IPO Analysis: Koufu Group Ltd

Koufu Logo.png

Singapore food court operator Koufu Group Ltd has filed for a IPO on the SGX Main board. Summary of listing details as follows:

Offer price: $0.63
Total shares offered: 97,008,000
Placement shares: 90,675,000
Public shares: 6,333,000
Closing date for application: 16 July 2018 12pm
Commencement of trading: 18 July 2018

Full prospectus can be found here.

Here’s my thoughts on the salient points of this listing.

1. Company Profile and Business Model

Koufu operates 2 key divisions, Outlet and mall management, and F&B retail largely in Singapore, with 1 food court in Macau.

Business Breakdown

Koufu Brands

Outlet and mall management

The outlet and mall management business relates to management of the operational aspects of the food courts and coffee shops – ensuring the premises are clean, finding stall operators, account management and billing, etc. They also operate a hawker centre in Jurong West (on a social enterprise model) and Punggol Plaza.

Interestingly, the prospectus also shines some light their sales cycle. Stall operators are generally charged the higher of a fixed monthly fee or a variable monthly fee pegged to stall sales. All sales are processed through the company provided POS system and cash are collected and retained daily by Koufu. Statements of account are issued twice monthly and sales proceeds net of monthly fees and other charges are paid to stall operators within 7 days.

This means that they have a low likelihood of bad debts as revenue is collected upfront. In fact, the time lag between collection of revenue and payout of sales to stall operators increases the interest income of the company, similar to insurance companies or payroll processors.

F&B Retail

F&B Retail consists of 4 concepts: F&B stalls, F&B kiosks, Quick Service Restaurants and Full Service Restaurants. F&B stalls make up the bulk of F&B retail revenue. These stalls are mostly drink stalls in their food courts, with some other stalls like Chicken Rice and Western food stalls.

2. Financials

Revenue and Profit

Revenue and profit figures have been growing over the past 3 years, but at a declining rate, which is concerning.

EPS.JPG

At adjusted EPS of 4.83 cents and 63 cents offering price, it represents a 13x trailing PE, which I think is fair but not necessarily exciting. Assuming a 50% dividend payout ratio guided by management, it represents a 2.415 cent dividend or 3.83% trailing yield.

3. Use of Proceeds

Use of proceeds

Total proceeds comes up to approximately 70.5 million, of which the bulk of the 45.5 million proceeds will be used for the integrated facility to serve as its HQ and expanded central kitchen to support its expansion plans in Singapore and achieve greater productivity gains. The remainder will go straight into the founders’ pockets as they are offering their own shares as part of the IPO.

4. Shareholders

The shareholding structure immediately post the IPO, assuming no over allotment, is as follows:

  • Jun Yuan Holdings – 78.7% (Founders’ investment company)
  • Cornerstone Shareholders – 3.8%
    • Cornerstone Shareholders are 2 Singapore family investment vehicles, One Hill Investments and Qilin Asset Management, and Maxi-Harvest Group. Maxi-Harvest Group is owned by Lee Sai Sing, a non-independent director of Koufu’s founder’s brother’s Catalist listed company GS Holdings Ltd. In summary, nothing much to shout about and at 3.8% holdings, hard to say they are really cornerstone.
  • Public Shareholders – 17.5%

Cornerstone shareholders are not subject to lock-ups, the founders are subject to a standard 6 month lock-up. Post IPO the founders still retain significant control over the company.

5. Peer Valuation

The closest listed peer to Koufu is Kimly Limited, a listed chain of coffee shops which IPO-ed in 2016. Kimly Limited currently trades at approximately 18.65 times P/E and 5.19 P/B. Between the 2, Koufu is priced more attractively at 13 times P/E and 4.9 P/B.

Looking back at the way Kimly performed since IPO, it priced at about 12 times P/E, enjoyed a ridiculous first day pop of over 100%, before spending the next 2 years dropping to its current valuation. Given the intense interest on day 1 for Kimly, it may be an indication for Singaporeans’ interest in a food court business like Koufu.

