I have been a shareholder of Procurri since last year. Recently I added to my position and it is now a top three position in my portfolio (I’m very diversified in my investing though). I first heard about the company from janeo on Twitter. Well worth a follow if you’re interested in deep value stocks, especially those listed in Asia.
I believe Procurri’s market price does not reflect the company’s current profitability, nor its attractive growth prospects. The company’s management has not made it easy for investors to understand what the true earnings power of the business is. I believe an accounting change regarding “maintenance parts” used in the company’s third party maintenance segment (TPM) contributed to obscuring the picture for investors.
Last year a “partial offer” was launched to minority shareholders. That offer had the goal substantially increasing the share ownership of a smart and successful private equity investor called Novo Tellus at, what I thought was, a bargain price. That effort ultimately failed.
I think the accounting change, relating to the classification and accounting treatment of “maintenance parts”, is still affecting earnings today. I believe this obscures the company’s true earnings power.
In addition, there is another strong indication that the business is worth far more than today’s market price and the partial offer price of last year.
There is a lot that can be said about Procurri. In this post I’ll mainly focus on the inventory accounting and the partial offer of last year, because I think those elements are the most important things investors might be missing when looking at this company. So this not really a comprehensive write-up about the business itself. I think this post would become much too long otherwise.
Share price: $0.335 SGD
Shares outstanding: 295.6m
Market cap: $99.0m SGD
Enterprise value: $81.5m
Net income 2021: $4.4m
Net income 2020: $2.7m
Free cash flow 2021: $6.0m
Free cash flow 2020: $23.3m
Free cash flow 2019: $13.1m
I calculated free cash flow by taking net cash generated by operating activities, subtracting depreciation of right-of-use assets and subtracting capex. The years 2020 and 2021 were impacted by large swings in the trade receivables balance. In 2020 they decreased by $16.2m while in 2021 they increased by $17.2m. The average free cash flow generated over the last three years is $14.1m.
Procurri provides lifecycle services of enterprise hardware for businesses worldwide. The company has two segments:
- Hardware, Lifecycle Services and IT Asset Disposition: consists of (i) Hardware Resale, (ii) Supply Chain Management and (iii) IT Asset Disposition (iv) ITAD Arbitrage
- Third Party Maintenance (TPM): (i) renewable maintenance contracts where the company provides IT maintenance services for a variety of IT systems and networks (ii) sales of maintenance parts tied to systems on the renewable contracts (iii) professional services tied to systems on the renewable contracts. TPM became a separate segment in 2021. In prior years it was part of the “Lifecycle Services” segment.
Most of the revenue is generated in the United States (54% in 2021) and Europe, Middle East, and Africa (EMEA) countries accounted for ~40% of revenue. The balance comes from Singapore and “other” countries.
The equipment they manage for companies is mainly data center hardware. From what I understand, Procurri can basically manage the data center needs for businesses by providing equipment, maintenance services and IT asset disposition (ITAD) services. The ITAD services are a growth market, because a growing focus on sustainable business practices means that companies are increasingly looking to extend the lifetime of hardware and reuse hardware where possible. Procurri can service hardware past the warranty periods offered by OEMs and can provide long-term support for legacy equipment.
This whole process of managing and maintaining data center hardware can get quite complex and demanding, so companies are outsourcing more of this work to reliable partners to save time and money.
Novo Tellus’s and DeClout’s involvement
In March 2019, private equity investor Novo Tellus Capital Partners became a shareholder of the company, acquiring 29.6% of the shares at the time. Mr. Loke Wai San is the founder and CEO of Novo Tellus. He’s on the Board of Procurri. Novo Tellus has successfully invested in several other Singapore listed companies, including AEM Holdings and ISDN Holdings.
On March 15, 2021 Novo Tellus launched a partial offer (.pdf) to increase their stake to 51% of the outstanding shares. The price offered was $0.365 per share. This would have given Novo Tellus a controlling stake had the offer succeeded, but on May 3, 2021 the offer lapsed (.pdf) because shareholders voted the transaction down.
