Is Mesiniaga an investment opportunity?

Value Investing Case Study 57-1: A fundamental analysis of Mesiniaga, a Bursa Malaysia IT services company.

I bought Mesiniaga (or the Group) in 2007/08 at about RM 1.55 per share compared to its Book Value of RM 2.86 per share. It had a past 6-year average EPS of RM 0.29 per share at that juncture. I thought that the Book Value and earnings provided sufficient margins of safety.

The Group performed well over the next 6 years achieving an average EPS of RM 0.17 per share. But then things started to go downhill in 2013. What was initially seen as a one-off blip became a declining revenue trend.

From 2013 to 2023, the Group had 6 years of losses. Mesiniaga had a good dividend track record before 2013, but since then, there have been only dividend payments in 4 out of the past 12 years.

To be transparent, I slowly sold off my shares in Mesiniaga from 2013 to 2019, with an average selling price of RM 1.92 per share. Together with the dividends I achieved a 12 % compounded annual return.

I noticed that the market price of Mesiniaga had gone up by about 20 % over the past 6 months. I was curious to see whether it had managed to turn around the performance.

Join me as I look at the current performance to see whether this can be another investment opportunity. Unfortunately, my conclusion is that from a long-term fundamental perspective, it is not.

Should you still go and buy it from a short-term perspective? Well, read my Disclaimer.

Investment Thesis

Business background

Operating performance

Financial position

Valuation

Conclusion

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Investment Thesis

Mesiniaga has seen its revenue decline over the past 12 years. This was opposite to the trends experienced by its peers. Furthermore, the Malaysian ICT services and software sector is not a sunset one. Mesiniaga does not seem to be addressing the right market despite efforts over the past decade to offer new products and services. Mesiniaga has to find the appropriate business direction to turn its performance around. Until it does, this is not an investment opportunity.

Business background

Mesiniaga started in the 1980s as a company selling IBM office products. It was listed on Bursa Malaysia in 1999 and has since evolved into a multi-platform business solutions provider.

According to Mesiniaga it “…equips organizations with digital solutions that produce positive business outcomes. We design and implement technology infrastructure that best fits your business with uncompromised after-sales support.”

Mesiniaga products and services include:

Providing customers with the latest equipment, gadgets, applications, and security solutions under its end-user computing business.

Cloud infrastructure. This ranged from in-country managed enterprise cloud to computing as as-a-service.

Providing cybersecurity monitoring services.

IT maintenance.

Network solutions. Mesiniaga helps companies optimize their network infrastructure.

The Group’s customers include those in the public, telecommunications, and enterprise sectors. According to the Group,

“We engage with GLCs and financial services organizations within the enterprise sector. In the telecommunications sector, Mesiniaga is involved in the strategic development and support of core network infrastructure for some of the biggest telecommunication companies in Malaysia.”

Operating performance

I looked at 2 groups of metrics to get a sense of where the business is heading. Refer to Chart 1.

The left part of Chart 1 tracks the trends of 3 metrics – revenue, PAT, and gross profitability (gross profits/total assets).

The right part of Chart 1 tracks the trends of 3 return metrics – ROIC, ROE, and ROA.

Over the past 12 years, revenue, PAT, and gross profitability declined. PAT was volatile with losses for 5 years. There were some common reasons for the losses – declining revenue and additional project completion costs.

According to Mesiniaga “As an organization with substantial fixed costs, such a decline in revenue had a significant impact on the Group’s profit.” This can be seen from 2013 to 2015 when there was a continuous decline in revenue.

Examples of losses due to completion costs were the additional costs of RM 25 million in 2014 and RM 5 million in 2015 to ensure that delayed projects were successfully delivered.

Chart 1: Performance Index and Returns

Given the PAT pattern, you should not be surprised to see similar patterns for the returns. Over the past 12 years, the average returns were low:

ROIC ranged from negative 21% to 16 % with an average of negative 2%.

ROE ranged from negative 21 % to 13 % with an average of negative 2%.

I would consider Mesiniaga’s performance as poor. There was a declining topline and no improvement in capital efficiency (as represented by the gross profitability). The poor operating results were because it was operating below its “breakeven level” most of the time.

This is illustrated in the left part of Chart 2 where I have broken down the operating profit into various components. In the Chart, the gap between revenue and total costs (fixed + variable) represents the operating profit.

You can see that this is a business with high fixed costs. On average, fixed cost was about 39% of the total cost. As mentioned earlier, with such an operating model, changes in revenue will have a big impact on the profits.

There was operating profit for only 7 years during the past 12 years. I have already mentioned low revenue being part of the reason for this.

