Hey-Ho Hai-O!

Usually I would not even waste my time on a stock like Hai-O, but the exchange between Bullbear and Moolah in the Fusion chat box had been voluminous and heated at times - that had to stir my interest. Basically BB still has concerns on its business model but thinks that the current run up in revenue and profit will allow for a substantial gain via a mid term trade. Moolah does not like the MLM model and the quite silly RM50m property investment from excess funds.

BullBear posted on FusionInvestor chat: HaiO is selling at a low PE (based on ttm-eps). It earns >25% on equity and its net profit margin >10% of its revenue. The arguments centred on its management and its business franchise. IF HaiO continues to perform, those who invested into it would have a return of x% (?5%, 10%, 30%, 50%, 100%), if it underperforms, one might lose y% (?5%, 10%, 30%, 50%, 100%) . Works out the odds (x/y), and see if you like the odds.

Moolah's Concerns: Yes, HaiO is making tons of money but what's the concerns? What's yours? Well mine are the two simple issue, management and business model. Main issue here is, are the concerns that I raised legitimate? Are you comfortable with a MLM business model? Would you invest and buy-and-hold for the long term in such a business?

My Take:
1) Revenue Streams: They have three: Wholesale, Retail and MLM. Lets take a look at their last 5 quarters on revenue. Figures in RM million. Start 1Q2007, last 1Q2008.
Wholesale: 21.2 / 20.1 / 30.2 / 34.8 / 25.5
MLM: 17.3 / 21 / 28.6 / 32.8 / 40 /
Retail: 7.9 / 9.9 / 8.1 / 11.8 / 7.9 /
Very obvious that Hai-O's fortunes is solely MLM. If you take away the MLM, Hai-O should be a penny stock with a very very poor business model. They got lucky by recruiting a lot of Malay ladies to do MLM. The executive who mooted the idea should get a RM1m bonus.

2) Margins: Same revenue streams, now look at the margins in percentage: Wholesale: 16.5 / 8.4 / 19.9 / 29.8 / 12.7 MLM: 13.2 / 16.3 / 14.9 / 11.9 / 14.2 Retail: 3 / 9 / (2.1) / 5.9 / 2.0 The retail is shit, might as well dump them.

3) Hai-O struck gold with their revamped MLM strategy, now they have also expanded into Indonesia - leveraging on the bright idea that Malay and Indonesians have the same market tastes. If they stuck to the MLM, they could see a bit more interest in their stock. But they would have to come up with better ideas on what to do with the cash. Suddenly they went into property by plonking RM50m (even though they will be using a portion of the space to manufacture their products). The margins in MLM are good enough. Better if the company come up with say they will pay 75% of net profits back every year as dividends. Then investors can look forward to a proper dividend yield. If they did that, the company will be paying 12 sen in 2007 and probably 26 sen in 2008.

4) MLM is not a model that generates a lot of positives. Market is small, growth may be excellent in the initial stages but will flat out very soon. There is also the need to keep coming up with new exciting product every few months to keep sales charged up - till now, no one knows what their future best sellers will be and where they will come from. There is not coherent communication of strategy, approach, R&D, partners, etc. in this aspect.

5) Back in 2003, the top guy on why Hai-O was venturing into the IT sector, he said: “We are debt free and cash rich as we have RM8mil in fixed deposits, RM4mil in our current account, and RM20mil in overdraft facilities. Therefore, we will venture into any business if it can bring us some benefit.” OMG, this is the type of management vision we are looking at - no strategy, no vision, no plan, where are its core competencies - its a family business still run kamikaze style.

6) The most dangerous caveat why I do not like holding Hai-O is that controlling shareholders have a relatively small stake left in Hai-O. The Tan family has 25.6% and the next biggest shareholder is Maybank Smallcap with 3.9%. Its understandable if it was a large cap but it has only 82.5m shares.

It has been brought to my attention that a group of entrepreneurs started to pool their resources to get the company listed, hence explaining the smallish stakes by controlling owners. I did notice that most of the shares of the controlling shareholders are "pledged to the broking houses" - for a margin line. Usually I would not be suspicious but hey, stranger things have happened before. With 25.6% and company's coffers growing alarmingly, what do you do? If you still hold 45% or more of the shares I am sure they would declare bigger dividends and spend excess cash better. At 25.6%, to reap the good fortune, you would have to buy back a lot of shares - nah... that ain't gonna happen.

The MLM was unexpected, hence the more fragile an opinion I have of management. As with many dicey and dubious companies where controlling shareholders have smallish stakes, if there is a lot of cash in the company, they will think of ways to take the cash out.

I am not saying Hai-O will be doing that but there is a greater likelihood. If Hai-O had RM100m in the bank now, do you think they will declare a RM1.00 cash dividend? Not on your life, not with 25.6%... maybe with a 45% stake. I am playing the devil's advocate here. If I was devious, I will "own some assets" say land or other small businesses and inject into Hai-O in exchange for new shares and cash. That way, I can inflate the assets being injected and increase shareholding in Hai-O and also take some cash out. That could happen.

Or, since I am the controlling shareholder, for every ringgit taken out, I am only entitled to 25.6%. Why do that? If I am the devil again, I would declare a very generous bonus and/or options scheme every year for the "connected senior management".

I am not saying Hai-O will do that, but the risk is much much higher given the shareholdings level. Hence the reluctance of other institutions and savvy investors to jump in even on the low PER attraction. Thus, the RM50m spending on the property project should raise more alarm bells than being viewed as a smart move to expand upstream or downstream.

p/s photo: Athena Chu Yan