Global Testing – That Problematic 9.5% Dividend Yielder

I wanted to write something about Global Testing for 1 year plus.

However, due to blogging circumstances, I keep this aside and didn’t write much about it. There are just so many companies to pen my thoughts about.

Global Testing have just announced their full year results and declared a $0.10 dividend and a $0.10 capital reduction so I guess let me try to see if I can pen my thoughts.

Current Share Price: $1.03 – $1.10
Number of Outstanding Shares: 35.58 million
Dividend per share: $0.10 (9.7% – 9%)

About Global Testing

The Group primarily provides testing services such as wafer sorting and final testing to the semiconductor industry, focusing on logic and mixed signal semiconductors used in consumer electronics and communication devices. The Group has also established its niche in the provision of wafer testing services to the automotive devices industry, which generally has more stringent quality and technical requirements compared to other types of wafers.

As part of its testing services, the Group provides test program development, conversion and optimization services, load board and probe card design, and leases its testers to its customers for trial and pilot testing purposes on an ad hoc basis.

Global Testing has been listed on the SGX Mainboard since 24 August 2005.

How do I get to know about Global Testing

I have known the existence of Global Testing since its IPO days when I was still an infant in stock investing.

Thinking back you can still recall the potential of the business that have been talked about around IPO time.

Global Testing listed at a good time but in 2007-2009, not many companies went through good times. Global Testing takes a lot of its business cue from the semi conductor industry, and the semi conductor industry takes its cue from the global business outlook.

During 2005, I can still remember the stock trades at $0.23. Today, the share price is around $1.05 but the share consolidate 20 to 1 in 2015, so if we adjust the IPO price its around $4.60. Yikes!

It fell off my radar.

Global Testing due to making a loss, couldn’t pay dividends, so how did it end up on my radar?

You cannot screen for good dividend yield, because it will never appear as it cannot pay a dividend. For some stocks their potential dividend yield is higher than their historical.

You have to do detective work to hunt them down.

My friend build up the habit of looking at the SGX Announcement section daily, or 3 hour once. People turn to Facebook Feeds or Twitter Feeds when they are bored, we read SGX Announcement when we are bored.

After 5 pm daily, that is when most of the announcement will come out.

What we started noticing is this company continue to buy back shares. On a very very frequent basis. We just let it passed by, but somehow, these things will register in your head.

You just need a moment or for each other to tell ourselves “maybe we should take a closer look”. And then, when you tallied up the share buyback, we realize its outstanding number of shares have shrunk by quite a lot.

But shrinking share base means nothing much on its own. There have to be some other traits that make this stock attractive for us.

We are dividend yield whores and we cannot run away from that.

The potential we see from this company is:

1. If they could buy back so much shares, that means they have cash flow (and their balance sheet is debt free). Maybe we are being faked by the consistent losses
2. Could the buy back of shares translate to paying out dividends?
3. What if they could pay out a special dividend with that huge cash holding

These questions are very hypothetical, but usually that is enough for us to do a preliminary prospecting to see if there are things that are worth investigating.

Subsequently, Global Testing announced that they will be paying out their huge cash holdings as a special dividend.

We missed that.

But I think I bought despite the share price jump. This is based on valuation,  which I will later explain.

Subsequently, KGI came out with a initiation report on this super illiquid company. And that helped us filled some of the business gaps that as an IT engineer, I would struggle hard to get round.

The way an investor should read these broker’s report is:

1. Read the qualitative fact finding, those business aspect that you need a lot of time to dig out
2. Understand the overall idea why the analysts think its very good or bad
3. Reflect upon the target price, knowing that target price is most often unreliable and wrong. However, it is a good avenue to tell if people are too bullish or bearish

I like company initiation reports. I always kept them, as I dunno when I will revisit them. This one help make sense of the company a little bit (actually I have to admit, I can never fully understand the mumbo jumbo behind semi conductor testing)

KGI report show the share buyback in a more dramatic manner. How come a loss making company can buy back to this extend?