Another reason was the low gross profit margins. You can see from the right part of Chart 2 that the gross profit margins were volatile with an average of 37%. This led to volatile contribution margins that ranged from 29 % to 47 % with an average of 39%.

The only positive point was that the Group had been able to control its fixed costs. Over the past 12 years, its fixed cost as a % of the total cost (fixed + variable) had declined from an average of 38 % in 2012/13 to an average of 32 % in 2022/23.

Chart 2: Operating Profit and Operating Trends

Note to Op Profit Profile. I broke down the operating profits into fixed costs and variable costs.

Fixed cost = SGA, Depreciation & Amortization and Others.
Variable cost = Cost of Sales – Depreciation & Amortization.
Contribution = Revenue – Variable Cost.
Contribution margin = Contribution/Revenue

Growth prospects

Cost control can only help up to a certain point. In the longer term, you need topline growth.

There are opportunities for revenue growth. The ICT sector in Malaysia is not a sunset one as shown by the following market research reports:

“The Malaysia ICT Market size is estimated at USD 27.20 billion in 2024, and is expected to reach USD 39.18 billion by 2029, growing at a CAGR of 7.57% during the forecast period (2024-2029).” Mordor Intelligence

“Malaysia’s overall ICT market was pegged at over $20 billion in 2022 and is expected to grow at a CAGR of more than 16% during 2022-2027 to reach over $44 billion…” Global Data

Looking at Mesiniaga’s performance, I would say that it has lost market share. This is a Group undergoing a turnaround.

Peer comparison

In 2022, I published an article titled “Hunting for Bursa Malaysia ICT Services and software companies”. The analyses covered 22 Bursa Malaysia ICT services and software companies under the ACE Board and 17 companies under the Main Board.

I had concluded that this was 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 (2010 to 2021). Based on the individual company ROE, about 68 % of the ACE Board had individual negative ROE. For the Main Board companies, this was 59%

Mesiniaga was one of the 17 Main Board companies. In that article, I also compiled the base rates for the sector covering 2010 to 2021.

I will use these base rates to compare Mesiniaga's performance for 6 metrics. Overall, I would rate Mesiniaga's performance as about similar to the Main Board's median performance. My rationales were as follows:

I have already mentioned Mesiniaga’s poor revenue performance. You can see this clearly from the left part of Chart 3. While Mesiniaga experienced a revenue downtrend from 2010 to 2021, this was opposite to the sector median revenue.

The right part of Chart 3 shows that Mesiniaga and the sector experienced declining PAT margin trends. I would consider Mesiniaga's performance to be about the same as the sector for this metric.

Chart 3: Peer Revenue and PAT Margin

When it came to capital efficiency, the results were mixed:

Mesiniaga's gross profitability was better than the sector most of the time. The exception was in 2021. Refer to the left part of Chart 4.

Mesiniaga had a more volatile ROE compared to the sector. Its average ROE of negative 1 % was similar to that of the ACE sector average ROE. But it was lower than the Main Board's average ROE of 3%. Refer to the right part of Chart 4.

Chart 4: Peer Gross Profitability and ROE

Mesiniaga's average DE ratio was similar to that of the median DE ratio of the Main Board companies. These in turn were higher than the median DE for the ACE companies. Refer to the right part of Chart 5.

Mesiniaga had a larger average cash flow from operations but it was also more volatile.

Chart 5: Peer DE and Cash Flow from Ops

Financial position

Notwithstanding the poor business operations, Mesiniaga is financially strong.

As of the end of Dec 2023, it had RM 65 million cash and cash equivalents. This is about 27% of the total assets.

As of the end of Dec 2023, it had a Debt Equity ratio of 13%. This had come down from its 2012 high of 35 %.

While there were 6 years of loss after tax over the past 12 years, there were only 4 years with negative cash flow from operations. During the past 12 years, it generated a total of RM 118 million from the cash flow from operations compared to a total net loss of RM 23 million. This is a good cash conversion ratio.

It has a good capital allocation plan as shown in Table 1. Its cash flow from operations was sufficient to cover its CAPEX and the balance was used to reduce debt and pay dividends.

Table 1: Sources and Uses of Funds 2012 to 2023

As an ICT Group, the key is its investment in R&D. Over the past few years, the Group had mentioned investing RM 2 million annually in R&D. However, I could not find any information on how this was treated in its accounts. Was it part of the operating expense? Or was it capitalized as part of the CAPEX?