One of those opposing shareholders was a company called DeClout. DeClout was itself a Singapore listed company and was a major shareholder of Procurri. They owned Procurri before it became public. DeClout sold its Procurri stake in a couple of transactions in januari and February 2019. The February sale was to Novo Tellus. DeClout sold itself in April 2019 to Japanese company Exeo Global. I think DeClout still held 40m Procurri shares when they sold to Exeo.
DeClout – now under Exeo ownership – was not happy with last year’s partial offer and substantially increased its ownership in the time period that the offer was open. DeClout’s stake increased from 40m shares to ~62.4m, about 21% of the outstanding shares.
Apparently the relations between Novo Tellus and DeClout are now quite good, because a DeClout officer was put on the Board of Procurri in November 2021.
The Partial Offer
In my opinion the partial offer made last year by Novo Tellus of $0.365 severely undervalued the company. A circular was published on April 19, 2021 and an Independent Financial Adviser (IFA) called Novus Corporate Finance had to give advice about the fairness of the offer. The result can be read from page 32 onward. Their valuation methods mainly relied on NAV and a P/E ratio. It was also mentioned that the offer was made at a 20.5% premium over the VWAP of the previous 12 month period.
There was however no consideration given to the large amounts of cash the company generated in 2019 and 2020. The true earning power of the business was obscured by large inventory write-offs. I believe these write-offs could have increased in these years due to an accounting change that was made before the offer. This change may have had the effect of impacting accounting earnings and thereby obscuring the performance of the business.
I’m still confused about the accounting treatment of the company’s “maintenance parts” myself however, so don’t assume I’m correct in this post about this issue.
Low earnings were certainly convenient for the Offeror when the IFA in the circular chose to use those “earnings” and “NAV” as a means of judging the fairness of the offer. Free cash flow was not taken into consideration, and an earlier takeover offer for one division of the company was dismissed as not being relevant. I’ll discuss that takeover offer later. First I’ll discuss the accounting changes relating to the inventory.
I’ll show the relevant sections from the annual reports to show what I believe happened and the questions I still have. Note that it wasn’t possible to learn what was going on exactly, because ultimately the valuation of the inventory relies on management judgment.
Third Party Maintenance (TPM)
I’ll mostly be focusing on the Third Party Maintenance (TPM) segment in this post, because I think that’s where the company’s deferred income is coming from. It seems that this segment has contributed to the large inventory write-downs that the company has made over the past two years. These inventory write-downs are the main reason for the large difference between earnings and free cash flow at this company.
My understanding is that Procurri’s TPM business has maintenance contracts with businesses and that these companies pre-pay Procurri to provide these services. This prepaid money is held as a liability (deferred income) on the balance sheet. Procurri must make sure to have sufficient maintenance parts in store to be able to service these contracts. So they need to buy parts (things like servers, network and storage equipment) and make judgments about what, and how much they will need to service the contracts.
The maintenance contracts are usually multi-year contracts. Here’s an example of a small three year contract from the 2020 annual report:
We also collaborated with an OEM to support hardware maintenance for a government agency in Malaysia, with a total contract value of circa S$450,000 over 3 years.
Source: page 17, AR 2020
This is one from 2018:
One notable deal in FY2018 was a new maintenance contract with a British pharmaceutical multinational corporation, which we first started servicing in 2016. Our success in this segment reaffirms the reliability of our maintenance services and the strength of our global footprint.
Source: page 18, AR 2018
I think that a customer usually only pays in advance for a period of one year however, even if there is a multi-year contract, because the bulk of the deferred income is listed as a current liability.
This is the section in the annual report that discusses the accounting treatment of deferred income:
For IT maintenance services, advance billings to customers are based on a payment schedule in the contract. A deferred income is recognised when the Group has yet to perform under the contracts but has received advanced payments from the customers.
Source: AR 2020, page 102
In 2020, the company reclassified “maintenance parts” that were used in servicing the maintenance contracts, from “plant and equipment” to “inventory”. It was disclosed in this small footnote on the page about the company’s plant and equipment in the annual report:
Source: AR 2020, page 114
The key information, besides the large dollar amount of $9.5m, is that the reclassified maintenance parts were now being held as inventory for both trading purposes and maintenance contracts. The word “both” could be especially important here, I think.
