Procurri Corporation: a lot cheaper than it looks

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.

Summary financials

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.

Business Description

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

Inventory Reclassification

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:

Year Inventory write-down
2017 $2.7m
2018 $3.0m
2019 $2.0m
2020 $7.4m
2021 $10.0m

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.

Year Lifecycle services / TPM (from 2021) revenue
2017 $41.5m
2018 $65.4m
2019 $71.5m
2020 $77.3m / $64.0m * (the $64.0m is TPM only)
2021 $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:

Year Deferred income
2017 $21.3m
2018 $20.3m
2019 $27.2m
2020 $18.9m
2021 $23.0m

This table shows the total amount of inventory and plant & equipment on the balance sheet:

Year Inv. + Plant & Equipm.
2017 $48.8m
2018 $43.8m
2019 $39.4m
2020 $29.0m
2021 $23.2m

And this is the deferred income expressed as a percentage of inventory and plant & equipment:

Year Deferred inc. as % of inv. & plant and equipm.
2017 43.6%
2018 46.3%
2019 69.0%
2020 65.2%
2021 99.4%

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 has sued Congruity and Park Place in relation to the sale of Congruity’s TPM business to Park Place.

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.

Conclusion

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)

Posted in Singapore stocks.

18 Comments

  1. This is why I love your blog. Classic security analysis. Please write more often 🙂

    I haven’t heard about the company before. Some questions.

    In the SGX response, the management also talks about reducing inventory days (66 to 55 in 2021). I think that may have contributed to less inventory and hence higher deferred income as a percentage of inventory+PE. Am I mistaken?

    It seems Procurri isn’t paying dividends recently, where does all that cash flow go?

    • Thanks CigarButtSmoker, glad you like the post. 🙂

      Yeah, that could be right. I don’t really know how they calculated the number. I was mainly using that table to try to get a picture about any relationship between deferred income and inventory / plant and equipment. They have other segments besides TPM that also account for some inventory, but what the split is between segments isn’t disclosed, I think.

      I just want to know if there is a problem with the inventory now or in the past, particularly relating to their maintenance parts. Are they currently short of maintenance parts to service their contracts? Do they need to buy a lot more shortly? Did they buy too much in the past? I don’t think there’s management commentary that suggests there’s a real problem currently.

      What’s interesting is that in their response they wrote that “The productivity improvements drove approximately S$776,000 of the increase” in obsolescence. But the increase in obsolescence from 2020 to 2021 isn’t the most important thing, I think.

      Why is the absolute amount of the write-offs so huge in the first place? That’s the key question. And to what degree are reclassified maintenance parts write-offs contributing to that? How can that number be so big during Covid supply chain disruptions when those parts should have been harder to get for end users? That high number seems to be caused by simply writing off all inventory that’s not sold within 395 days. That’s how I read that filing, at least.

      About the cash flow: in November 2018 they agreed to purchase the remaining 49% of a subsidiary called Rockland Congruity. The first payment of US$12m was paid on March 30, 2019. The second payment of US$10m (of which $2m was in stock) was made in Feb. 2020. So that’s US$20m (some millions more in Singapore Dollars) in cash flow that went to acquisitions. In 2021 they had a big increase in receivables, so that consumed a lot of cash. Not sure how that trend will develop. I think 2020 and 2021 cancel each other out fairly well on that point and that avg. free cash flow over the last few years give a reasonable estimate. In 2018 they also had a $7.3m increase in receivables, so they seem to be pretty lumpy.

      I would not be surprised if Procurri does not pay any dividends in its future as a public company. Perhaps they’ll make acquisitions, perhaps they’ll let some cash build up. It benefits the major shareholders if the share price stays low in case Novo Tellus / DeClout wants to take a shot at taking it private on the cheap. I think shareholders should be prepared not to get anything in dividends. I know a lot of investors in Singapore put a lot of weight on dividends. But I think selling on the basis of a lack of a dividend is a mistake, as it plays into the hands of the majority shareholders.