You either think debt is cheaper than equity and you take on debt to do a share buy back. When you do that you boost your earnings per share.

But Global Testing, from its balance sheet are not taking on more debts.

Let’s take a look at some figures.

Cash Flow Analysis

Before we start, it is important to have an anchor in our head.

The amount of outstanding shares is 35.6 mil, after a 20 to 1 share consolidation. At a price of SG$1.05, the market cap is SG$37.38 mil.

Converted to USD, which is the base currency of how Global Testing reports its financials at a rate of 1.40, the market cap is US$ 26.7 mil.

When you hear about Semi Conductor and Testing business, you have the idea that the business tends to be cyclical. The profits will tend to move in cycles and be volatile.

What you are expecting is not a very consistent set of earnings or cash flow.

When we look at its net profit after tax (NPAT) before 2015, normally you would have dismissed it right there because just like I said 2007 onwards it has been bleeding a lot of profits.

When we look at the gross profit margin, its 31%. Not very spectacular. Warren Buffet usually considers a business with a sustainable above 40-50% gross profit margins at a start.

A consistently high gross profit margin is a sign that the business is able to protect its business.

What my friend discovered is that the gross profit reported have deducted depreciation from the figure. Depreciation, is an accounting line item that expense away the wear and tear of tangible or intangible assets you own, indicating that one day you will need to replace it. However, it does not result in a cash outflow.

If we add back the depreciation to the gross profit we get something like this.

The gross margins are high. But it is declining.

The question in my head at this point is: would the decline slow down, stop and get to a terminal state? Businesses lose their competitive edge, lose their edge in intense competition, but they do tend to stabilize.

In the case of Global Testing it does not stop.

The line of depreciation at the most bottom shows the depreciation charge. It is declining as well and if we use hindsight to take a look, the decline looks to be accelerating.

We could dismissed this prospect here and there, but if you pair it with the context that the market capitalization of Global Testing is US$26.7 mil, that depreciation (which is actual cash flow and not expense) don’t look so bad!

Global Testing’s depreciation in 2011 for example is almost equal to current market cap (we can take debt out of the equation because as you would see on its balance sheet, the company do not have debts)

Let us take a look at the operating cash flow and free cash flow over time.

Operating Cash Flow

The operating cash flow over time and free cash flow will give us an idea that, after paying all the expenses, and maintenance capital expenditure, interest expenses, taxes, how is the cash flow we as the shareholders can tap look like.

Net OCF, which is the operating cash flow taking account depreciation and working capital is declining. This amount was US$26 mil and at 2015, was down to US$16 mil. In recent year it is down even further to US$11.6 mil.

Even in its worse year, which is during the great financial crisis, which is in FY2009, the OCF is US$11 mil, which is how it was now.

Putting this into context, with a market cap of US$26.7 mil, even a US$11 mil OCF brings about a yield of 41%.

This business is generating cash, even if its declining.

To put this in another perspective, the balance sheet have US$ 8 mil in cash. If Global Testing does not spend on capital expenditure, and is able to maintain its OCF of $11 mil for one more year, We are buying like  1.45 EV/EBITDA.

Capital Expenditure

However, Global Testing is not self liquidating.

They will not be investing in expansionary capital expenditure but they will be spending on maintenance.

From Aug 2016’s KGI update on Global Testing’s result, we can see how the CEO sees the capital expenditure requirements.

From 2005 to 2008, the capital expenditure have been $31 to $66 mil. Since then the capex have been averaging around $6.9 mil.

Past 3 years’ FCF has been around US$10 mil. On a Market Capitalization of US$26.7 mil, the free cash flow yield is 37%!

However, this year, the FCF have dropped to $4 mil. The FCF yield is just 14.9%.

Net Cash of US$8 mil and Capital Reduction

I explained in the previous section that part of the market capitalization is cash that the company do not need.

How do we know that?

