Avi Tech Electronics: a net-net experiencing a turnaround?

I have bought a very small position in Avi Tech Electronics (ticker: SGX:CT1) in Singapore. The company provides burn-in, engineering and manufacturing services for the semiconductor and electronics industries.

Avi Tech has lost a lot of money in recent years, but their biggest losses came from two subsidiaries in the US and these operations are currently being liquidated.

Share price: $0.078
Shares outstanding: 342,422,096
Market cap: $26.7 million
Net current asset value 30-09-2014: $27.3m
Book value 30-09-2014: $40.0m
Cash & financial investments: $25.7m
Total liabilities: $7.6m

Avi Tech is very cash rich and selling at 0.98x NCAV and 0.67x book value.
Avi Tech’s continuing operations showed a decent improvement in the 1st fiscal quarter ended Sept. 30, with pretax profit up from $157k to $695k. I’m still unsure if their operations have really turned around and I don’t feel I know their business and industry well enough at this point. As such my buy is speculative and as a consequence my position size is also very small.

Value in real estate?

Avi Tech’s real estate is carried on the books for $10.7 million. This is a picture of their head office:

The company generated rental income of $741k in fisc. 2014 and $536k in 2013 from this building. So the company seems to have excess space and I wonder if there isn’t a way to monetize the real estate value if management wished to do so.

Ill-fated acquisitions

In 2011 the Avi Tech diversified their business and made investments in two subsidiaries in the USA: Verde Designs and Aplegen. These investments turned out to be a disaster and a lot of money was burned before management made the decision to liquidate the subsidiaries. This is management’s explanation in the 2014 annual report:

“We took the decision to invest in two US technology subsidiaries, Verde and Aplegen. While we made much progress in research and development into new products and expanded the portfolio of products of these two subsidiaries, the revenue projections fell short of expectations. This was due in part to the market dynamics of bigger companies entering into the same space and competing aggressively on price, as well as delays in the launch of our new products which impacted revenues. As these subsidiaries failed to achieve the set milestones which are used to evaluate and track the progress of our investments and assets, we have had to take the difficult decision to start the process of discontinuing the operations of these two subsidiaries in 4Q FY14.”

Placed on the watchlist

What makes the whole situation more interesting is that Avi Tech has been placed on the watchlist of the Singapore Exchange. This is a result of the company producing pre-tax losses for the last three financial years.

Now that Avi Tech is on the watchlist it risks being delisted from the exchange. Rule 1314 & 1315 explain what Avi Tech will need to do to get itself off the watchlist:

1314

An issuer on the watch-list may apply to the Exchange for its removal from the watch-list if it satisfies any one of the following requirements:—
(1) the issuer records consolidated pre-tax profit for the most recently completed financial year (based on the latest full year consolidated audited accounts, excluding exceptional or nonrecurrent income and extraordinary items) and has an average daily market capitalisation of $40 million or more over the last 120 market days on which trading was not suspended or halted. For the purpose of this rule, trading is deemed to be suspended or halted if trading is ceased for the full market day; or
(2) the issuer satisfies Rule 210(3) and either one of the following requirements:—
(a) cumulative consolidated pre-tax profit of at least $7.5 million for the last three years, and a minimum pre-tax profit of $1 million for each of those three years; or
(b) cumulative consolidated pre-tax profit of at least $10 million for the last one or two years. Rule 210(3)(a) applies to the last one year or last two years as the case may be.

The Exchange may approve the application, or reject the application if the Exchange is of the opinion that there are other factors that justify the continued inclusion of the issuer in the watch-list.

1315

An issuer must take active steps to meet the requirements of Rule 1314. If the issuer fails to submit an application pursuant to Rule 1314 within 24 months of the date on which it was placed on the watch-list, the Exchange may either remove the issuer from the Official List, or suspend trading of the listed securities of the issuer (without the agreement of the issuer) with a view to removing the issuer from the Official List.

There is a possibility for a 12 month extension if a company satisfies at least one of the requirements under Rule 1314(1) and it has achieved “healthy cash flow from its operating activities”.