Valuation

The Asset Value of Mesiniaga is RM 1.83 per share (as of Dec 2023) compared to its market price of RM 1.60 per share (as of 24 May 2024).

The main reason for the low market price is that the market is looking at earnings. In this respect,

Its past 12 years average EPS was negative.

Its average EPS over the past 3 years (with positive earnings) was RM 0.09 per share. As such you should not be surprised by the RM 1.60 market price as this was equal to a PE multiple of 18.

Mesiniaga is undergoing a turnaround. Its value would depend on the assumption of the turnaround performance. Rather than attempt to project this, I reverse-engineered the market price to determine the expected revenue.

This resulted in an annual revenue of RM 285 million with an intrinsic value of RM 1.64 per share. This is close enough to the current market price.

Chart 6: Valuation

Over the past 3 years, the average revenue was only RM 264 million. The market has priced in expectation of some turnaround.

However, my analyses suggest that the turnaround is going to be challenging as it is about changing the business direction. It is a strategy issue and not merely an operating one. You can understand why I do not consider that there is a sufficient margin of safety currently. I have missed the boat.

Valuation model

I valued Mesiniaga using a single-stage discounted free cash flow to the firm (FCFF) model.

Value of the firm = FCFF X (1 + g) / (r - g).

FCFF = EBIT(1 - tax rate) - Reinvestment.

The EBIT was based on the operating profit model illustrated in the left part of Chart 2.

The valuation model is illustrated in Table 2.

Table 2: Valuation model

Most of the items in the model are self-explanatory except for the following:

Item h. I excluded 2019 as the ratio for the year was negative due to the high cash position.

Item k. From the fundamental growth equation. Growth rate = Reinvestment rate X Return.

Item n. I derived the WACC following Damodaran's approach with a 2.4 % risk-free rate, an unleveled Beta of 1.01 for the information services sector, and a 24 % tax rate.

Case Notes

Investing in technology companies can be more challenging due to the nature of the products and services.

According to Bain & Company,

In the tech sector, investors are attracted to young, disruptive companies based on their growth potential.

As companies and their markets mature, investors expect a mix of growth and returns.

Mature companies with a proven track record in stable markets can expect slower growth while their investors are closely focused on profitability and return on invested capital.

Understanding where your company is in its life cycle and signaling expectations to the right group of investors is essential for attracting the capital that companies need to operate.

Understanding where a company is in the life cycle impacts your valuation. This comes with experience. One way to accelerate your learning curve is to look at how others have carried out DCF valuations. One good source of this is sites like Seeking Alpha*. Click the link for some free stock valuation examples. If you subscribe to their services, you can tap into their business analysis and valuation.

Conclusion

Mesiniaga's business performance is nothing to shout about:

Revenue, PAT, and gross profitability have been on declining trends.

It delivered an average negative ROIC and ROE over the past 12 years.

It is in a sector where it is challenging to make money.

But there were some positive points:

It is financially sound.

It had been able to manage its fixed costs as revenue declined.

Mesiniaga has been in the technology business for more than four decades. In its 2023 Annual Report, it stated that:

“Within the last 42 years, the technology landscape has changed tremendously. New trends have emerged resulting in changes in how companies do business.”

I would like to postulate that the declining revenue and performance are because Mesiniaga has not been successful in addressing the changing technology landscape. This is not because of a lack of trying.

“…we ventured into Smart Developments, Business Analytics, Mobility, Network Operations Centre (NOC), and Cloud technology.” 2012 Annual Report

“…we started the Product Differentiation Initiative…required that we rethink existing businesses…” 2015 Annual Report

“This year’s report is built upon Mesiniaga’s aspiration of accelerating digital growth through Robotic Process Automation (RPA), Internet of Things (IoT) and Blockchain.” 2018 Annual Report

“…offer solutions such as Edge Computing (MEC) for Edge Cloud, Network Function Virtual Infrastructure (NFVI) for Core Cloud and Service Orchestration System. These are part of our strategic skills and strengths to support 5G Deployment and Malaysia’s Digital Transformation Agenda” 2021 Annual Report

“…we have intensified efforts and investments…focusing mainly on Application Development, Cybersecurity, and Artificial Intelligence (AI)… to meet the needs of our customers, stay ahead of the industry trends, and remain relevant in the Malaysian Digital Economy ecosystem.” 2023 Annual Report

As illustrated above, Mesiniaga has yet to find a business direction that will enable it to tap the growing ICT market.

The goal is topline growth. Until it finds the appropriate strategy that can deliver continuous topline growth, it will continue with the lackluster performance. Accordingly, this is not an investment opportunity given the lack of a margin of safety.

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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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