Wednesday, February 27, 2008

Reply to Ossia's post

Yong said,

I spotted a few errors in your analysis and inaccurate statements. Allow me to correct them one by one.

1)"From hence on, there will be higher expenses from the rental of the building in which they sold and leased back. "

Ans: This is not true at all. Ossia is the master lessee of the building now. They pay a fixed sum of money for the rent of the building to MI REIT. Should they sub let out the units in the building to other parties and collect cash in excess of what they are require to pay, they would have a profit. And Ossia has confirmed that they are already doing that. They have also negotiated for a very competitive rent from MI REIT.

2) "Isn't Hong Kong part of Asia pacific? Why the disposal then? Money losing subsidiaries?"

Ans: Your analysis is inaccurate as you failed to consider the principle buisness activity of their HK subsidiary. Their HK subsidiary is involved in the selling of Millie's Lady shoes in China, Malaysia, SIngapore, HK, Taiwan and US. They only invested $10million for the business and opened up numerous outlets in China. Most of the earnings were in RMB and NOT HKD.

Results wasnt really fantastic at first, but they have mentioned many times they wanted to fight head on with Belle International-their biggest competitor. However, Belle International decided to buy them out at a bombshell price. Since the profit is in excess of 80million, why not take the money and invest in somethingelse?

SHareholders certainly enjoyed the 15cents a share special dividend arising from the disposal of the buisness.

And profit was eroding due to higher expansion and distribution cost, not becos of an increaisng HKD. In fact, its the SGD that has risen against the HKD that resulted in a forex loss. This loss was not possible to be hedged as the management didnt know the exact date as to when the money was coming in.

By the way, included on their balance sheets are results from Pertama holdings which ossia has a 50% stake in it. Do remember to factor that in.

Going forward, Ossia will focus on the retail industry, with possible selective acquisitions of other retailing buisness.

Perhaps you would like to meet the management over a cup of tea? I assure you that the Goh Brothers are very kind people who will look after the interest of Minority shareholders. If you look at the past announcements, the Goh Brother have been buying back Ossia's share at 15cents-26cents, and they are doing it because its severely undervalued.


First of all, a very grateful thank you for having read through the piece that I wrote for Ossia. I admit I didn't read a full picture of the Ossia business (in fact, I read only the latest full year report and base my article from there...anything that isn't in there, I wouldn't have known). I really appreciate your insightful comments and I thank you for your time and effort to give a qualified commentary of my post :) I shall proceed to give a qualified reply too.

A. The issue of the "Put and Call option" agreement for the sale of Ossia building along Changi Road with Macarthur Cook property investment Pte Ltd (MCK).

I did some background following your comments, so this is what I've dug up.

On 28th Feb, 2007, Ossia entered a put and call option agreement with MCK for the sale of Ossia building. Under the option agreement, and on the exercise of the option theron, Ossia will sell and MCK wil purchase the property for a consideration of S$33.8 million. The lease agreement is for a term of 7 years, payable on a monthly basis for a total of S$2.4 million per annum and subjected to rent review on lease year 3 and year 5. Subject to the rent review, the rent can be increased by 3.25% on lease year 3 and/or lease year 5 onwards.

I wanted to find out the present value of all the rent paid out for the 7 years of lease on the property, based on two scenarios and on an annual basis instead of monthly basis (which is the actual rental pay period)

Scenario 1: Increment of rent on year 3 and increment of rent again on year 5 (worst case)
Scenario 2: No increment of rent (best case)

I just set the discount rate as 0% to see what's the best price I can get for the two scenarios listed. The company's own evaluation of the net book value of the property is at S$30.4 million. MCK and their valuators valued it at S$33.8 million (which is the price that are paying). I really do not know how MCK valued the property, so perhaps you can shed some light on this.

For scenario one, I get a present value of S$16.8 million. For scenario two, I get a present value of S$17.4 million. Both are so way below the price that MCK paid out to Ossia. As you mentioned, Ossia really negotiated a very cheap rent from MCK. However, the question is what happens after the 7 years of lease is over. From my calculation, they can lease around 15 years if everything else remains the same, to 'break even' MCK's paid price of S$33.8 million.