My Thoughts

Positives

  • Defensive and largely recession proof business
  • Highly positive operational cash flow
  • Experienced management and founders
  • Fair valuation
  • Dividend paying
  • Proceeds used to improve productivity of the business
  • Potential strong demand as seen in Kimly IPO

Negatives

  • Highly competitive business in a highly fragmented market
  • Management has no proven overseas expansion track record
  • Founders are cashing out
  • Weak cornerstone shareholders
  • IPO-ing in a weak environment given the trade war fears among other factors

In spite of the negatives, I have applied for a small position for speculation purposes. If I am allotted some shares, my initial thoughts is to sell any insane 1st week pop. If no pop happens, hunker down for sometime and observe the company’s performance. Of course, if I get nothing, I also don’t mind.

My first time applying for IPO shares so we’ll see how things go. Applications close tomorrow at 12pm.

Happy Hunting,
KK

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The curious case of the Spotify direct listing

Spotify Logo

Once in a while, unusual and fascinating things happen in the financial markets. Spotify, a popular music streaming company, filing for a direct listing (instead of a traditional IPO) of its shares on the NYSE certainly qualifies. Given the uniqueness of this listing, I shall disregard my usual “An Unbalanced View” format for IPOs in favour of a more deep dive analysis of this listing.

The Basics

Spotify is a music streaming service founded in Sweden by CEO Daniel Ek and Martin Lorentzon in 2008. It is currently the world’s largest music streaming service with 159 million monthly active users (MAUs), which Spotify believes to be double their closest competitor, Apple Music.

Spotify filed a prospectus with the SEC to begin the following road map to list on the NYSE under ticker symbol SPOT:

Timeline.JPG

Direct listing vs Traditional IPO

The direct listing path is very different from that of a traditional IPO. Here’s a summary of the key differences:

Direct Listing vs IPO.JPG

A direct listing involves the company simply listing all of its existing shares on an exchange, without a need to issue new shares to new investors. As a result, there are no bankers involved and you do not have the usual army of dealers and bankers conducting roadshows and presentations to market the company’s shares to its network of investors. As such, it is a more democratic process as all investors are only given access to purchase shares on the listing day, other than early investors. It is also cheaper as you do not have to pay expensive investment banking fees on this process.

The downside is potential volatility of price after your listing due to the following factors:

  1. No underwriters in place to stabilise the market and prop up the share price
  2. No lock up on pre listing investors, resulting in nothing preventing cornerstone investors from selling on day one.
  3. No IPO price is set, as such there is no price anchoring in the minds of investors.

Some of the reasons given by CEO Daniel Ek for doing a direct listing instead of an IPO  was that:

  1. They had 1.5 billion in cash and short term investments, no debt and thus did not need the money.
  2. They believe in being transparent and not favouring 1 investor over another.
  3. They have been allowing investors and employees to freely buy and sell their shares in the private market and didn’t want to lock up any investors as part of a IPO.

The CEO even committed to not ringing the bell, taking interviews or even being in the exchange when his company’s stock lists, which is undoubtedly a breath of fresh air.

Spotify’s Business Model

Spotify operates on a “Freemium” model, with a free product and a premium upgrade.

Spotify Pricing

Source: Spotify

The free service is basically a shuffle playlist sprinkled with ads. The premium service gives you freedom to play any track and other premium features. The premium service costs $9.90 for a single user, $4.99 for a student and $14.98 for up to 5 users at the same address for the family package. (Take note of the family package pricing)

The company’s only other significant revenue stream is from advertising within the free service. The main cost of the company is royalty fees payable for each play of a song.

Financial Highlights

1. Revenue and Gross Margins

Revenue and cost analysis

Source: Spotify Prospectus

Revenue ratios.JPG

The revenue of the company has been experiencing explosive growth since 2015. Although the revenue growth rate has been slowing, it still grew revenues at 38.55% in 2017. Management issued 2018 guidance of 4.9-5.3 billion which represents a 20-30% year on year growth.

The upside is that gross margins have been improving, mainly due to new licensing agreements with the record labels that have lower royalty rates. The company has also guided for 23-25% margins in 2018, which is a further improvement on 2017.

That itself  is a interesting dynamic though, as by lowering royalty rates, you are essentially squeezing your content providers who can someday decide that enough is enough and pull their content from the platform. We’ve seen that happen with some high profile absentees from Spotify’s platform like Taylor Swift and Jay-Z. Whether Spotify can continue threading that fine line remains to be seen.

2. R&D, SG&A and Other Expenses

R&D Ratios

Other expenses are have been slightly outpacing revenue growth. For a very scale-able business like Spotify, it is pretty surprising as it should benefit from economies of scale. The only reason I can think of possibly costs associated with 2-sided platform development (to be elaborated later) and marketing into new markets. One to watch out for.

