Mencast Holdings

[Nick]

Hi Nick,

Thanks for the summary and your thoughts.

A few curious questions from me, if I may:-

1) Does Mencast plan to borrow the amount of money ($9.6m) required for the cash component portion of the deal? I ask this because under gearing, Mencast envisages going into net debt from its current net cash position; but in the announcement itself it is mentioned that internal cash flows will be used. So the question is does the debt come from Top Great itself?

2) Mencast is simply adding up the profit from Top Great into their own Group profit to achieve the fully diluted EPS figure assuming transaction is completed. I would take this to be more of a forecast rather than concrete proof that the acquisition will really enable an increase in EPS as stated. Too many uncertainties regarding synergy between acquiror and acquiree. Also, I think ROE may be a more valid measure rather than EPS.

3) Goodwill from the transaction is noticeably high at $13.4 million. Why is't there any impairment or amortization of goodwill? Is this to be expected in the near term and how will it impact earnings?

The positives of the deal are the Penjuru land and also the 3-year vendor partnership + profit warranty. Mencast managed to negotiate a pretty good deal IMHO.

(Not Vested)

1) Based on the payment structure, only $6.0 million cash outflow is required this year to meet the Vendor's payment. Based on its B/S on 31 Dec 2010, the Group has $11.6 million cash and borrowings of $10.7 million. I would expect the cash position and the cash generated in 1H 11 to be sufficient in meeting the payment requirement. Debt might be used as well if necessary. The development of the Penjuru facility has outstanding capital commitments of $7.7 million based on AR 2010.

2) It is quite impossible to predict the EPS since this is not a long term rental/charter contract with fixed earnings. The figures are meant to be a guidance and with the profit warranty in place, it is quite useful to extrapolate forward. However, based on my experience with the Recon and Defcon acquisition in 2009, the earnings forecast could be accurate near term ! Based on the Recon and Defcon M&A announcement ( http://mencast.listedcompany.com/newsroo...1947.1.pdf ), the pro forma earnings was estimated to be $6.94 million in FY 09 (based on FY 08 earnings). Mencast generated $7.03 million NPAT for FY 09. IMO, the wild card for FY 12 will be the Mencast Central in Penjuru Lane.

3) I don't think goodwill is impaired/amortized unless the business earnings deteriorates.

The deal looks good on paper. I hope it translates to bottom-line growth in the coming years. I don't expect dividends to rise judging by the high capex this year. The current payout ratio is 21%.

[Musicwhiz]

Thanks again Nick. Very informative!

I checked the dividend history. Mencast has been paying a consistent 1c/share dividend for the last 2 years, and 1.1 cents/share for the year just past. This translates to a yield of about 2.5% base on last done price of 44 cents. Not exactly high but then again Mencast is more of a growth company than a yield play.

Do you forsee a drop in dividend per share? Currently Mencast is paying out about $1.876 million based on its current issued share cap and 1.1 c/share. Assuming issued share cap goes up to 205,695,000 shares, they will have to pay out $2.263 million if they keep DPS constant. That's about 20% higher.

Thanks!

[Nick]

No problem MW. Rare chance to discuss Mencast since its share float is so small haha !

You are right about the small yield and that it should be considered to be a growth play with company deploying the retained earnings at revenue generating businesses with ROE > 10%.

No of Shares at 31 Dec 2010: 170.57 million
No of Shares to be issued in 2011 (using minimum issue price of $0.41): 17.56 million
No of Shares at 31 Dec 2011: 188.13 million (estimated)

If dividend of 1.1 SG cents is declared, the cash out-flow will grow to $2.07 million. It will be interesting to see how its profits will grow by year end and the level of FCF (if any). It will be difficult to judge whether the dividend will be maintained. There are 2 type of opinions which I have gathered with regards to dividends - i) The true measure of dividend payout will be the core earnings. Dividends will be derived from the core earnings and distributed to shareholders. ii) The true measure of dividend payout is free cash-flow. If the company pays a dividend while generating negative FCF on a regular basis, it is essentially borrowing money to pay its dividend. Both seem to make sense and I believe they are intrinsically linked together but in some companies (not necessarily Mencast), it makes it difficult to judge how viable the dividends are.