In 2019, there was a substantial reclassification as well:
Source: AR 2019, page 109
What I think this means is that the company had decided it was also going to trade in maintenance parts, instead of just holding the parts to service the maintenance contracts. This little change has implications for the accounting treatment of these maintenance parts. These parts now become part of “inventory” instead of being held under “plant and equipment” on the balance sheet.
All this inventory was now also labeled in the annual report as being “held for sale”. Note there is no distinction made between maintenance parts and other inventory:
Source: AR 2020, page 124
But that doesn’t mean that the company is actually going to sell this equipment, or is even planning to sell it. Because they are holding the maintenance parts “for both trading purposes and maintenance contracts”. So they wouldn’t be able to sell everything because then they’d have nothing in stock to service the maintenance contracts for their customers. But for the accounting treatment this is irrelevant apparently: since the company has the option to trade these parts, they must now be held as inventory and marked “held for sale”. This is, at least, my interpretation of the accounting treatment of the reclassified maintenance parts.
Ok, so what’s the big deal? Due to the reclassification in 2019 and 2020 the company’s “Plant and Equipment” on the balance sheet decreased from $22.1m in 2018 to just $3.0m in 2020. But the company’s inventory only increased from $21.8m in 2018 to $26.0m. A lot of the reclassified maintenance parts seem to have been written-off after reclassification.
How did that happen?
When maintenance parts were held as Plant and Equipment they were depreciated on a straight-line basis in five years:
Source: AR 2020, page 93
In the new situation, where maintenance parts are held as inventory, these inventories are stated at the lower of cost and net realisable value:
Source: AR 2020, page 98
Starting from 2020 the write-downs then start increasing (the bottom line):
Source: AR 2020, page 124
The amount for 2021 is even bigger: a further $10.0m was written-down:
Source: Results announcement 2021, page 10
The table below shows the inventory write-downs in recent years:
This is the disclosure about the management’s use of judgment for inventories. Note there is no distinction made between maintenance parts and other inventory:
• Inventories write-down
Inventory is stated at the lower of cost and net realisable value (“NRV”). The Group’s inventories mainly consist of computer hardware and peripheral equipment, which are subject to risk of obsolescence due to technological advancements or changes in consumers’ preferences. The determination of inventories write-down to NRV requires management to exercise judgement in identifying slow-moving and obsolete inventories and make estimates of write-down required.
Source: Results announcement 2021, page 6. Bold text mine.
So management now has a lot of judgement in determining the value of the maintenance parts and other inventory. Investors were, in my opinion, left in the dark about the exact reasons for the inventory write-downs. There was no disclosure about the amount of maintenance parts that were sold for “trading purposes”, the aging profile of inventories, how management determined exactly when a write-off was necessary and in general, no disclosure about the quality of the inventory in regards to the company’s ability to service its maintenance contracts. In short: was there an actual problem with the inventory, or is this just an accounting issue?
The inventory write-offs depressed net income severely in 2020 and 2021. In 2021, Novo Tellus launches its partial offer, and in this offer, the IFA based its opinion about the fairness of the price offered on these same “earnings” and NAV.
Segment revenue and deferred income
The table below shows the segment revenue for “Lifecycle Services”. The TPM business was a part of this segment until 2021. Lifecycle services also included activities like IT asset disposal and some other activities.
In 2021, the TPM business got its own segment. It is mentioned in the 2021 report that the TPM business generated $64.0m in 2020 and $56.2m in 2021. Overall it seems like a relatively stable picture. There was a 12% decline in 2021 for TPM revenue, but nothing dramatic in the past five years.
|Lifecycle services / TPM (from 2021) revenue
|$77.3m / $64.0m * (the $64.0m is TPM only)
|$56.2m * (TPM only)
The next table shows the company’s deferred income. It does not indicate any problem in regards to declining maintenance contracts:
This table shows the total amount of inventory and plant & equipment on the balance sheet:
|Inv. + Plant & Equipm.