  2. Who are they purchasing inventory from? The inventory issues seems weird… I’m guessing its not IFRS standard because SGX is asking questions?

    How do you handicap the risk of Novo Tellus and DeClout screwing over minority shareholders? I’ve been in a situation or two which something similar happened.

    • I don’t know if they buy mainly from OEMs or in a second-hand market. They are marking the inventory at the lower of cost and net realizable value, I think that’s standard accounting treatment. But the aging profile of the write-offs and the decision to write-off everything after 395 days make no sense to me. Especially in light of Covid disruptions. And the reclassification of maintenance parts from plant & equipment to inventory is very relevant too in this regard.

      Yeah, that’s definitely a major risk. If minority shareholders just vote down any lowball offer, things should eventually work out, I think. I’m hoping shareholders will stick together. Novo Tellus and DeClout together have just over 50% at the moment. I think they need 90% to delist in Singapore.The worst examples I have seen were offers where management had 80%+. They are still far removed from that.

      Ideal would be if there’s a large shareholder who will just hold out no matter what, but I don’t think that’s the case currently. In the partial offer they offered $0.365, which is still above the current price. DeClout itself voted against the partial offer at that price. But I really hope shareholders won’t get tempted by a modest premium over that price.

      Sitting around and not even talking about this situation to current shareholders is not a good strategy for me. So I’m posting my views and the questions I still have in this post. Perhaps I’m completely wrong about the things I wrote about inventory though. If so, that’s also very useful for me to learn.

  3. Just stumbled upon another interesting datapoint from competitor Service Express. Their “OnDeck Predictive Parts Sparing” software allows them to make pretty accurate predictions about the parts that their clients are likely to need in the future. Check out: https://serviceexpress.com/why-service-express/partsedge/ondeck/ or this YouTube video: https://www.youtube.com/watch?v=MkxHi9twoOM.

    Now compare this approach by Service Express to Procurri’s full inventory write-offs after 395 days… Perhaps Service Express is doing things a bit better in certain ways, but that’s not the point. Procurri also has a lot of historical customer and hardware data to work with. They probably have their own software solution to help them make predictions about their customers’ future needs.

    I think this is another indication that their large maintenance parts write-offs are not a reflection of the true economic value of this inventory in servicing their contracts.

  4. A new filing out today with the company’s answers to questions that were asked by Securities Investors Association Singapore (SIAS): https://links.sgx.com/1.0.0/corporate-announcements/XSF696K5VZRG15WB/713179_PCL_QA%20SIAS%20220422.pdf (.pdf).

    There were some inventory related questions asked by SIAS as well. These were the quotes that stood out to me:

    – Pages 4 & 5 (bold text mine):

    Q: Can management help shareholders better understand the reasons for the significant increases in inventories write-down in FY2020 and FY2021? Why was there an increase in “multi-generational inventories”? Does this refer to old/outdated inventories?

    A: The strategic reduction of inventory in FY2020 and FY2021 included efforts to sell inventory and to write off inventory identified as unlikely to be sellable, resulting in higher than usual write-downs.

    Multi-generation inventories refer to the inventories of superseded models of IT equipment produced at different time which specification will have changed due technological advancements. The Group purchases and sells data centre IT equipment to serve enterprise customers whose IT equipment ranges from brand new to over 30 years old. With the significant diversity of usable equipment across our customer base, and the long operating life of the IT hardware equipment, there is no corelation between product shelf life and old/outdated inventories against the write-down.

    – Page 5 (bold text mine):

    Q: Was there under-provision in prior years for stock obsolescence? Or has management changed its stock obsolescence policy? What is the level of oversight by the AC on the group’s stock obsolescence?

    A: The Company does not believe it under-provisioned in prior years for stock obsolescence. Rather, the higher obsolescence in FY2020 and FY2021 was the result of our efforts to reduce the inventory dependence of our business and thereby increase efficiency of our inventory.