3. Cashflows

Cashflows.JPG

Source: Spotify Prospectus

The business as turned cashflow positive in 2016 and continues to improve into 2017. This is a good sign as the continuing operations is able to fund itself.

4. Key Performance Indicators

KPIs

Monthly active users (MAUs) and premium subscribers has been growing steadily over the past 3 years. Management has guided for further growth to 198-208 million MAUs while premium subscribers are expected to grow to 92-96 million. This represents further declining growth rates perhaps due to the law of large numbers and competition.

Interestingly, Premium average revenue per user (ARPU) has been declining, in a large part due to the Family Package deal earlier mentioned. This means that each premium user signed up has been worth less in incremental revenue as the years go by. Another thing to watch out for going forward.

The Positives

1) Financials paint a mostly rosy picture

The company is experiencing double digit percentage growth in revenue and subscriber growth, which are fantastic numbers. Gross margins are also improving and the company is already operating cashflow positive. With many markets still to unlock like India and South-east Asia, there is still a clear pathway to growth those numbers.

Blemishes include operating expenses outpacing revenue slightly and declining ARPUs.

2) Recovery in Music Industry Revenues

Global music revenue trend.JPG

Source: IFPI

Global music industry revenues have stabilised and slowly recovered since 2014, with it largely driven by growth in Digital music revenues and music streaming. If Spotify continues to maintain their market leading position, they will be able to ride this wave.

3) The Big Data value driver

The unique advantage Spotify has is the ability to identify each user’s listening preferences and suggest music and playlists to try and discover. On the flipside, they are able to use this data to build tools to help artistes to better engage and target their fans. This creates a “2 sided platform” mentioned earlier that allows you to sell services to both the artiste and the listener.

With the recent focus on data privacy arising from the Cambridge Analytica scandal with Facebook, Big data software firms are experiencing a re-rating in valuation. As such, this aspect may be a drag on the company. I would argue that there is a smaller scope of use for knowing my music preferences than if they knew my age, race and job. I mean, is Putin going to conclude that because I love Jay Chou music, I would be in favour of Taiwanese independence and target me as a result?

The Risks

1) Competition

The giant elephant in the room is of course Apple Music. With Apple Music on track to surpass Spotify’s US subscriber base, Apple has proven to be significant competitor to Spotify. With cash to burn and a ready database of iOS users to sell their services to, Apple could rain on Spotify’s parade.

That being said, given the closed ecosystem nature of Apple’s strategy, I see potential for both services to thrive with Spotify filling in the non-Apple gaps of the market.

2) Reliance on Artistes and content providers

Spotify is very much reliant on the artistes and content providers to stay interested in the platform. This is very much why Netflix pursued an original content strategy, to not be beholden to their content providers. As such, Spotify has to continue to drive value to their content providers while also balancing the licensing fee reductions. We’ve already had Taylor Swift and Jay-Z leave the platform, it’ll be crucial if they can retain and provide a greater value proposition to their artistes and maybe one day bring back these A-list artistes back on board.

3) Ownership structure

Principal Shareholders.JPG

Source: Spotify Prospectus

As is the case with founder driven tech unicorns, although founders Daniel Ek and Martin Lorentzon own a combined 38.9% of the company, they hold a combined 80.4% of all the voting rights in the company by virtue of the Beneficiary Certificates issued to them pre-listing. As such, you are essentially entrusting your money to them to hopefully do the right thing with the company.

4) Potentially unstable market prices

As mentioned above, the direct listing path results in no share lock-ups or market stabilisation facility. Plus the current market climate being highly volatile, much care has to be taken if you choose to invest on day 1.

What price to buy?

As there is no IPO price, retail investors especially do not have a price anchor to target and fix to.

Thankfully, the prospectus provides some guidance:

Share Price History.JPG

Source: Spotify Prospectus

The prospectus shows the private market share transaction price and volume since 2017. Based on this, it is likely that the share price will trade at least between $95 – $132.50, implying a $16.8 – 23.4 billion valuation.

Renown business valuation professor Aswath Damodaran at NYU also did a Discounted Cash Flow (DCF) valuation of Spotify and arrived at a valuation of $115.31 based on his own set of assumptions. He also has done up a excel file for his DCF if you wish play around with it. His blog and his workings can be found here.