And this is the deferred income expressed as a percentage of inventory and plant & equipment:
|Deferred inc. as % of inv. & plant and equipm.
Why has this percentage increased so much? Is it a sign that there is, or was, a problem with the inventory in terms of not being of good enough quality to service the company’s maintenance contracts? Was the company holding an excessive amount of inventory / maintenance parts in 2017 and 2018? Or has the company been very aggressive in writing-off inventory?
Sanity check: record write-downs during Covid-19?
Every investor knows that Covid wreaked havoc on supply chains in 2020 and 2021. There were countless stories about companies scrambling for essential supplies, IT equipment, etc. Some of these companies were paying higher prices for second-hand equipment during Covid than they were paying for new equipment pre-covid.
At Procurri however, none of this seemed to have any effect on inventory write-offs. They were $7.4m and $10.0m for 2020 and 2021 respectively. These are large amounts compared to the total book value of the inventories. It just seemed very unlikely to me that these write-offs could represent economic reality. As supply chains were disrupted, Procurri’s inventory should have become more desirable than in prior years. Investors were presented with record inventory write-offs instead. That made no sense to me.
SGX asks inventory questions
I sent some inventory related questions to Procurri’s IR e-mail a couple of weeks ago, but received no reply. Fortunately, their full year results – with a record inventory write-off – seems to have raised some eyebrows over at the regulators in Singapore, because SGX asked some detailed inventory related questions. The company’s answers to SGX’s questions filed on March 7 (.pdf) finally gave investors some insight about the company’s valuation of their inventory:
Source: Procurri’s March 7, 2022 filing, page 2
So they simply write-off the inventory after 395 days.
This is the company’s answer about SGX’s question about the aging profile of the inventory write-off:
Source: Procurri’s March 7, 2022 filing, page 2
That is a very extreme progression in write-offs! So, in management’s judgment we go from writing-off just $311k of inventory aged 181-360 days to suddenly writing off $9.5m when it is 360+ days old.
Note that the company has not mentioned any distinction between “maintenance parts” and other inventory in its answers to SGX. Does that mean that maintenance parts are also written-off after 395 days, even if it is likely that these parts will be used for servicing maintenance contracts in future years? From what I’ve read, that is my conclusion, because I can’t find anything that says that the maintenance parts held in inventory is treated any differently from the other inventory.
This is a quote from the 2018 annual report:
Our IT Resale business provides us with a real time view of supply and demand for used IT equipment worldwide, which helps us effectively price maintenance contracts (we know what equipment is failing around the world) and asset disposition contracts (we know the resale value of disposed equipment).
Source: page 9, AR 2018
Back then the company was saying they had good insight in the supply and demand for equipment and the resale value. That statement does not seem to be in line with simply obsoleting all inventory after 395 days.
What the SGX doesn’t mention in its questions and what could be important is that the reclassification of inventory in 2019 and 2020 seems to have contributed to the high inventory write-offs in 2020 and 2021. Otherwise the company would still be depreciating those maintenance parts on a straight-line basis. To what degree has that negatively impacted accounting earnings in 2020 and 2021?
It remains unclear to me how much revenue is generated by selling maintenance parts in the company’s “trading activities” and if, and how many fully written-down maintenance parts are being used to service the maintenance contracts. From the company’s reports, I don’t see any indication or management discussion that there is, or has been in the last few years, a major problem with the inventory. The company’s revenues are also fairly stable and deferred income is pretty steady as well. I think the company has been very aggressive in writing-off inventory and that there’s no major problem with the inventory, but I could be wrong. As I said before, I’m still quite confused about their inventory write-downs and what they mean exactly. I’m not sure it’s even possible to find the answers in the company’s reports.
That’s it for the inventory discussion on my part. Hope you didn’t find it too boring. 🙂 And sorry for the length of this post. I’ll now briefly discuss the offer from Park Place Technologies in 2019.
Park Place Technologies offer for TPM business
Procurri received an offer for its TPM business in 2019 from competitor Park Place Technologies in 2019. Procurri agreed to sell the business for S$156.9 million. Ultimately this bid failed as the parties could not agree on the final price and structure. But obviously it is a very good sign that Park Place was willing to offer ~$157m – a price that substantially exceeds the current market cap of ~$99m – for just the TPM segment.
