Hunting for Bursa Malaysia ICT services and software companies
Case Notes 22. This post compiles the base rates for the Bursa Malaysia ICT services and software companies. I have also identified a potential company for further investigation.
Over the years, I have invested in Bursa Malaysia ICT services/software companies such as Heitech Padu and Mesiniaga. They were selected for their dividend yield rather than for the capital gain. At the same time, they provided some diversity to my stock portfolio.
I have since sold them as their performance had deteriorated. From a portfolio diversification perspective, I am looking for other new companies in this sector to invest in.
My investment is made after a comprehensive company analysis and valuation. As this is time-consuming, I first screen the companies. This process involves:
- Compiling the base rates for the sector.
- Based on the results of the sector analysis, identify the criteria to be used in the screening process.
- Identify the companies for detailed analysis.
Unlike other sectors under Bursa Malaysia, many of the ICT services/software companies are listed under the ACE Market. The ACE here stands for “Access, Certainty, Efficiency”. It is the new name for the formerly known MESDAQ (Malaysian Exchange of Securities Dealing and Automated Quotation) market.
MESDAQ came into existence in 1997 when it was the home of mainly technology stocks. The ACE Market is seen as the ideal market for start-ups and new companies.
When looking at base rates for the ICT services/software sector, I had to consider both the ACE Market and the Main Market companies.
Join me as I hunt for the Bursa Malaysia ICT services and software companies to invest in.
Should go and buy them? Read my Disclaimer.
Contents
- Summary
- Panel profile
- Base rates
- Valuation
- Screening for investment opportunities
- Methodology
- Appendix
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Summary
- The analyses covered 22 companies under the ACE Board and 17 companies under the Main Board.
- This is a tough sector to make money in. More than half of the companies in both the ACE and Main Boards had cumulative losses for the past 12 years. Based on the individual company ROE from 2010 t0 2021, about 68 % of the ACE Board had individual negative ROE. For the Main Board companies, this was 59%.
- The positive point was that the sector was conservative when it came to borrowings. However, the majority had cumulative negative Cash Flow from Ops.
- There was only one company that meets my screening criteria - Opensys.
Panel profile
In selecting the panel, I considered two criteria - nature of business and availability of data.
My focus was on those companies in the ICT services and/or software businesses. I excluded those whose main business was in hardware or equipment. As of April 2022, there were 25 ACE Board and 18 Main Board companies under Bursa Malaysia involved in the ICT services and/or software business.
To get a sense of the long-term performance, I looked at the performance from 2010 to 2021. However, there were a few that did not have a decade of listing history. As such the panel analyses covered only 22 companies under ACE Market and 17 companies under the Main Board.
Refer to Appendix 1 for the list of companies and the Methodology section for further details.
The majority of the companies in the panel are relatively small both in terms of the 2021 revenue and Total Equity. Refer to the 2 histograms in Chart 1:
- The 2021 revenue of the ACE panel ranged from RM 5.5 m to RM 308 m with an average of RM 71 m. The 2021 revenue of the Main Board panel ranged from less than RM 1 m to RM 724 m with an average of RM 173 m.
- The 2021 Total Equity of the ACE panel ranged from RM 13 m to RM 355 m with an average of RM 110 m. For the Main Board panel, the 2021 Total Equity ranged from RM (5) m to RM 1,542 m with an average of RM 277 m. Contrast this with the KLCI component companies where the smallest company had a Total Equity of RM 550 million.
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| Chart 1: Panel Profile |
Sector background
According to the Malaysia Dept of Statistics, the Malaysian ICT sector contributed about 22.6 % of the Malaysian economy in 2020. This contribution came from 2 sources - the gross value added of the ICT industry (GVAICT) and the e-commerce of other industries.
The GVAICT grew from about RM 106 billion in 2010 to about RM 202 billion in 2020, equal to a CAGR of 6.7 %. To give you a sense of the growth, the Malaysian GDP grew at a 4.0 % CAGR for the same period.
The GVAICT is further sub-divided into 4 with the following profile in 2020.
- ICT services which accounted for about 45.0 % of the GVAICT.
- ICT manufacturing which accounted for about 34.5 %.
- ICT trade which accounted for about 14.2 %.
- Content and Media making up the balance
As you can see the ICT services sub-sector is the largest component of the GVAICT. It contributed about RM 90 billion to the GDV in 2020. I estimated that the panel companies (ACE plus Main Boards) accounted for about 5 % of the nation’s ICT services sub-sector.
Base Rates
The objective of compiling base rates is to provide a reference when analysing companies in the sector.
In his book “Thinking Fast and Slow” Daniel Kahneman presented his ideas about the inside and outside view. This is a useful model when analyzing companies.
The inside view generally refers to a conclusion reached using an individual own experience and reasoning. It is the perspective of someone looking at the problem from “the inside”. The focus is on the specific situation rather than looking at a broader class of similar situations.
In contrast, the outside view refers to the perspective of someone looking at the problem "from the outside". It is the view taking into consideration the experience of other people.
