Saturday, May 14, 2011

The Good: Excel Force MSC Bhd

It has been some time since my last post. I have a friend to thank where he thought me how I could use some tools provided by my broker to filter stocks. Yea, it is kinda embarrassing since I have been using it for some years. Well, to my defence, I don't visit my stock broking site that often - I am a lousy customer remember?

Alright, Excel Force. As usual, some little background. Excel Force principally or I would mainly owned and operated by 2 Taiwanese, Jeff Wang and his spouse Sharon Sun. It began operations in 1994 before it is incorporated in 2002. So it is quite a young company I would say. They both founded Excel Force which are now in the stock information applications and services business. In short, if you happen to use AA Anthony, ECM Libra, HLeBroking,  Jupiter Securities and so on, you are using their software.



Business Economics, Management and Finances
Since these 3 factors are pretty much linked together, I think it'll be easier if I write them as a whole. Excel Force categorize their business into 3 divisions.

  • Application Solutions: This is where the RnD took place and revenue are generated from the sales of products as well as trainings.
  • Maintenance Services: Contractual maintenance services after products warranty expiry period
  • Application Service Provisions: Uses ASP model, that have fixed monthly charges for services and transaction charges
The third contribute the most to its profits over the past 3 years (60%-72%) and we can easily understand why. This is where customers pay for its services after purchasing its products and system which provide steady stream of income to the business. The use of ASP model is that the customer would outsource its entire IT department to Excel Force which provide access to its apps and services through this model. This would have save lots of fixed cost incurred by its customers. Excel Force then charges monthly fees for this services and charges variable fees for transactions, buying/selling of stocks for example. So the more trades are, the more it earns. hmmm.....



The moat level for this division is pretty wide as customers are locked in to use their services due to high switching cost. However Excel Force could destroy it if something goes wrong with their server which jeopardize their relationship with customers as well as reputation. For the customers side, switching to other service just because it provides slightly cheaper services could be cumbersome, time costly and worst very costly (imagine poor service, brokers might lose their own customers). That's probably why you would see most of those customers they shown on their website have more than 15 years of relationship. Plus, I have no knowledge of any listed competitors to them and there is reason for that. Although this is a profitable business model (we'll get to that), the market aren't huge. There are only a handful of stock brokers and investment bankers available. Its ability to "lock in" works as a double edge sword as well. It means other are able to "lock in" their customers making Excel Force difficult to grow....unless their competitors are mediocre.

Its fundamental are pretty solid. Having no debts and profit margin of 36%-50%. Return on equity are high averages about 26%. If you look at the table below, you could see a decreasing ROE. Well, that is because cash earnings has been retained over the past few years and thus reducing the ROE. My guess, it was kept for expansion purposes as they were looking expand in SEA region.


Looking at the 2010 ROE, I bet it is time for the management to think about its retained cash position. (OK, to avoid confusion, ROE is to evaluate management and my standard is 15% and ROIC is on the profitability of the business). After several adjustment with the assumption that RM1mil is needed for operation, it has about RM22mil excess in cash. With that adjustment, we could see the ROIC of the business is 160% which is highly profitable

Valuation
Oh yeah, this is nice. Their recent earnings drops (>40%) has cause their stock price to plunge to about RM0.30 - RM0.35. That gives the market valuation of about RM40million. Yes, this is a very small company and possibly the tiniest I have research on so far. Like I said before, the market aren't huge so that comes in little surprise. The book value is about RM0.26 per share so there is about 4 to 10 sen premium for the current price. But does it worth the premium?

That we'll have to look at the earnings power value (EPV). But first, what's its earning power? Lets look at the table below.

We could see that App Services has been the main profits generator over the past 5 years and we could also see that all 3 divisions profits margin have been squeezed in 2010. Although the management said it only happens to App Solutions division, but it seems to impact across all division. Well, that is all because of the high expenses needed for its overseas projects. That makes sense because if we were to look at the revenue table below, it actually increases. So I believe these are 1 time charges.


How sould we value this? Erm...I would split these into 2. First, I'll just take the more stable earning stream from App Services Division plus a slight adjustment to the other 2 division in 2010. That we'll have an estimated earnings of about RM4.5mil. That would give me a valuation of RM0.37 per share which about the market value. Then I'll use the normalized earnings power that I believe it should be which is about RM6mil and that would give me a price of about RM0.46 per share. That would give me about 19.5% margin of safety to the first. So with the current price, I would say, this is a Sweeeeeeeeet deal.