Actually, I foresee, the Management turning to scrip dividend in the near future (my own gut feeling) as a way to conserve cash while enticing shareholders to raise their stake by purchasing shares at a discount. MTQ has done this with pretty good effect.

I await the 1H 11 report to see the impact the latest acquisition will have (1 month contribution) and the shape of the B/S.

[Nick]

http://info.sgx.com/webcoranncatth.nsf/V...40033A378/$file/Mencast_Top_Great_Acq_Press_Release.pdf?openelement - Press Release from Mencast.

Nothing material with the exception of comments from the CEO Mr Glenndle Sim. Mencast shares closed at 44.0 cents (down 1 cent) with 130,000 shares traded.

[Musicwhiz]

http://info.sgx.com/webcoranncatth.nsf/V...40033A378/$file/Mencast_Top_Great_Acq_Press_Release.pdf?openelement - Press Release from Mencast.

Nothing material with the exception of comments from the CEO Mr Glenndle Sim. Mencast shares closed at 44.0 cents (down 1 cent) with 130,000 shares traded.

Glenddle is a really interesting and unique name haha!

Yes, I forgot about the scrip dividend option. I assume Mencast already has convened an AGM and passed a Resolution for this? If not, I don't think they can offer scrip (unsure though, have to check on this). Scrip does help to conserve cash and since the Company needs to spend on capex for their Penjuru expansion, it will be prudent to cut down on dividends in the near-term in order to be able to afford the growth and expansion. How much of the Company does the CEO own? If it is significant then he can choose scrip and indirectly increase his stake just like what father and son team did at MTQ haha....

Do you view Mencast as diversifying away from their core business of Sterngear Manufacture and Repairs? Top Great is in the business of fabrication, procurement and installation of structural and precision engineering systems, and this is not in any way related to Sterngear. The immediate benefit which I can see is the additional land which Top Great also has at Penjuru which can complement Mencast, otherwise their services do not appear to overlap too much.

Also, will Mencast be aggressively pursuing M&A in the next few years? What did Glenddle Sim mention during interviews and AGMs? You said Recon Propeller was acquired in FY 2009 and now in FY 2011 they are buying yet another Company. It seems to be the case that the Company has to rely more on acquisitive growth rather than organic. This may also lead to them taking on more debt (eventually) and having to integrate systems, processes and working styles (of different companies). Any views on this?

Thanks again!

[Nick]

Mencast don't have a scrip dividend policy but I wouldn't be surprised if it turns to it in the near future to conserve cash for its expansion. As a shareholder, if scrip dividend were offered at a slight discount to current market prices, I will most likely take it up. At the moment, the CEO controls 57% of the Company (not including the latest acquisition and issue of new shares). He succeeded his father in 2009 as CEO. The dividend would give him $1 million cash flow annually so it is up to him whether the scrip dividend comes into play in the future.

Mencast has a market share of close to 70% in the local sterngear market so it will be quite difficult to make M&A here unless Stone Marine seeks to be part of the Mencast Group. The only alternative is to grow organically which is what they are doing with Mencast Central in Penjuru and this will allow them to manufacture new sterngear products for larger vessels and service new range of vessels. I suspect that Mencast intends to change its model from a pure-play sterngear service provider into a full fledged Marine MRO provider. I had been puzzled by the change of its description in the AR 2010 -

AR 2009:
Established in 1981, Mencast Holdings Ltd. and its subsidiaries (the “Group”) is a Singapore-based sterngear equipment manufacturer and supplier, and sterngear services provider for a wide range of commercial vessel applications catering to customers in the marine and offshore oil and gas industries in the Asia Pacific.

AR 2010:
Established in 1981, Mencast Holdings Ltd. and its subsidiaries (the "Group") is a Singapore-based marine maintenance, repair and overhaul ("Marine MRO") provider, and a leader in sterngear equipment manufacturing and servicing. The Group specialises in the provision of propeller and sterngear services for a wide range of vessels catering to customers in the marine and offshore oil and gas industries in the Asia Pacific.