The fact that Procurri initially agreed to sell also tells us that it is possible to separate the two segments, if desired.
In the partial offer the IFA had to downplay the relevance of this offer of course, as the Park Place offer for just the TPM segment already exceeded Novo Tellus’s offer by a huge margin:
Source: page 61, Circular Cash Offer; filed April 19, 2021
I think it is a highly relevant offer and that investors should keep it strongly in mind when evaluating any potential future offer from Novo Tellus.
Keep in mind that the company’s “Hardware, Lifecycle Services and IT Asset Disposition” also has significant value. I’ve not discussed this segment at all in this post, but it’s probably where most of Procurri’s growth will come from. As sustainability becomes a greater concern for companies, they will use these services more.
Park Place background information
From what I was able to find, Park Place is owned by GTCR, a private-equity investment firm from Chicago. It bought Park Place in 2015.
Park Place seems to be growing quickly and has acquired a number of competitors. A large recent transaction is Park Place’s acquisition of Curvature in 2020.
Procurri is demanding at least $17m USD in compensatory damages. No idea what the chances of success are, but it shows that Procurri and Park Place are competing hard. All the above information about Park Place just shows that they are a serious player with a lot of capital behind it. It is certainly possible that they are still interested in acquiring Procurri’s TPM business, or perhaps the entire business, in the future.
I think the free cash flow that the company generates tells the real story here. Today, the company’s enterprise value is about $82m. The company’s average free cash flow over the last three years was $14m. It looks like the company can grow nicely in the future, especially in its lifecycle services and IT asset disposition activities. I think a cash flow multiple that reflects the current cash generation and the company’s growth potential should be used in thinking about valuation. Park Place seems to have done that when it offered $157m for just the TPM segment in 2019.
I think minority investors are in a potentially vulnerable position with Novo Tellus and DeClout holding a controlling stake. The partial offer at a bargain price showed that Novo Tellus was looking to buy a lot more and I don’t think that has changed. It is important that minority investors reject any inadequate offer in the future from Novo Tellus, perhaps then acting together with DeClout.
It would be a disaster for minority shareholders if they sold out to Novo Tellus in any future offer at a bargain price. Any such offer should be evaluated by minorities with a critical eye, especially if earnings are depressed by large inventory write-offs, cash flow is not being taken into account in a valuation by the IFA, and if no consideration is being given to attempting to make another deal with Park Place for the TPM segment or the entire business.
Minority shareholders should put themselves on the same side of the table as Novo Tellus and (possibly) DeClout in any future offer. If the controlling shareholders want to sell the business in the future: fine, but not after first buying out minorities at a bargain price and then perhaps selling the business to a buyer like Park Place at a huge premium shortly afterwards.
Even if you think the company looks cheap, you could argue that a large discount is justified because Novo Tellus and DeClout have a controlling stake. I think this situation is a bit different from the typical family-controlled Singapore company trading at a cheap price. Novo Tellus is a private equity investor and will want to cash out of Procurri at some point in the future, or at least see Procurri’s value reflected in the market price. Novo Tellus’s own investors will want to see returns from them. They are not going to leave the business to the next generation of the family and things will continue to be cheap forever. I think the real risk here is a take-private attempt at a bargain price. I think investors should be prepared to hold this company for multiple years and not expect any near-term catalyst.
My goal with this post is to highlight the inventory write-offs and the Park Place offer, because these elements seem highly relevant to me in the company’s valuation. I hope minority investors will stick together and not be tempted by a modest premium in any future offer. I’ve seen this happen a number of times with SGX listed companies. It was also surprising to me that I couldn’t find any write-ups about the company or any recent discussion on Singaporean stock forums like ValueBuddies.com and ShareJunction. That’s why I decided to highlight this company here and hopefully put it on the radar screen of more investors. I think the company should also appeal to US and Europe focused investors as 94% of its revenue is generated in these regions.
Disclosure: long Procurri Corporation (BVQ.SI)