    The Group expects that its strategic efforts to increase the productivity of its inventory should help reduce its obsolescence rate over time. […]

    ————

    So I think this basically answers my questions about the quality of the inventory in recent years, with the company now clearly stating that they believe they did not under-provision for obsolescence in prior years.

    I’m not quite sure what the company’s statement that there’s “no correlation between product shelf life and old/outdated inventories against the write-down” means exactly. But I think it reinforces the point that the high write-downs of the last two years don’t reflect quality issues or past mistakes in buying inventory.

    There was also a quote about the TPM business and the typical length of a contract:

    The typical duration of a TPM contract is 12 months. However, the majority of contracts are renewed, creating multi-year commercial relationships with our customers.

    Source: Page 3

    So 1-year contracts, but typically they are renewed and the client relationships are usually long-term in nature. That means that Procurri should be able to analyze its clients’ future inventory needs effectively. More clients give you more data, allowing you to do a better job at forecasting and also creating economies of scale (buying power of maintenance parts and servicing clients more efficiently). However, despite having a solid picture about their clients’ needs, the company will still be writing off those maintenance parts after 395 days, as they disclosed in their filing about the questions asked by SGX. That’s why the cash flow statement will continue to give a much better picture of business performance than the income statement.

    The SIAS questions created more clarity, but one thing that has not been addressed by them or the company in this filing, is the issue of the reclassification of maintenance parts. That’s what allowed the company to write-off so much inventory in the first place. If all those parts were still held under Property, Plant and Equipment, the company would have been straight-line depreciating those assets. So I don’t think the company’s explanation on page 4 is frank about that:

    The reduction of inventory is one of the benefits of the global strategic re-organisation Procurri has undertaken to build long-term growth prospects. A lower dependence on inventory allows Procurri to reduce its structural exposure to inventory obsolescence, and improve the Company’s return on working capital.

    The strategic reduction of inventory involved a comprehensive approach including accelerated selling of inventory to reduce ongoing stocks, investment in IT systems to automate inventory reporting and management, identification of and write-downs of stale inventory, and efforts to share inventory across our hardware and TPM lines of business to improve inventory efficiency.

    All in all, I’m pretty happy about the additional information that has come out with this filing.

  5. I think you are right about the inventory write-offs. But what is the endgame here? Do you expect them to report higher profits after all the inventory that can be written off is written off, leading to a rise in the share price? Or are you hoping for privatization? It seems they will either hoard cash or continue making weird acquisitions that may even be detrimental to the earnings.

    • I do think profits will increase due to lower write-offs in the future. But perhaps that is understood by investors by now, so not sure if the share price will react if accounting earnings do rise. People can look at the cash flow statement today and the recent disclosures about inventory and get the picture.

      Best case scenario is for the business to be sold to a competitor like Park Place. I think that’s what Novo Tellus will ultimately do. Question is: will minority investors get to benefit from that? It seems likely to me that Novo Tellus and DeClout will first try to buy out minorities at a low price. If they try, minorities will need to reject it. They should not get depressed by the absence of a dividend, or be fooled by an offer that is based on earnings or NAV and ignores cash flow, like Novo Tellus tried in the partial offer last year.

      As for capital allocation in the meantime: I’d be happy to see them make a bolt-on acquisition. I’d be very surprised to see them do something extreme, like going into a different industry. There are probably smaller players they can acquire. The guys from Novo Tellus seem pretty smart, so I’m not too worried there.

      Cash hoarding won’t help Novo Tellus get returns on their investment in this company. Sure, they might do it for a year or two, but only as a tactic to depress the share price to set-up a lowball take private offer. Park Place and other competitors will keep growing though and if Procurri wants to keep up, they’d better scale up their business as well. That will probably require them making an acquisition at some point. Cash hoarding for years is a losing strategy for them.

