Ezion Holdings

[ichiran]

Despite reporting better than expected 3Q10 results, the share price of Ezion has been softening for the past days.

Ezion reported a 120.7% YoY rise (+39% QoQ) in revenue to S$45.7m and a 143% increase (but -39.4% QoQ) in net profit to S$10.0m in 3Q10.

Is Mr Market offering an opportunity to scope up shares of this highly profitable company in the Oil and Gas sector?

Or could it be due to the agreement with Venstar Investments Pte Ltd on the proposed issue up to 53m redeemable exchangeable preference shares?

Assuming all preference shares are ultimately exchanged for Ezion's stock, there will be up to about 80.4m new ordinary shares, representing about 11.3% of Ezion's current share base.

However, the issue of the preference shares is such that the dilution will be spread out with no dilution in FY10 and estimated maximum dilution in FY11 is 28.2m new ordinary shares.

Appreciate views from forummers on this company, pls!!!

[dydx]

This counter I will not touch. There are just too much fund-raising and financial engineering involved. I just can't make myself put money into a business where the main assets are employed to generate revenue in the high sea far, far away, and rotting (rusting) away when the assets are not employed under contracts.

I may sound cynical here, but profits from such type of offshore equipment rental business are very much derived from accounting. When the investment cost of a specialised vessel is depreciated over 20 years straight-line, while the vessel is chartered out on an initial 3-year contract, surely the accounting profits will look very impressive in the course of the 3 years. Of course, as investors we ought to be aware that there are many other risks involved in this kind of business activity - the charter-party may give problems or not pay the amounts due; technical problems may arise in the vessel, leading to a dispute; the financier may pose a problem; the vessel may not have further contracts after the first 3-year contract, etc. Take a look into Sinwa's recent problems, you will know what I mean.

Of course, big profits are also created when a relatively new vessel is sold under a sale-and-leaseback contract soon after its delivery. We should be mindful that rationally such contracts should be motivated by financing considerations - i.e. it brings in new funds (which can be deployed for further business expansion) likely at a higher-than-normal borrowing cost over the leaseback period. But accounting wise, a company is allowed to structure such a kind of deal to show a big gain upfront, which many listed companies have quite gladly used to improve their investment merits in the short-term.

[ichiran]

Dydx,

Thanks for your post.

Would like to learn more from you....in terms of investment merit, are you speaking generally in terms of the industry as a whole, or are your views company-specific? Appreciate your views pls.

I also note that Ezra Holdings hold a 14% stake in Ezion.

[dydx]

....in terms of investment merit, are you speaking generally in terms of the industry as a whole, or are your views company-specific? Appreciate your views pls.

I also note that Ezra Holdings hold a 14% stake in Ezion.

Here I am refering to the key characteristics of the business of supplying vessels, temporary construction platforms, and other equipment or hardware, to support exploration and production of offshore oil & gas. This business is clearly cyclical, asset-intensive, financing-intensive, and risky; and while the assets are generally expensive and have a long economic life (over 10 years), the typical commercial contracts are relatively shorter in tenure and carry complex terms & conditions. Based on these factors alone, I don't find the business attractive at all for my own investment purpose.

On the other hand, the active and excessive use of financial leverage to grow a business quickly, or financial engineering techniques to grow or inflate short-term profits, are really a matter of choice of a listed company's senior management. At the root of it all, it depends on the senior management's character, their sense of business and financial prudence, and whether they are trying to build a real-good business steadily for the long term, or a mediocre business in a hurry and perhaps try to maximize their own gains including on their shareholdings from the stock market. Based on my observation, one thing is quite true - those who picked up the (bad) habbit of using excessive financial leverage to grow a business or finnacial engineering techniques to grow or inflate short-term profits, will want to do more and more of it, mainly out or greed, and very likely eventually to their own peril.

Ezion appears to be another 'satellite' of Ezra. Musicwhiz should have more to share on Ezra, as he used to own the counter and has done indepth research into it.

