Wednesday, April 27, 2011
Capital management in a Chinese software firm
The stock came to the market the conventional way: through an IPO. And its not like CCME (you can confirm its existence). Moreover when I do a quick run through board members I don't find any with easily identifiable links to organized crime.
Finally the CFO used to work for reputable companies. You don't find an unbroken litany of failed companies and stock promotes in his history. Same seems to apply for the other directors but I have not done a comprehensive search.
Finally Longtop even paid a dividend once. None of my Chinese frauds ever paid a dividend – after all why give cash to your victims (ahem: shareholders)?
Longtop you see is a software and bank-outsource service company. It claims as clients three of the four Chinese megabanks, China Life and a slew of lesser companies. In China this is a blue-chip customer list and might reasonably support a nice business with good economics. Some of Longtop's blue-chip customers can be easily verified which is a pleasant change from some other Chinese companies I have looked at.
Nonetheless Longtop still leaves me puzzled.
The first puzzle (and the subject of the first post) is capital management. You see Longtop has very little need for capital (at least as reported in their balance sheet) - and yet they have gone to market to raise cash.
In the last annual report (on form 20F) fixed assets (net) were $26.3 million. Gross fixed assets (ie before depreciation) was $35.8 million. Buildings were the bulk of that (almost 20 million). Equipment and fixtures was only 13.0 million. Apart from buildings there is not very much fixed asset on this balance sheet – and renting rather than owning buildings is always an option. They purchased 13.0 million of fixed assets during the year and presumably much of that were buildings.
By the end of the third quarter (December 2010) fixed assets had risen from $26.3 million to $27.9 million – a modest rise of $1.6 million. Also during that time revenue rose 40-50 percent (depending on which quarters you compared).
You see – looking at the accounts this company can do amazing things: it can add 40-50 percent to revenue without increasing fixtures, fittings etc. The only incremental capital employed is in receivables which grew from 65 to 97 million. Receivables are high relative to revenue but grew only slightly faster than revenue.
You might say “doh – its a software company – why do they need capital?” And - based on the accounts - I couldn't help but agree. All I am saying is that the company does not – on its accounts – seem to have any need for capital from financial markets. Which begs the question: why are they listed? But lets ignore that for the moment (Microsoft and Coca Cola – both companies with no need for external capital are listed.)
But it sure as hell makes me query their capital management. Here is the quarterly cash balance:
2010-12 $423.2 million
2010-09 $379.0 million
2010-06 $342.4 million
2010-03 $331.9 million - note the drop here was because $70 million went out for an acquisition
2009-12 $389.7 million - note the large rise here is because the company raised $127 million
2009-09 $226.4 million
2009-06 $215.1 million
Debt throughout this time has been trivial - typically less than $10 million.
Now this is - at least according to its accounts - an inordinately cash generative business. It is almost without fixed assets - it grows its revenue very fast.
But for the life of me I can't see any reason why it really needed to raise $127 million in cash in December 2009 quarter? Its sort of like a mini-version of Microsoft going to the market to raise money. They are - according to their accounts - swimming in money.
Indeed their current cash holdings represent something like 200 quarters of capital expenditure. Come to think of it - the company has enough cash for 26 quarters - more than 6 years - of all pre-tax operating expenditures. Lets put this in context. Microsoft has about 36 billion in cash and short term investments and $38 billion in annual operating expenditure. Relative to expenses (and hence needs) Longtop has over 6 times as much cash as Microsoft.
They are swimming in it.
But they still went to market and raised more.
To be fair they have announced but - as far as I can tell - not executed a buy-back plan for $50 million in stock. If they do that over a year they will still have six times more cash relative to needs than Microsoft.
What can I say? I am puzzled. Puzzles are interesting. Expect me to look further at this company.
PS. I have been sitting on this post for a while - thinking what else I might put in it. Someone else has published - which in blogger terms is to be trumped. That someone is Citron who are more strident than I would ever be.
I disclose being short though. Puzzled is enough to be short.
The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.