Why I Like Wasco (A Lot)

Its been difficult to locate good companies at fair prices. After much reading and going through the research, Wah Seong looks like a no brainer. There is a genuine transformation in their outlook and approach. Being a billion ringgit company will only get you so far. They have managed to secure projects overseas but its always less than RM1bn in value as the bigger jobs would want a bidding company to be better capitalised. Wah Seong has laid out two acquisitions in their pipeline and have a good chance to secure both. One has sufficient leverage in the Golden Triangle, while the other will mark their platform into Africa.

While I generally frown on name changes, this time it makes sense to be a globally integrated energy infrastructure group - under Wasco. The name change proposal is more than just rhetoric. The management knows well enough that they would not have enough jobs locally to move to the next level.

Wah Seong is likely to wrap up the deal with Socotherm, to be followed by the Orleans deal. Wah Seong has sufficient funds to finance the acquisitions and has ruled out a fundraising exercise. As at Dec 09, the group had cash reserves of RM471m. Deputy MD Giancarlo Maccagno confirmed that Wah Seong had submitted three weeks ago a proposal to acquire the entire stake in Socotherm, an Italian pipe coater currently in financial trouble. There are four other bidders whose identities are not disclosed. Wah Seong did not reveal its offer price.

The success of the proposal would give Wah Seong an immediate presence in the Golden Triangle of Brazil, the Middle East and the Gulf of Mexico. There will be about US$130bn worth of investments in deepwater exploration are expected to be made in the Golden Triangle over the next five years. Hence, management is optimistic that Socotherm’s annual revenue could return to its previous height of €250m-300m in at least two years compared with €130m currently. This could add no less than RM1bn to Wah Seong’s topline.

Wah Seong's management has done its justification for moving this way, and they are going in with somebody whom they are already well familiar. Ties with Socotherm go way back. Socotherm and Wah Seong are no strangers, having been partners in pipe coating unit PPSC for 19 years before Socotherm sold its 32.5% stake to Wah Seong for RM76m in Oct 09 to cover some of its losses. Maccagno was a project manager for Socotherm’s projects in Nigeria in 1984-1990.

Wah Seong is at an advanced stage of negotiations with Orleans, which owns pipe coating plants in Nigeria and Angola. The group is considering three options: taking up an equity stake, providing technical assistance and doing both. Originally, the plants were housed under a 40:60 JV between Orleans and Socotherm. In Dec 09, Orleans bought out Socotherm’s stake in the JV as the latter restructured its finances. Orleans’s two pipe coating plants generate annual revenue of around US$40m. The facilities are currently loss-making but Wah Seong sees potential in them and the countries in which they are located. Nigeria and Angola are OPEC members and had oil reserves of 37bn barrels and 10bn barrels, respectively, in 2008. Collectively, both countries held 4.5% of OPEC’s oil reserves of 1,023bn barrels in 2008. Wah Seong is likely to spend about US$10m-15m on the facilities. If the deal materialises, it could expand Wah Seong’s earnings and geographical base, and put the company in a monopolistic position in Angola and a duopolistic position in Nigeria.

Wah Seong is well aware of the risks with Orleans, being in Nigeria. To mitigate the huge risks in Nigeria, Wah Seong is looking at a technical arrangement to first provide pipecoating consultancy services to the Orleans Group, with an option to later buy an equity stake if the operation were to kick off successfully.

By international standards, Wah Seong’s current market capitalisation of RM1.8bn is modest and has, on occasion, hampered it in its bid for major deals. With a bigger market cap, the company would be in a better position to go for bigger prizes internationally. Backed by the Socotherm and Orleans acquisitions, management aims for a RM3bn market cap over the next few years.

When the group was listed in 2002, its market cap was RM250m. Presently, Wah Seong’s order book is worth RM1.42bn. The group is bidding for RM5.3bn worth of contracts. Wah Seong’s tenders for new jobs has grown from RM4bil from the past two months to RM5.3bil currently. This represents 3.8x the group’s existing outstanding order book of RM1.4bil. Assuming a 20% success rate for current tenders, the group’s order book could reach RM1.8bil by the end of the year.

Its pipe-coating and corrosion production services account for 60% of this tender book. The pipe-coating tenders are for jobs in South-East Asia, China and Australia. The balance 40% of the tender book value comprise gas compression equipment and packages and industrial services.

The acquisition plans, assuming they pan out, would give Wah Seong access to a string of new markets, namely Nigeria, Angola, Brazil, the Middle East and the Gulf of Mexico, thereby narrowing the gap between itself and Bredero, whose annual sales are in excess of US$1bn. Apart from the M&A efforts, the newsflow is also remain active on the order book front as Wah Seong awaits the awards of pipe coating contracts from clients in Australia and Papua New Guinea.

Even without the two acquisitions, Wah Seong should be fairly valued at RM3.00. Once news comes through that the acquisitions have been firmed up, I expect Wah Seong to trade close to its higher PER band of 20x, which would suggest RM3.50 as a target.

