Thursday, July 1, 2010

The Great: Hai-O Enterprise Bhd

Hai-O Ent, the company that I so called The Great has its share price battered last Monday and Tuesday. Okay, I have to admit it is a bad Q4FY10 result but if you look at the overall FY10 result, it is still quite impressive. Revenue grows 17.4% and operating profit grows 26.1%. So is the market overreacting? Well, maybe not. The reason is that Hai-O's MLM division has grown so huge that its sales contributes 80%-90% to the group's revenue ever since FY08. If MLM does bad, Hai-O does bad. So, investors have good reason for their concern since the bad quarter is caused by below expectation MLM result.

[Q4FY10 Result: Revenue drops 25.6% and operating profits drops 32.5% to preceding year corresponding quarter]

Here's what the management has to say about this:

  • MLM division is applying a more stringent rules on new members recruitment - in line with the new Direct Selling Act (DSA) by the government
  • The rise of interested rate has indirectly reduce the number of new members venturing into MLM business
  • the group view sales in MLM division will slow down next financial year
  • to rectify the situation the group plans to launch more new supplements and increase the range of skincare products as well as organize more training workshop for existing members
  • [info from RHB research house] - the group does not discount the possibility of members dropping out due to the more stringent rules. To mitigate this situation, the group plans to organize more roadshows and promotions, providing mentoring, support and training as well as introducing new range of products. The group also plans to separate committed members than those that are not for more sustainable earnings


My View:
MLM Division
I think it is best to have more focus on their MLM division as for now since it is their largest sales contributor. To be have better understanding on Hai-O's MLM business model I took a visit on Taipan181 and Hai-O marketing 369 (means Google lah). Taipan181 since to have some issues on their webpage so it is left with Hai-O Marketing 369. Yea, as I understand these are two groups formed by its MLM members - sort of like a group that works together on their marketing or business plan and they are both independent to Hai-O Marketing. From their webpage, there are actually 11 distributor levels. The 369 group focuses on having their member to start with level 7 where they purchase 10 units of water filters (RM20800) to qualify themselves into Sales Manager level with bonus of RM4600. In other words, a person will get profit by purchasing 10 units of water filters and to realize it of course he would have to sell all of them. That is where the loan and installment stuff comes about. To qualify for level 8 and its bonus, he'll need to have another 2 person purchasing the same amount of water filters on his downline. In other words get another 2 persons to start from level 7. Hmm...I don't have the full details on the new DSA yet, but I feel that might get them into some trouble IF it gets abused. I think this is probably why you see many of the distributors convince their new members to begin with level 7 and also the reason why you see many eventually complains such model as scam and stuff. From my view, there could be some loophole in Hai-O's model. But just like every business model, every system, every law and every constitution, all of these can be abused. The problem is the people. If that person has all the intentions to mislead and abuse the system, no matter how good the model is, it could just well turn out to be a scam. So there is a thin line between scam and not which is why I suspect Hai-O Marketing management might have a little tweak on their model and of course applying more stringent rules to existing members. The management is right to expect higher members turnover by this. It might affect them in the short term but it is what best for Hai-O and the entire MLM industry as well. I haven't got the chance to look at Taipan181 yet, they might operate differently.

Another loophole I notice from Hai-O's model is that it could get their distributors into price war - similar to what happen to MonaVie few months back. This could also dampens their effort to recruit new members. 

So I could see the rationale for Hai-O to cool their recruitment activities down a little which could impact their performance next financial year. BUT, there seems to be some mis-correlation between members growth and sales growth. Take a look at the MLM sales table below.



You could see, in year 2007 and 2008, members grow roughly about 10K annually and their sales grows by 84% and 182% respectively. If you were to compare 2009 and 2010 which have much higher member growth, sales only grows by 24% and 20% respectively. MLM suppose to be sporadic where higher members growth should relatively gives higher sales. I know it isn't that simple but the difference shouldn't be that huge. Clearly there is other factor driven the sales growth which I suspect is their products. Hai-O has  higher priced products introduced which are Premium Beautiful in 2007 and Bio-Aura in 2008. Sales growth slows down in 2009 and 2010 could be due to no new higher-priced products introduced. Remember the 369 marketing plan? I suspect there are some members who got themselves stocked up with too many unsold units which could contribute to lower sales growth too.

I think, the sustainability of the earnings are contributed by the lower priced shorter life span products. The two star products mentioned above have longer-life span although 3 of Bio-Aura filters have to be replaced every year and the other 3 every three years, their priced is still relatively low. So I believe if no action taken, the sustainability of current earnings could be put into question. However it is good to know that the group are introducing both higher and lower priced products along with other measures mentioned above. For me they are moving into the right direction and all these could improve any gaps that happens currently.



Retailing
Retail division which use to be Hai-O's core business has not been given fair attention. The struggle with tight margin is the problem of the past. Its FY10 performance is nothing less than impressive. The only thing is that its contribution to both revenues and earnings is still relatively small compare to its MLM sister. Revenue in FY10 grows by 6.6% while earnings grows 43% as a result of the sales of more in-house brand products which give better margin. The group has the intention to expand its retail side and have been actively promoting its brand which is good to see.

Technology  
If you read the 4th quarter segmental report, you would see they've added this new technology segment into it - which is in red as expected. This division is driven its subsidiary called Hai-O Energy. If you are interested to know more, you could go to this webpage http://www.hai-oenergy.com.my/. The reason I do this is because it is too difficult to understand what they wrote there. It is not because of it is too technical, it is because it sounds like it has been written by some Chinamen or some dude copy the entire Chinese text and translates it using Google Translate. But the rough idea in short is, Hai-O heat pipe technology able to conduct heat more efficiently than any other technology that we have in the market today.

What is Hai-O doing with this heat pipe thingy? It has nothing to do with whatever they does? Well, for a start, Hai-O invest in some Chinamen to do a research on this technology. So they gave the money, and others do the research for them. How they got into this? I don't know. Maybe they got bought off by the idea. somehow. I think this investment has a huge potential. I'm too tired to write too much into detail about this.But the application of this technology is wide ranging from consumer households to industrial applications. They have completed the R&D and pending for patent. How, Hai-O plan to use this technology, that we'll have to wait and see. Hey, consumer household? They could even use this to produce some products for their MLM division....I don't know. That is many years from now.

The big question is, is this technology really that efficient? If it is, I can say, this is really a breakthrough. So far, the progress looks good. Some analyst even cover that they have experiment it in a glove factory and it is successful. But we'll not see contribution from this division in a year or two. Patent may take some time.

My Thought:
I think Hai-O Ent's value lies in its long-term potential and vibrant management. On the MLM front, they have Indonesia and potentially China. The management are more careful nowadays. They actually mention about Indonesia in 2007 applied for license around 2008 and setup in 2009. Considering that they took 2 years to setup their business there, I assume they have done enough study. I was wrong and over estimated their sustainability on the local front but I believe the management are able to cushion this. Plus there is a huge potential on the technology side.

I am still working on the valuation for Hai-O to see the impact of the potential earnings shrink next couple of years. So I don't have the price as for now. Lastly, FY2011 will be an interesting year for Hai-O. How the go through it will determine if they are great or ordinarily good.

This comment is based on my personal thoughts, opinions and my risk tolerance. It should not be considered as an investment advise. Please consult your financial advisor or do some research of your own before making any decision. You might have your own thoughts. I would love to here from you. You can always place your comments here and or email me privately at luzeeker@gmail.com 

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