      So I am fine with either an outright sale of the business to a competitor, or to just be a long-term shareholder alongside Novo Tellus if they decide to keep Procurri public. Not sure what Novo Tellus’s time horizon is though. They’ll probably want to monetize their investment at some point.

      • I see. So your thesis relies on Novo Tellus and, to some degree, DeClout being a private equity/company and pushing for an eventual monetization. Perhaps you are right. I have no background on Novo Tellus but both other companies you mentioned, AEM and ISDN, are successful stories although part of that may be attributed to the semiconductor boom.

        After watching many non-dividend-paying owner-operated small companies artificially depressing the share price by hoarding cash and making terrible acquisitions assuming that they must be good at everything, my confidence in such situations has diminished. One company I’ve been watching from the sidelines is Time Watch Investments Limited (2033.HK). The company stopped paying dividends in 2019 despite still producing large cash flows. The Chairman-CEO had earlier listed the same business in Singapore, taking it back private following the lows of the 2008 crash, and then listing it in HK. Now I’m pretty sure he will try to take it private again, but at what price I have no idea.

        I recognize that this is a different situation than what I described due to the majority shareholder being Novo Tellus. Do you mind sharing how you obtained these insights about Novo Tellus? You are probably aware but it seems they took Sunningdale Tech private in 2021:
        https://www.businesstimes.com.sg/companies-markets/sunningdale-to-delist-after-scheme-scrapes-through-with-512-of-shareholders

        • Yeah, Novo Tellus will want to make money on their investment. The situation is in my opinion different from a typical family-controlled co. in Singapore where the son/daughter is already on the Board and there is little incentive to allocate capital well.

          I think Novo Tellus and DeClout are just under 50% ownership today. So I think that minorities are in a vulnerable position, but it is possible to defeat an inadequate offer. The Sunningdale scheme of arrangement did pass, but not before increasing their offer and even then it barely got done with 51.2% of the *number* of shareholders (so not the value represented by those shares) voting in favour.

          For maximizing value for minorities, it’s best if those shareholders that are looking for dividends, or that are happy with a small premium in a take-private offer to just sell their stock to someone who is willing to vote against a lowball offer. Ideally one or two larger shareholders emerge here over time, but I don’t have control over that.

          I don’t really have any special insights about Novo Tellus. I think private equity investors have similar goals though and that they will look to monetize their investment in time. They raised $250m for one of their funds in 2021: https://www.firstavenue.com/media/final-close-of-novo-tellus-pe-fund-2-at-usd-250mn/. Global institutional investors represented 88% of the capital raised. These are the type of investors they have and those investors will want to see a return on their investment.

  6. Procurri released a press release today announcing they have received “non-binding indications of interest from several third parties for the purchase of certain assets of the Company and its subsidiaries”: https://links.sgx.com/1.0.0/corporate-announcements/9NPV4ZPD0GGJDF1G/83d1b8b8772cd1a7f1495d6fde7a867db4775b89d9402f780f63c0c160bb56b9.

    It reads to me like they’re considering selling a division (TPM seems most likely) to an outside party. It seems likely that Park Place is among those interested, as they’ve tried to buy the TPM business in 2019 for $115m USD ($156.9m SGD at the time). The press release from November 5, 2019 mentioned “some of the assets of the business” which ultimately led to a bid for the TPM business. That transaction failed. I think it would be very positive if a sale of a division to an outside party is concluded.

    As pointed out in the post, my main worry is a take-private offer by Novo Tellus / DeClout at a bargain price. Today’s press release reads like something different though. It seems quite similar in wording to the November 5, 2019 press release that led to the Park Place offer: https://links.sgx.com/1.0.0/corporate-announcements/WMTT38VVBZ4MPNTT/3cfed2f8f90645279bed2575710484a4830b8075c90b76981b4e3bdbeec26e96. The main difference is that there is no letter of intent yet.