1. In 2015, they did a capital reduction of roughly US$30 mil
2. In Sep 2016, they did a capital reduction of $0.10 or US$2.54 mil
3. In the most recent announced result, they further announced a capital reduction of $0.10 or US$2.54 mil

Majority Owner: Chairman Chen Tie Min

Global Testing’s Executive Chairman not only controls Global Testing but also Yageo Corporation and Chilisin Corporation in Taiwan.

Both Yageo Corporation and Chilisin Corporation is listed in Taiwan stock exchange and you can view how their business is ran.

(from StockFacts @SGX)

Global Testing is owned in a large chunk by Yageo Corporation and Chen Tie Min, with the 2 owning up to 40% of the company. Chia Soon Loi is an independent director who is also in the same industry with Scan Technologies.

Doing share buybacks, capital reduction is not something new to the owner. And this is why KGI thinks the management will take this route to get the capital out of the company.

Judging by the subsequent $0.10 capital reduction twice, they are right.

Personally if the business is undervalued, and return on investment is lower than cost of capital, perhaps buying back shares will be a much better return. Unless you say that as an individual investor you can redeploy the dividends at greater than 10-15% return.

Doing a share buyback will make their outstanding number of shares even lesser, more illiquid. (After the share consolidation the trading volume is very low)

 

How do I view Global Testing

My highest share purchase was at SG$1.30. Since then I added on at lower price.

My conclusion of Global Testing is as follows:

• It seems to have a limited lifespan. Purchasing Global Testing is closer to it being a special situation where the sum of what I purchase it for at SG$1.30 is lower than what it is worth, despite factoring it is limited lifespan. At some point, the technology will change, and they may need money for capital investments to keep up with customers. Currently, they do not seem to need it. If they do they would not do a share buy back.
• The payback in terms of cash flow is fast. With a free cash flow yield of 37%, we probably need 2 to 3 years to earn back the market cap of Global Test, after which, whatever they earn, is free money to me as the investor.
• The cash flow declines. However, the cash flow should reach a terminal state, which still makes it an attractive proposition
• Losses could severely impact the value analysis. Global Testing’s undervalue nature depends very much on its upcoming 5 year cash flow profile. However, any losses during this period changes the picture.
• Management sees the status quo of this company. They are not going to put more capital than needed to grow it. All indications they will only maintain the ability to keep producing. Therefore, they have the incentive to extract what money, from this cash flow machine that they can in this limited time.

This was how I view it then.

I have some time to digest the set of full year result.

Here is what I think:

• The problem with Global Test is that revenue is declining. Their control of cost is ok as can be seen from gross margins. That margin is not dropping like a rock. Distribution and admin costs is very controlled as well. However if they cannot raise revenue, then I might not have 3 to 4 years to see that US$10 mil annual cash flow I envisioned
• Is this a declining outlook or just a cyclical low. The operating cash flow profile looks similar to that of 2009. I wonder if things will get worse, or that this is the worse it will get. If we look across the board, UMS and Micromech is doing great, yet their narrative tells us that this is at a point where semiconductor is facing challenges. Latest Jan 2017 Semiconductor Book to Bill stands at 1.06, indicating more orders booked than what was billed
• Including this time $0.20 pay out, I would have gotten US$10 mil out of the US$26 mil market cap in equivalent return. If we include US$5.5 mil in cash (left after the capital reduction), the question is whether Global Testing have what it takes to return US$10 mil more to me. They do still have US$37 mil worth of plant and property. After taking into consideration the US$ 8 mil in total liabilities, I think Global Testing is still value
• Not many big stock investor can purchase Global Testing. There are just 35 mil shares outstanding. Daily trading volume is very low. This would mean that if there is mis-pricing, small nimble players can take advantage. Yet, if we analyze it wrongly, or there is some negative event like sudden fraud, bad cash flow, the small investor may not get out well as well.

Stock like Global Testing is not something I advocate people to purchase, unless you are in the business of prospecting business deeply.

You also need to know why you got into the stock, and what are the conditions to exit. Not knowing the exit conditions, how to look out for them, could prove troublesome.

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