A very subtle change which few may have noticed but I did and I was quite puzzled initially. I reckoned it could be due to the diversification in its service division in FY 2010 when it formed a fleet maintenance program which counted the likes of PSA Marine as its clients. But it made sense today - I believe Mencast is seeking to diversify its product manufacturing and service division into new streams. The Top Great acquisition is one way of achieving it inorganically. Is this a good move ? I can't say for now since I have no idea how the other streams will perform in the next 3-5 years. Mencast has not shied away from changes before. Prior the crisis, manufacturing was its biggest contributor but today, service has over-taken it.

With regards to growth, I like to think that Mencast has employed both organic and M&A to get sustainable and optimal growth in profits while maintaining its ROE.

Organic: Expansion of new products in FY 2011 (Mewis Duct), formation of fleet maintenance program, formation of worlwide propeller service teams, developing Mencast Central in Penjuru etc

Inorganic: Recon & Defcon Acquisition, formation of JV with TG Offshore and Top Great Group acquisition.

I would expect organic growth within the newly acquired companies going forward as well. It shouldn't be static. Ultimately, Mencast is still a small company trying to grow fast. The crunch comes when it decides to grow too fast and end up stunting itself permanently. Must always keep an eye on small cap

[Musicwhiz]

Business Times - 19 May 2011

Mencast to acquire Top Great for $24m

Move to diversify product and service range

By TEO SI JIA

STERNGEAR equipment manufacturer and services provider Mencast Holdings has entered into an agreement to acquire Top Great Engineering & Marine for $24 million.

Of the amount, $9.6 million will be funded by cash and the balance through the issue of new shares.

Top Great and its subsidiaries are involved in engineering design, procurement, fabrication and installation of structural and precision engineering systems and plants.

The group's client base includes customers from the environmental, marine and oil and gas sectors of various countries.

For the financial year ended Dec 31, 2010, the Top Great group had an unaudited profit before income tax of $4.7 million and a net asset value of $10.64 million.

Top Great has warranted that its group shall achieve a net profit of not less than $8 million in the period from May 1, 2011 to April 31, 2013. If it fails to do so, the vendors of Top Great will reimburse Mencast the shortfall in cash.

Catalist-listed Mencast serves customers in the offshore oil and gas as well as the marine industry in local and regional shipyards.

With Mencast's current core business dealing with the marine maintenance, repair and overhaul, the proposed acquisition is expected to diversify its range of products and services.

The company also plans to leverage on Top Great's established client base, reputation and accreditation.

Executive chairman and CEO of Mencast, Glenndle Sim, said that the acquisition will enable the company to 'create . . . economies of scale and strengthen its value proposition to attract and retain new clientele'.

Mencast shares fell one cent to close at 44 cents yesterday.

[Nick]

I just realized that I missed out something from this deal. Mencast relationship with Top Great was cemented a year ago with the formation of a 51% owned JV company called TG Offshore which deal with ship repair. The JV company was formed on 3rd Feb 2010 - http://mencast.listedcompany.com/newsroo...BC94.1.pdf Top Great owned the remaining 49%. I guess the CEO Mr Sim decided to further solidify the partnership with Mr Wong after a year worth of operating together ? I now feel more confident about the deal since it is clear that the Management did decide to spend a year working together before committing to any M&A decision.

[Musicwhiz]

I just realized that I missed out something from this deal. Mencast relationship with Top Great was cemented a year ago with the formation of a 51% owned JV company called TG Offshore which deal with ship repair. The JV company was formed on 3rd Feb 2010 - http://mencast.listedcompany.com/newsroo...BC94.1.pdf Top Great owned the remaining 49%. I guess the CEO Mr Sim decided to further solidify the partnership with Mr Wong after a year worth of operating together ? I now feel more confident about the deal since it is clear that the Management did decide to spend a year working together before committing to any M&A decision.

Wow, that's indeed interesting! It shows that the partnership had actually begun 1 year ago already with the formation of the JV. Yes it would seem that there are potential synergies from merging of the two businesses. Let's wait for their upcoming results to find out!

(Not Vested)

[Musicwhiz]

Hmm, another acquisition. The Company has been pretty aggressive on the M&A front!

http://info.sgx.com/webcoranncatth.nsf/V...6001AFD44/$file/Acquisition_of_UNIDIVE.PDF?openelement

(Not Vested)