If Avi Tech does end up getting delisted, it must give shareholders “a reasonable exit offer”. Rules 1306 and 1309:

1306

If the Exchange exercises its power to remove an issuer from the Official List, the issuer or its controlling shareholder(s) must comply with the requirements of Rule 1309. For purposes of Rule 1309, a reasonable exit offer may include a voluntary liquidation of the issuer’s assets and distribution of cash back to shareholders.

1309

If an issuer is seeking to delist from the Exchange:—
(1) a reasonable exit alternative, which should normally be in cash, should be offered to (a) the issuer’s shareholders and (b) holders of any other classes of listed securities to be delisted.
(2) the issuer should normally appoint an independent financial adviser to advise on the exit offer.

Another option seems to be to transfer the listing from the SGX Mainboard to SGX Catalist. This move requires shareholder approval.

More acquisitions?

Lim Eng Hong, the CEO of Avi Tech owns about 32% of the outstanding shares. Other insiders own very few shares. The list of the largest shareholders in the annual report is unusual as the shareholdings are very dispersed. There are no large owners of stock other than the CEO.

I think outside investors would be better off if a large shareholder emerged who can keep management on the right path. Unfortunately there doesn’t seem to be much shareholder activism in Singapore and Asia in general. A passive shareholder base could be dangerous for minority holders in this case. Management has completely messed up with their investments in the USA. That is bad enough and it seems to me it would be best if management fully focused on the core business to salvage the value that remains in the business for the shareholders. A ~75% decline of the share price from their IPO price of S$0.33 in 2007 until today is enough in my opinion. Instead management is still looking for potential acquisitions. This is from the letter to shareholders in the 2014 annual report:

“Our balance sheet remains robust and able to support potential initiatives, whether through mergers and acquisitions or any other structured transactions or businesses that will add value to our shareholders and the Group.”

I wonder how many minority shareholders would like to see management attempt another acquisition at this point? Perhaps this topic was discussed at the annual meeting, I don’t know.

Dividend cut

Another thing I don’t like is the fact that management has decided to stop paying a dividend in 2013 and 2014. This was their motivation in the annual report:

“We cannot pay dividend in light of the Group’s financial performance in FY14. We are of the opinion that it is in the interest of the Company and ultimately the shareholders to invest in the Company for future returns, rather than to return this cash to shareholders at this point in time. The cash is being retained for expansion and working capital requirements.”

It sounds reasonable, but it isn’t really, considering the company has more than $20 million in cash and cash equivalents. Share buybacks have been minimal as well.

Insider buys

Meanwhile, what does Avi Tech’s CEO do as shareholders sell their stock in disgust? He is perfectly content to personally purchase shares in 2014 and 2013 as the shares are trading for less than the cash on the company’s balance sheet. While I usually like to see insiders buy shares in the open market, I think in this case it is not appropriate to do so. The CEO should be working to salvage what value remains for all the shareholders after the disastrous acquisitions. Instead Avi Tech gets moved to the SGX watchlist, the company cuts the dividend and the CEO picks up shares as the stock price drops.

At this point I think shareholders would be best off with management focusing exclusively on operating the existing businesses and not considering any future acquisitions. The excess cash should be returned to shareholders. If there is no reasonable expectation of reaching the criteria set in the SGX listing rules on time, management should seek to sell the business or offer a realistic price to the minority shareholders to take the company private themselves. This is all just wishful thinking though. There is a real risk that management makes another poor acquisition and destroys more value and I don’t see that risk decreasing unless a large outside shareholder emerges. Since I don’t have a few million lying around, it won’t be me.

Conclusion

Reading over these last few paragraphs makes me sound overly negative about Avi Tech. The negative comments are about some of the actions of the management. The fact remains that you can invest in this cash-rich business slightly below NCAV and that there are some early signs that their operations are experiencing a turnaround. The company is liquidating their money losing US operations and this liquidation will probably generate some extra cash as well. The value of the real estate you get for free. The fact that the company has been placed on the watchlist might act as a catalyst and lead management to focus on reaching the criteria as defined in the SGX listing rules or to pursue a sale of the company.

Disclosure: long Avi Tech Electronics