Its almost pointless to compare Wah Seong with other similar industry players in valuation, locally and regionally as none has the ability to boast that it is a major player globally, none can say they are not terribly dependent on local jobs. We need more companies to follow Wah Seong, manage it well, grow locally, then regionally, and when you consider that you have the management expertise and technological professionalism to be competitive globally, just leverage onto the next platform.

p/s photos: Asin

NOTE: The above opinion is not an invitation to buy or sell. It serves as a blogging activity of my investing thoughts and ideas, this does not represent an investment advisory service as I charge no subscription or management fees (donations are welcomed though). The content on this site is provided as general information only and should not be taken as investment advice. All site content, shall not be construed as a recommendation to buy or sell any security or financial instrument. The ideas expressed are solely the opinions of the author. Any action that you take as a result of information, analysis, or commentary on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

India's Economic Strength Compared To China

Why is China the “workshop of the world” when Indian labour is even cheaper and her entrepreneurs admired worldwide? There are many reasons, including (until recently) the anti-foreign-trade policies and small-scale industry reservation policies as well as poor infrastructure in power, roads, water and ports. Perhaps even more important are the restrictive labour laws and certain other regulations, which encourage Indian manufacturing units to “stay small”, thereby forgoing the classic industrial economies of scale and scope.

Both China and India have sizable population, both are seeing a growing middle class by improving the economic livelihood of those in the rural areas. Yet as an economic engine or superpower, India seems to be bogged down by certain factors. The biggest division is that one is state planned centralised economy while the other is probably to most democratised country in Asia with many "almost independently managed states". However, thats the big picture, the reality would show that India's economy is more powerful and resilient in many ways when compared to China.

As a percentage of GDP, China's domestic consumption is the lowest of all major economies, hovering at just 1/3 of GDP. Most of China's growth in 2009 had come from infrastructure spending or speculation in domestic assets. In India, the domestic consumption accounts for 2/3 of GDP - now that is food for thought. China's artificial suppression of the yuan restricts domestic spending. As great as the surpluses are, more than 3/4 of China's capital goes to the 120,000 state controlled entities. That being the case, most of the profits in China end up in state coffers.

The OECD’s Investment Policy Review of India says India has designed policies to encourage investment as part of market-oriented reforms since 1991 that have paved the way for improved prosperity.

“Restrictions on large-scale investment have been greatly relaxed. Many sectors formerly reserved to the public sector have been opened up to private enterprise. Import substitution and protectionism have been replaced by an open trade regime,” the OECD report notes.

But further reforms are needed. India’s policy framework for FDI still remains restrictive compared with most OECD countries. Meanwhile, its investment needs remain massive, with poor infrastructure holding back improvements in both living conditions and productivity.

India’s growth is led by domestic demand and growing incomes in the coming years will continue to boost domestic demand and industrial activity. Reforms, the growth of home-grown corporations and rising scale of foreign direct investment are also pluses. Large domestic savings (37% of GDP in 2007), both by households and corporations, have played a pivotal role in India's economic growth. High domestic savings and the development of homegrown corporations have boosted investment (39% of GDP in 2007), helped by cheap foreign capital. Combined with a large private consumption (55% of GDP in 2007) base and a low trade dependence (imports and exports account for around 20% of GDP), the Indian economy is perceived by foreign investors as a "domestic demand-led story".

Due to the economic slowdown in 2008, household savings in financial assets fell to 10.9% of GDP in 2008 from 11.5% in the previous two years led by the large decline in holdings of shares and debentures. Households also shifted their savings from mutual funds to bank deposits due to an increase in risk aversion in 2008. With the decline in risk aversion in 2009, households will slowly shift back to equities. India's gross domestic saving rate might have declined from 37.7% in 2007 to 31% in 2008-09.

Indis' middle class stands at a formidable 300m while China's figure is around 150m. Half of China's population is in rural areas while India still have 2/3 of them in rural areas. According to a recent study by MIT School of Management, China's absolute levels of poverty and illiteracy have doubled since 2000, while India's have been halved! In India, economic growth in rural areas have outpaced growth in urban areas by 40%. Rural India now accounts for half of India's GDP, it was 42% in 1982, and it contibutes about 2/3 of India's growth . Rural China accounts for only 1/3 of China's GDP, and contributed to just 15% of the country's growth.

Increasing the growth potential and attaining the Chinese type of economic growth is constrained by India's democratic set-up, which requires political consensus to implement economic reforms. Coalition governments in the recent years have slowed the approval of reform and liberalization-oriented legislations. However, policymakers argue that slow and sequenced reforms and liberalization over the years have in fact helped India achieve strong and sustainable economic growth and limited the impact of global cues on the Indian economy.

India's medium term challenges include reducing dependence on foreign oil, increase efficiency in oil consumption to reduce its impact on fiscal and trade deficits. Cutting down oil and agriculture subsidies to reduce unproductive fiscal spending and large budget gap. Structural reforms include improving agriculture yields, development of infrastructure, health care and education access to increase absorptive capacity of economy. Other challenges include: The stance on Foreign Institutional Investors (FIIs) and capital inflows, and managing their role in generating credit and asset bubbles. Balancing private sector and foreign investors' role with concerns about social stability. Reducing corruption, and income and wealth inequality, especially between states and between rural and urban areas. Boosting human capital development and job creation can raise consumer spending, especially for the lower and middle income groups and in rural areas. Liberalizing foreign investment caps, broadening and deepening the domestic capital markets, easing capital controls on companies to borrow from abroad, and improving financial intermediation of domestic savings can buoy investment.

We should reconsider India in relation to China in their path to dominating the global economic scene over the next 20 years. Both will be taking very different path and will have major consequences to the global competitive paradigm. China's still lags in a several areas and the rural dislocation and to a certain extent the "forgotten group" being left behind will have grave social and economic costs in the coming years, if not properly managed and improved on.

p/s photos: Asin