  7. Major insider buys were reported by DeClout today: https://links.sgx.com/1.0.0/corporate-announcements/2VLM5SRZUE3OIKKD/e3aeb4bb9ce9a1ec5e263004a37b8921681022d450097fa5024e7c3dd50656ce.

    They bought 12.2m shares in recent days, taking their stake from ~22.0% to 26.1% of the outstanding shares. I was a bit surprised that DeClout is allowed to buy during a time when there are ongoing discussions with third parties, since DeClout is also on Procurri’s Board of Directors. But to see them buying so aggressively at these prices IMO clearly shows that they see a lot of value here.

    The downside for minorities could be that DeClout’s buys further secure Novo Tellus’ and DeClout’s position as the controlling shareholders. But I think last week’s press release, combined with the aggressive buys from DeClout, point more in the direction of a potential sale of a major division (TPM?). It would be a very positive development if this happened while minorities are still at the table at Procurri and not under private ownership.

  8. Congratulations! Perhaps 42.5 cents was not the outcome you were wishing for, but considering how quickly it played out, it was a great call. 27% in two months if somebody had invested right after your post.

    • It’s a mandatory offer from DeClout that was triggered when they went over 30%. They say they intend to maintain Procurri’s listing. Shareholders can hold their shares if they think DeClout’s offer is too low. Everyone knows how I feel about that issue. 🙂

      I hope that minority investors stick together, that’s what I’ve said from the start. I think I’ve done what I can to highlight the value. It would be a bad outcome if DeClout gets so many shares that the free float requirement is no longer met. That’s not a foregone conclusion though.

  9. DeClout made a mandatory cash offer after reaching a 30% ownership threshold. The offer is for $0.425 per share: https://links.sgx.com/1.0.0/corporate-announcements/OYBWLR4PNIPQW0E2/6bbb9a4ce13906f490084e8a8b2f88d8afbe2405e8dbf7699b0087dc8a8ba63f. After making additional purchases, DeClout with other “undertaking shareholders” are now up to ~50.8% ownership. Novo Tellus is not part of these undertaking shareholders.

    Procurri’s CEO, Thomas Sean Murphy, sold his shares to DeClout. I think he did this in the open market. Murphy supported Novo Tellus’ partial offer last year, in which he pledged to sell his shares to Novo Tellus for $0.365 per share. That offer failed and his shares were not accepted. I think the optics of him now joining the undertaking shareholders in DeClout’s offer would have been bad, as it would connect the Novo Tellus group of last year’s offer to DeClout’s undertaking shareholders. Novo Tellus is not part of the DeClout group for this offer, so they are not allowed to be acting in concert with DeClout for this offer. With Murphy simply disposing his shares to DeClout in the market, those worries are off the table and his shares are now in DeClout’s hands. I think Murphy’s actions do indicate that Novo Tellus is probably supportive of DeClout’s actions and that DeClout’s offer is not a sign of major disagreement between Novo Tellus and DeClout.

    Shareholders are allowed to hold their shares and not sell to DeClout. DeClout has said it intends to maintain the listing status of the company.

    But there is a minimum public float requirement in the SGX listing manual that is relevant for this offer. From page 6 of the offer announcement:

    “Under Rule 724(1) of the Listing Manual, if the percentage of the Shares held in public hands falls below 10%, the Company must, as soon as practicable, announce that fact, and the SGX-ST may suspend trading of all the Shares. Rule 724(2) of the Listing Manual states that the SGX-ST may allow the Company a period of three (3) months, or such longer period as the SGX-ST may agree, to raise the percentage of the Shares held in public hands to at least 10%, failing which the Company may be removed from the Official List of the SGX-ST.”

    On page 135 of Procurri’s annual report it is disclosed that “as at 22 March 2022, approximately 35.89% of the issued ordinary shares of the Company is held by the public as defined in the Listing Manual of the Singapore Exchange Securities Trading Limited”.

    Obviously that percentage will be lower now. I don’t think we can find out the updated number currently.