[Musicwhiz]

Well Ichiran I am no expert on either Ezion or Ezra, though I did own some Ezra previously but divested it in late 2009.

Ezra bought into Ezion (previously known as Nylect) some time back, and that was when it was still floundering as a tech company and not making any profits. The aim at the time was to use Ezion as a company providing "support vessel services" to Ezra, and they could cross-sell services to each other. I believe Ezion now has its own order book and business which I am not totally familiar with, thus I am not in a position to comment on the prospects of the Company.

Do note that what dydx says has merit, for financial engineering cum leverage is what can cause the Profit and Loss to look so sparklingly good in the short-term. However, if you examine Ezra's Balance Sheet and Cash Flow Statement, it's a little like a slow-motion train wreck. I did a post on this not so long ago when Ezra released their FY 2010 results (their year-end is August 31, 2010). Assuming Ezion and their associate EOC are structured (financially) the same way, then you have the big question of whether the Companies can sustain their cash flows and operations in the mediun term without asking for more funds, and without going back to the capital markets again.

I've learnt (the hard way) to avoid companies which need heavy capex to grow, and the O&G sector seems to be a ripe one for that. So companies such as Ezra, Ezion and probably Falcon Energy are in this league, where they need to employ massive amounts of capital just to generate returns, and with heavy leverage.

[Nick]

Sometimes I think it is better to invest in the people driving the fire engine than the hero holding the fire-hose to douse the flames. Everyone wants to be the hero but few (if any) wants to be the driver.

If you find a sector attractive, sometimes the company doing the very exciting job may not be the best investment candidate since everyone wants a piece of the pie. However, within the same sector, there might be other smaller companies supporting such 'hero' companies. The smaller market and lack of recognition may result in less competitors and hence stabler earnings. Of course, the hero company may also dwarf the supporting players and make all sort of demands.

Disclaimer: Not a call to buy or sell any companies.

[ichiran]

Dear Dydx and Musicwhiz,

thanks for your un-selfish sharing! I've learnt a lot from you guys.

Nick - Not so sure who you are referring to when you mention "Driver" and "Hero"? Do you mind elaborating a bit more? Thanks.

[Jon-san]

Sometimes I think it is better to invest in the people driving the fire engine than the hero holding the fire-hose to douse the flames. Everyone wants to be the hero but few (if any) wants to be the driver.

If you find a sector attractive, sometimes the company doing the very exciting job may not be the best investment candidate since everyone wants a piece of the pie. However, within the same sector, there might be other smaller companies supporting such 'hero' companies. The smaller market and lack of recognition may result in less competitors and hence stabler earnings. Of course, the hero company may also dwarf the supporting players and make all sort of demands.

Disclaimer: Not a call to buy or sell any companies.

But also, you have to consider one thing, if the hero dies, then the driver has no more job. And one more thing, many drivers can do the job (low barriers to entry), but only 1 hero can save the day. Lol!

[Musicwhiz]

Wow this is going deep into Porter's 5-Forces territory. I am currently reading up intensively on this and will post my thoughts on it once I have finished. Industry dynamics is far from simple though for some companies/industries it is much easier to get a hold of what's happening as they change/evolve much more slowly.

That said, take a look at the proliferation of players in the O&G segment ni the last couple of years, due to high rates of return. This has caused an oversupply of OSV and day rates are falling, which is one reason why companies like Ezra go for "specialized" vessels to command a premium to the current low rates for "normal" OSV.

That said, the downside for specialized vessels is the sunk costs and the inability to deploy these vessels should the industry change to render them obsolete; hence they might end up as expensive pieces of "junk" in that eventuality.

Just my 2-cents.

[Nick]

Bullish report from CIMB explaining the demand behind the lift-boats and the future of their marine supply bases in Australia.

http://www.remisiers.org/cms_images/Ezion-1503111.pdf