When you analyze a company, the inside view may lead to unrealistic expectations. To counter this, you need an outside view.
This is where base rates come in. The performance of the industry would give you a basis to check on your analysis and projections.
All valuations are based on assumptions and the base rates will help to ensure that the assumptions are realistic.
The following sections present the base rates for a number of key metrics for the Bursa Malaysia ICT services and/or software sector. I have presented the analysis separately for the ACE Board and the Main Board companies.
Revenue
From 2010 to 2021, the median revenue of the ACE panel grew at an 11.3 % CAGR whereas that for the Main panel grew at 8.4 % CAGR.
When you dig into the trends of the panel you will notice that for the ACE Board, the mean is very close to the upper quartile levels for the analysis period. This suggests that the mean value was skewed by a few “outlier” companies. Refer to Chart 2.
However, in the case of the Main Board companies, we see the same phenomenon in the early half of the analysis period. But in the second half, we see a more common characteristic of the mean lying between the upper and lower quartile levels.
To ensure that the analysis is not skewed by these “outliers”, I chose the median rather than the mean to represent the average performance. At the same time, to represent the range, I used the interquartile range rather than the standard deviation.
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| Chart 2: Revenue Profile |
For both the ACE and Main panels, the inter-quartile range widened from 2010 to 2021. I interpreted this as the more successful companies becoming more successful. Looking at Chart 2, I would deduce that the sector growth was driven by the successful ones. This is of course equating success with large and increasing revenues.
Note that under the ACE Board, there were 5 companies whose revenue shrunk from 2010 to 2021. There were 6 under the Main Board with this shrinking revenue.
PAT
This was a tough sector to make money in the 12 years from 2010 to 2021.
- Based on the median PAT, there were 6 years of losses for the ACE Board. At the same time, there was also a cumulative loss for the period. The Main Board performed better in that there were only 3 years of losses for the median PAT and cumulatively, the panel was profitable.
- You can see from Chart 3 that for both the ACE and Main Board, the lower quartile was at a loss for the whole 12 years. More than half of the companies in both the ACE and Main Board had cumulative losses for the 12 years.
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| Chart 3: PAT Profile |
Like revenue, the PAT inter-quartile range for both panels widened from 2010 to 2021. In the case of the Main Board, this was mainly the upper quartile companies becoming more profitable. For the ACE Board, it was both the upper quartile companies that became more profitable while the lower quartile ones had bigger losses.
ROE
Over the 12 years the median ROE was negative for most of the 12 years for the ACE Board companies.
Based on the individual company ROE from 2010 t0 2021, about 68 % of the ACE Board had negative ROE. For the Main Board companies, this was 59%.
I normally look for at least a 10% average ROE over the past 10 years in my investee companies. On such a basis, very few ACE Board companies would meet this criterion.
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| Chart 4: ROE Profile |
To understand the dynamics of the ROE, I carried out a DuPont analysis of the ROE. Refer to Charts 5 to 7. Not surprisingly, it was the profit margin that accounted for the bulk of the variation in the ROE.
Profit Margin
If you compare the pattern of the profit margin with that of the ROE, you can see that they resemble each other.
The second point is that the profit margins of the Main Board are significantly higher than those of the ACE Board companies.
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| Chart 5: PAT Margin Profile |
Asset Turnover
The asset turnover of both panels declined from 2010 to 2021. Based on the median, the decline for the Main Board was more severe in that it declined at a 4.8 % compounded annual rate compared to 1.9 % for the ACE panel
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| Chart 6: Asset Turnover Profile |
Leverage
Compared to the profit margins and asset turnover, the leverages for both panels were less volatile. The interesting feature is that the median leverage was around 1.5 or lower. This suggests that the panel had low gearing.
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| Chart 7: Leverage Profile |
The leverage was also low compared to other sectors. Note that the other sectors were from my previous base rates studies.
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| Table 1: Sector Leverage Note (a) Based on both the ACE and Bursa Main Board for the ICT services sector. But all the others are based on the Main Board |
Debt
Both the ACE and Main Board companies had a median Debt Equity ratio of 0.1 over the past 12 years. There were 10 ACE Board and 2 Main Board companies with zero Debt for the past 12 years. This is a conservative sector when it comes to borrowing.
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| Chart 8: Debt Equity Profile |
Cash Flow from Ops
The cash flow from operations for the ACE Board are not very encouraging. 71 % of the ACE Board companies had negative cumulative cash flow from operations from 2010 to 2021.
On the other hand, only 29 % of the Main Board companies had negative cumulative cash flow from operations for the same period
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| Chart 9: Cash Flow from Ops Profile |
Gross profitability
Gross profitability is defined as gross profits divided by total assets. According to Professor Novy-Marx, it is one of the best indicators for predicting future returns.
The results of the analysis do not augur well for the short-term profitability of the sector. This is because there are declining trends for both the ACE and Main Board panels.