    So if shareholders want to maintain Procurri’s public listing it is very important that they do not sell their shares to DeClout on the market or by accepting their offer.

    For any larger investors that are convinced there’s value in Procurri, this offer will probably create a lot of volume. Perhaps a few smaller funds will pick up some shares that will help to create a blocking stake, so that neither DeClout and/or Novo Tellus can get to the 90% threshold, now or in any future inadequate offer.

    In regards to blocking stakes, it is important that larger shareholders stay below 5%, because otherwise those shareholders will be seen as a “substantial shareholder” and their stake will not be deemed to be “in public hands”. This is at least my interpretation of the SGX rules when I look at the definition of the term “public” in SGX’s rulebook: http://rulebook.sgx.com/rulebook/definitions-and-interpretation-0#definition-p. The section about “substantial shareholders” can be found in footnote 5 on this page: http://rulebook.sgx.com/rulebook/board-matters-2

    I’m not part of any group or aware of any initiatives. As a private investor, I think the offer is inadequate as I explained in detail on this blog. As such, I hope that Procurri’s listing status is maintained and that all shareholders will benefit from the value creation and realization at Procurri.

  10. Interesting writeup, and it’s nice you gave updates on the situation in the comments. As you think the offer is too low, what price/share would you believe to be proper for the business?

  11. Hi – I just saw the announcements in SGX that Novo Tellus has totally sold out of their shares in Procurri. This means that they are totally out, and DeClout is solely in charge now. I’m quite puzzled, as Novo Tellus had put in a lot of work over the past 3+ years to reorganize Procurri, and put in place new IT systems, processes, sales teams, etc. And just when the pandemic controls are lifted, and the maintenance business is positioned to thrive again, they sell out. It doesn’t make logical sense to me, as it seems that they are selling out too soon, and at too low a price to justify a return on their time and capital invested. Unless there is other information that outsiders aren’t aware of currently –

    • Hi Sum Tze Tsien,

      I was also very surprised to see Novo Tellus selling out to DeClout. Especially since only last year they were still trying to increase their stake substantially in the partial offer that they launched.

      I can come up with a few theories why they would sell, but of course this is all guesswork. One theory could be that for NT the clock was ticking and that they had to monetize the Procurri stake at some point. Perhaps the fund in which they hold Procurri might be maturing relatively soon. With DeClout essentially beating them to the punch in the partial offer last year, and a couple of weeks ago also getting to 50% ownership, NT is only a large minority investor. Perhaps DeClout has no intention to sell any of Procurri’s divisions or to monetize anything. They might be happy to own Procurri for the long term. With DeClout in control, NT can’t really do anything against that. So if they had to monetize relatively soon, they were basically forced to sell.

      That would make sense to me. NT’s plan was perhaps to get to 50%+ last year, try to get the rest this year and take it private. Then sell the TPM business at a big profit to someone like Park Place. In this scenario, DeClout simply got in their way and blocked them.

      Anyway, NT’s sale seems like a very negative development for minority shareholders. I was quite confident that NT was looking to monetize their investment over the next few years. I am not at all sure that DeClout is looking to do the same. It seems more likely that they are happy to simply own Procurri and to own as much of it as they can. That doesn’t have to be a disaster for minority shareholders necessarily. Unfortunately DeClout is under Japanese ownership and Japanese companies tend to have terrible capital allocation.

      So I’m now asking myself: am I still happy to own Procurri with DeClout fully in charge? What, if anything, does NT’s sale indicate about DeClout’s intentions for Procurri from here on out? How is this situation now different from all the perpetually undervalued companies with terrible capital allocation that I can buy in Japan?

      Those are my thoughts about NT’s sale right now. I think the IFA has to produce a document about the offer. Perhaps that has some more background information about DeClout’s offer and about any other parties that showed interest in Procurri’s assets. Maybe that will provide a bit more clarity.

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