What is the reason I buy it ? How would the company looked like at the end of my investment period ? What information do I have to justify such expectation ?" If I can't find answers for such questions, I usually don't invest in a stock. Even if I invest in it, it usually won't last long and I end up disposing it of after some time.


2. Felda Investment Corp Took Over Encorp

Back to Encorp.

Yesterday, Encorp announced that its major shareholders had entered into sale and purchase agreements to dispose of 49.5% equity interest to Felda Investment Corp ("FIC").

Soon after Encorp shares and Warrants resumed trading this morning, I went in and bought Encorp-WA at 70 sen. The WA closed at 65 sen by end of the day. I intend to hold the Warrants until expiry and if necessary, exercise them if they are out of money by the end of their tenure.


3. Dawn of a New Era

The reason I bought into Encorp was because of the potential that can be unlocked with the entry of such a strong shareholder like FIC.

As we all know, the Felda group is a giant conglomerate. It's principal business activity is plantation. However, it also owns many other assets such as hotel, agricultural business, land bank, etc.

As at to date, FIC had not made any statement on what they intend to do with Encorp going forward. However, since Encorp's principal business activities are construction and property development, I would like to zero in on these two segments for discussion.

Constructon - Would FIC leverage on its strong relationship with the government to secure contracts for Encorp ? I don't think the top people of FIC would like to run around to lobby for contracts for Encorp. The Felda group had traditionally not been active in construction. I doubt their top people would have the passion to really go into it in a big way just because of Encorp.

Property Development - According to publicly available information, FIC has amongst other, 20 acres of prime land in KL. We dont know whether FIC would link those land bank to Encorp. But for discussion sake, let's explore what are the options available in the event that they choose to do so :-


(Option 1) - Encorp issues new securities to acquire the land bank from FIC

I think this is unlikely to happen. The land bank is quite huge. Issuance of new securities to FIC will result in FIC holding too much securities in Encorp, potentially causing a public spread problem. Furthermore, if those land bank are not income generating (pending development), issuance of new securities will result in significant dilution of EPS.


(Option 2) - Encorp acquires the land bank by cash and funds the transaction by way of a rights issue

Companies like Tropicana, MAICA and Ecoworld did their assets injection this way recently.

At first look, this could help FIC to avoid the potential public spread problem. However, same as Option 1, if the land bank are not income generating, the rights issue might result in significant dilution of EPS. Would minority shareholders still subscribe for the rights ? If they don't subscribe for the rights, FIC might need to underwrite it. If that is the case, they are going to end up with a public spread problem again.
As such, I am of the view that this option is also not viable.


(Option 3) - Encorp enters into joint venture with FIC to develop the land

The benefit of this option is that there is no need to worry about cash call and / or public spread shortfall. But wouldn't that result in earnings leakage for FIC since they only own 49.5% of Encorp ? Let's look at some numbers.

Let's assume the land bank will generate net profit of RM100 mil. If FIC develops the land on its own, it will capture 100% of the profit (RM100 mil). If they use Encorp to develop the land, Encorp will book in RM100 mil profit. Does that mean that FIC will only have exposure to RM49.5 mil of the profit ? Not really.

Encorp is a public listed entity. Every single dollar it makes, it will create incremental market cap based on PE mutiples ascribed to it by the investing public. Even if based on conservative assumption of 7 times PE multiple, the additional value created will be RM700 mil and FIC's 49.5% share will amount to RM347 mil, significantly higher than the RM100 mil profit to be booked in if it develops the land on its own as a private entity.

In view of the foregoing, I would say that Option 3 is a viable option and worth considering by FIC.



4. Concluding Remarks

For me, investing is an art, not science. Sometime I invest based on detailed analysis backed by facts and figures. Sometime I just follow my gut instinct. As long as I can smell the money, and there is no sharks or tigers to pounce on me, I don't mind putting my money in a stock based on some fuzzy concept.

However, I would like to caution that patience is required for this stock (I have no specific preference for mother share or Warrants. I think both are just fine). The MGO would easily take 6 months to complete. And probably another 6 months before any corporate development will take place (if it takes place at all).

Have a nice evening.