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| Chart 10: Gross Profitability Profile |
Valuation
The intrinsic value of a company is commonly defined as the present value of the cash flow generated over the life of the company. What then do you use to represent the cash flow?
Warren Buffet used what he called “owners’ earnings”. This is the earnings less the amount set aside to maintain and/or grow the business. This is commonly referred to as Free Cash Flow (FCF). Looking at the FCF from a firm perspective, we have the formula:
FCF = EBIT(1 - t) - (CAPEX - Depreciation & Amortization + NWC)
Where:
EBIT = Earnings before interest and tax
t = Tax.
NCW = increase in working capital
FCF to the firm can also be derived as = Cash Flow from Ops - CAPEX
As a back-of-envelop calculation, I derive the FCF = Cash Flow from Ops less Cash Flow from Investments
This simple metric can provide an indication of the intrinsic value of a company. A negative value would imply that there is no value. The higher the FCF, the greater the intrinsic value.
You can see from Chart 11 that the majority of the ACE Board companies do not have positive FCF. There were only 5 ACE Board companies with cumulative positive FCF. Compare this with the Main Board that had 10 companies with cumulative positive FCF.
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| Chart 11: Free Cash Flow Profile |
Screening for investment opportunities
I used 4 metrics to screen for investment opportunities. The first three relate to the business fundamentals while the last relates to valuation.
- ROE. My target is to have a 10% return based on the average ROE over the 12 years.
- Growth in gross profitability. I consider gross profitability as the main metric to predict stock market returns. As such I am looking for companies with improving gross profitability.
- Positive cumulative Cash Flow from Ops. I used this as a proxy for financial strengths. Normally I would look at the DE ratio. However as shown earlier, this sector has conservative borrowings and low leverage. As such I chose Cash Flow as the more appropriate metric.
- Free Cash Flow Yield > 5%.
I used a simple Pass (denoted by 1 in the table) and Fail (denoted by a blank in the table) to test each company. The results of the test are shown in the following table.
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| Table 2: Screening for ICT services and software companies |
The goal is to identify the companies that meet all the 4 criteria. In the context of Table 2, this meant achieving a total of 4. As can be seen, there is only one company - Opensys - that meets this requirement.
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Methodology
The data for the base rates were extracted from the Financial Statements for each company for the period 2010 to 2021. Note that it is comprised of companies with different financial year ends. For many companies, the 2021 values were the LTM values.
2 companies had changes in the financial year. As such the information for certain years was not available. In my analysis, I have taken the average of the year before and year after as the relevant data.
Note that 3 of the ACE companies and one of the Main Board companies did not have full financials in the first few years of the analysis period. In such cases, the statistics ignored them. Since most of the statistics were based on median and quartile values, this did not affect the analysis too much.
The Financial Statements were taken from a platform/app called TIKR.com.
I have 2 types of analyses:
- The average of the sector. This measures the central tendency. The mean is the most frequently used measure of central tendency because it uses all values in the data set to give you an average. For data from skewed distributions, the median is better than the mean because it is not influenced by extremely large values. In this analysis, I have used the median as the measure of central tendency.
- The distribution of individual companies making up the panel. For these, I extracted the quartiles for each year based on the ranking of the respective metric.
When you analyse a panel, there are two perspectives. The first is to look at the performance of the panel as a whole. The second is to focus on the performance of the individual companies. I have the following example to illustrate the difference between these 2 perspectives.
Suppose that there are 9 companies in the panel with the Revenue, PAT, and Profit Margin (PAT/Revenue) as shown in the table below.
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| Table 3: Sample panel |
To get the distribution of the Profit Margin, the companies were ranked based on Profit Margin with the results shown as per the table below. Note that they are in descending order.
This is then used to determine the quartile and median values.
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| Table 4: Determining the Median and Quartiles |
There are then 3 ways to measure the central tendency of the profit margin.
- The mean profit margin for the sector is derived by dividing the total PAT for the panel by the total revenue. In the example, the Profit Margin = 121 / 865 = 14.0 %. This is looking at the central tendency of the panel as a whole.
- You can also get the mean profit margin by adding up individual company Profit Margin ie 132.3 and dividing by 9 = 14.7% as shown in the table. This is looking at the distribution of individual profit margins.
- The median of the sample is 12.5 %. This is looking at the distribution of the individual profit margins.
If the distribution is skewed, the mean and the median will be different. In this analysis, we have outliers that skewed the measure of central tendencies. As such I have used the median to represent the central tendency.
At the same time, I am more interested in the performance of individual companies rather than the panel as a whole. As such whenever I used the mean, I refer to the computation as per the second bullet point.
Appendix 1
The companies covered in the analysis were those in the ICT services and/or software sector. I based it on the description as provided in the profile of the respective companies under the TIKR.com platform.
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Disclaimer & Disclosure
I am not an investment adviser, security analyst, or stockbroker. The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies. Investments or strategies mentioned on this website may not be suitable for you and you should have your own independent decision regarding them.
The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such.
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