We are confident these companies will be able to surpass the profit guarantee levels barring unforeseen circumstances - Ang

It has been four months since ACE Market-listed Tejari Technologies Bhd, a hydraulic-products manufacturer, ventured into the information and communications technology (ICT) sector with the establishment of ICT Utopia Sdn Bhd, and it appears the group is moving quickly to consolidate its position in the sector.

At the end of April, Tejari announced that it would acquire two companies — PC3 Technology Sdn Bhd and Essential Action Sdn Bhd — for a total of RM9.28 million to be paid in cash and new Tejari shares.

Tejari has said the acquisitions would provide wholly-owned subsidiary ICT Utopia “synergistic” benefits in providing ICT solutions at its one-stop centre in Plaza Low Yat, Kuala Lumpur. ICT Utopia recently leased 30,000 sq ft of floor space for its retail ICT business and the acquisition expands its floor space to 50,000 sq ft.

The market took the news enthusiastically as Tejari’s share price doubled to 29 sen on May 3, from 14 sen in January.

However, industry observers have raised concerns about the deals.

Based on the descriptions of PC3 and Essential that Tejari has provided, these two companies are effectively retail distributors of computers and accessories. PC3 is one of the authorised dealers for Acer brand desktop PCs in Plaza Low Yat, while Essential is an authorised reseller of Lenovo computers.

An analyst says, given the retail ICT industry’s low barriers to entry, business is very competitive and companies generally make low margins. Hence, there is little value to be extracted from such acquisitions, especially when these companies do not have significant intellectual property that would make Tejari’s ICT business stand out, he adds.

The analyst says it is concerned that Tejari may be paying a high price for the acquisitions, which  will also raise its gearing substantially as Tejari will also be assuming  net debt of RM31.85 million from the two companies.

Tejari proposed to pay RM5.78 million for a 51% stake in PC3, of which RM1.73 will be in cash and the remaining RM4.05 million via an issuance of Tejari shares. At RM5.78 milion for the 51% stake, PC3 is being priced at RM11.34 million. However, PC3 has borrowings of RM31.2 million and cash balances of RM4.53 million. This means PC3 is in net debt position of RM26.7 million. As Tejari is absorbing the borrowings in PC3, the acquisition effectively prices PC3 at RM38.04 million. On an annualized basis, PC3 is expected to post net profit of around RM1.53 million for FY2010.

Tejari also proposed to pay RM3.52 million cash to acquire a 51% stake in Essential, valuing the company at RM6.9 million. Essential has borrowings of RM7.85 million and cash balances of RM2.7 million. This puts Essential in a net debt position of RM5.15 million.Thus, the Essential acquisition is being effectively priced at RM12.05 million.

In its announcement to Bursa Malaysia, Tejari says that, upon completion of the acquisitions, its borrowings will balloon to RM40.8 million, resulting in a net gearing ratio of 1.32 times compared with borrowings of RM1.8 million or a gearing ratio of 0.07 times as at Nov 30, 2009.

When contacted, Tejari’s group financial controller Jorrine Ang explains that PC3’s borrowings are mainly short-term trade financing to support the working capital of its business, which is normal in the ICT industry.

Tejari is acquiring the stakes in PC3 and Essential from Chin Boon Long. Chin has also signed net-profit-guarantee agreements with Tejari for three financial years up to Nov 30, 2012.Tejari says it is guaranteed up to RM2.43 million in net profit from PC3 or an average of RM810,000 a year.

According to Tejari’s circular to shareholders, PC3 made a net profit of RM1.02 million for the eight months ended Nov 30, 2009, on revenue of RM179.23 million.

Information obtained from the Registrar of Companies (ROC) shows that PC3 made a net profit of RM1.08 million for FY2009 ended March 31, on the back of RM224.2 million in revenue, indicating that the company’s profit margins are low.

For the 51% stake in Essential, Tejari is also guaranteed total income of RM1.48 million for three years, indicating that the latter is expected to generate RM2.89 million or an average of RM963,000 annually.

According to Tejari’s circular to shareholders, Essential’s net profit for the eight months ended Nov 30, 2009 was RM867,163 on the back of RM29.17 million in revenue. Interestingly, ROC records show that Essential made a net profit of only RM26,046 on the back of RM4.98 million in revenue for FY2009 ended March 31.

Ang explains that since Essential was only incorporated in 2008, the income statement at the ROC only reflects several months of Essential’s earnings.

“Besides, based on the net profit of PC3 and Essential for the eight months ended Nov 30, 2009, we are confident that these companies will be able to surpass the profit guarantee levels barring unforeseen circumstances,” she tells The Edge.

On whether PC3 and Essential would be able to maintain or increase their earnings in the future, especially when the profit guarantees lapse, Ang says Tejari believes that, with the ICT industry growing, their earnings should be strong enough by then.

Tejari is principally involved in manufacturing and designing mobile hydraulic equipment for the industrial sector. Due to the weak operating environment in FY2009, Tejari made net losses of RM4.47 million on the back of lower revenue of RM14.73 million, compared with a net profit of RM3.06 million and revenue of RM28.99 million a year earlier.

Tejari saw some major shareholding changes in January when managing director Ooi Chai Huat emerged as the group’s largest shareholder with a 32% stake. Post-acquisition, Ooi’s stake in Tejari will fall to 27.3%.

An industry observer says that while it is common for companies to look at ways to diversify their income stream, the ICT industry can be a challenging one, as the past experiences of several companies show.

It is noteworthy that, in 2001, property developer Bolton Bhd also diversified into the ICT sector when it acquired the entire stake in ICT-related company Global Innovative Management Partners-ACT Sdn Bhd for a total of RM280 million. However, in 2003, Bolton posted RM33.1 million in impairment losses, following the disposal of its entire stake in the company.

Similarly, ECS ICT Bhd, which was listed in April, showed that despite earning revenue of RM315.1 million for 1Q2010, net profit was only RM5.69 million — a net profit margin of 1.8%.

It should be interesting to see how Tejari will boost its earnings from its new ICT businesses.

This article appeared in Corporate page of The Edge Malaysia, Issue 810, June 14-20, 2010