Where did you get the information that Ossia is the main lessee of the building? Are there other tenants in the building? Where did Ossia confirmed that they are leasing out to earn rental profit?

B. On the issue of HK subsidiaries and Millie's shoes.

I did some background again.

Ossia marketing (HK) Co Ltd is involved in the trading and retailing of leather products and fashion, with cost of investment as $2,164,000. Osim International (HK) ltd is involved in wholesaling and retailing of footwear and apparel, with cost of investment is $555,000. Based on this, the total cost of investment is actually $2.719 million. How did you get the $10 million for the investment? Am I missing some things out?

I noticed that Ossia also have separate subsidiaries for trading for Millie's shoes in PRC, namely Millie's Shoes (Foshan) Co. ltd (they held 64% of effective interest) and another Millie's shoes (Shenzhen) Co. Ltd (they held 100% effective interest), both are trading in the business of footwear in PRC. While it is stated that Ossia marketing and Ossia international are principally engaged in the distribution and retail sales of footwear products in PRC, HK and macau. They're also the registered and owner of trademarks including "Millie's".

Does your extra S$7.281 million (10 - 2.719 = 7.281) come from the combination of the investment in these subsidiaries that are subsumed under Ossia international and Ossia marketing?

Having read more about Millie's shoes in their annual report for FY06, I realised that this brand and their products are quite well known in the region that they are selling. But what happened in FY's like HK segment isn't doing well. In just 1-2 years time, business turned around?

It's of utmost importance to be able to valuate this business as accurately as possible. By selling the two HK subsidiaries, am I right to say that they are in fact selling Millie's trademark to their competitor? I wonder if their sale of 80 odd million is worth the money, and how do you know it's a bombshell price? To me, it could be like buying a cow for $10 and selling it for $80, but forgoing the big business of milking the cow constantly for cash.

But thanks, really, for telling me about the real cause of the foreign exchange loss. I admit my mistake of not checking which currency is depreciating (never really good at currency stuff).

I'm also not vested in Ossia, so can't talk to the management. However, I do like to dispute that buying back shares need not mean that the shares are undervalued. I mean there are many reasons for that. Perhaps they are really cash rich and are obliged to increase shareholders's value (and ultimately their coffers as they own 60% of the shares).

I also do not read more about the Pertama holdings investment. Am i right to say that they own 50% of harvey norman? I do hope that my reply give justice to the effort you put in to comment on my post :)


Musicwhiz said...

Hi LP,

Seeing that Yong has given such a spirited reply to your original Ossia post, allow me to just make a few minor comments. Also do note that I am not familiar with the retail industry nor do I know many of the brands which Ossia is promoting/distributing. I am merely commenting from a financial perspective and what I am reading from the replies from Yong and your own analysis too.

First off, I noted that a net profit of S$75 million was achieved but that gain from disposal was S$85.2 million and gain from disposal of investment property was S$3.4 million. Stripping those away, this means that Ossia had made a net loss of S$11.7 million for FY 2007 ! Please verify the numbers because you did mention that "margins were very low compared to FJ Ben", but from a first glance I computed a net loss, not a net profit.

The retail business has always been cutthroat anywhere in the world and I am not surprised that the Management of Ossia decided to sell out the business before cost pressures eroded their business profits. After all, if one is given such a good price for the business, it's hard to resist ! (Look at Labroy Marine's Tan Boey Tee hehe). The fact that they are sitting on a pile of cash now without knowing exactly what to do with it (other than doing share buybacks) is worrying. There is the usual prattle about "exploring business opportunities" but if there is no firm plan and no concrete strategy then I would advise an "avoid" till the company figures out exactly what it's going to do. A cash rich company is only good if it already has a sustainable and growing CORE business (an example I can think of is Boustead which I am vested in), because it can deploy the cash to grow their business further or for acquisitions which would enhance or complement their current one.

Perhaps I do not know the business well enough, so Yong can correct me on the above para.

I also concur with you that share buybacks do not necessarily mean that a company is under-valued. Some examples are Aztech and Trek 2000 which have been buying back shares for quite some time but have not been able to increase shareholder value because their core business is declining.