Conclusion:

In a world where tech unicorns going public are becoming increasingly rare, Spotify seems to have chosen the right time in their growth story to list – a good enough story to garner interest but with enough execution risk to allow people to speculate and participate in the upside. How it will trade and at what price on day 1 intrigues me and I will definitely allocate some capital to buy if it hits my personal price target.

Happy Hunting,
KK

References:
Direct listing prospectus
Spotify Investor Day presentations
Spotify 2018 guidance

An Unbalanced View: Ayondo Ltd

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It’s been a while since a SGX IPO caught my eye as most SGX IPOs are, honestly, pretty boring (Yet another REIT IPO anybody? No?) So when you hear of a fintech company filing to list here (which is pretty rare), you just gotta dive into it.

Here’s An Unbalanced View of Ayondo Ltd.

Ayon-who?

Ayondo Ltd is a fintech company headquartered in Germany. It is looking to float 80.77 million shares on the Catalist board, of which 8.9 million are available for public subscription. This represents roughly 16% of total shares in the company after the IPO closes. The IPO price is $0.26, which translates roughly to a $130.7 million market cap. Offer will close on 22 March and begin trading at 26 March.

Ayondo.JPG

They operate a trading platform that allows you to trade Contracts For Difference (CFDs) and spread betting on all kinds of underlying instruments (stocks, bonds, currencies, even cryptocurrencies). This on its own is nothing new. The interesting twist is the social trading aspect that is introduced on the platform.

Social Trading

Social trading is such that “Top Traders” can put themselves out there to be followed by other amateur / lazy / ignorant investors. Essentially what happens is that once you follow a Top Trader, your money will automatically be used to mimic the trades the Top Trader does, a bit like letting a fund manager manage your funds.

Career Track

Top Traders’ past performance is used to determine their “Career rank” and there are tiered remuneration percentages for the corresponding rank. This essentially means you take a cut on the platform fees charged by Ayondo to your followers. This essentially democratises the fund management process by allowing anybody to be a fund manager. Interestingly, Top Traders have the option of just doing simulated trading (ie no personal money is involved) and build their Career rank that way.

Why I won’t be subscribing to this IPO

Still Loss Making and Premium Valuation

Financials

The company has yet to turn a profit in the past 3 years. Although revenue has been increasing, operating expense growth has also been outpacing revenue growth. Interestingly, revenue actually dropped in 2017 despite user growth. The company is also still not cashflow positive with financing activities funding the company’s growth.

Also, the IPO price of $0.26 cents is at a significant premium from audited NAV of $0.029, which already includes goodwill from acquisitions of its subsidiaries as part of its assets. Goodwill is subject to potential impairments, meaning NAV might be even lower.

As a result, it is difficult to value based on future cashflows or based on NAV.

Competitive industry

The brokerage industry is highly competitive and cut throat. Page 175 of the prospectus already provides a formidable and aggressive list of competitors, namely:

  1. Social trading competitors like eToro (Those annoying youtube ads) and Sprinklebit
  2. Self directed trading competitors like CMC Markets, IG and Saxo Bank.

As such, there is no guarantee that Ayondo will win and prosper in this crowded market.

I also don’t see any reason why social trading cannot be implemented on all competitor platforms which in turn leads to further erosion of your one differentiator from your competition.

Private equity deal

Significant pre-IPO investor Luminor Capital is a private equity firm that is probably using the IPO as a way to cash out of the company. The lock-up period on their shares range from 6 – 12 months, meaning they can sell a significant portion of their shares 6 – 12 months after the IPO. They may or may not do so, but my bet is that they would sell, thus creating significant downward pressure on the stock in the near term.

Non-conversion of Shareholder loans

Proceeds are from the IPO is being using to pay off significant amounts of shareholder convertible debt, which are held by significant shareholders like the founder. If they were so convinced of the share value, they would have converted those loans into shares without hesitation.

Conclusion

The Ayondo Ltd IPO is a rare fintech listing in Singapore. However, in its current state, it is definitely not a viable long term investment. If I were to subscribe to the IPO, I would be there only for the potential pop on Day 1 due to scarcity value. I’ll be giving it a pass for now.

Happy Hunting,
KK

The “An Unbalanced View” series gives my reasons why I am or am not investing in an IPO. There might be contrasting factors that I did not highlight in my post. It is not that I didn’t consider them before making my decision, it is more likely that the reasons presented overwhelmed those factors and thus were not presented. Bear in mind that it is after all, an unbalanced view.