Answer from RCE Capital for RM18 cash purchase of a one-month old IT firm

I remember a reader asked on RCE Capital's purchase of a company for RM18 million cash. Well, here is the answer that the CEO of RCE Capital has provided. If it is something that will provide competitive advantage, I am all for it. The biggest question however is "how come the company, Urusan Ihsan was just incorporated on July 2012." This one is the biggest question mark, don't you think? Usually, software development work will take more than a month or two to build on. The CEO focused his answer on the code mechanism.

My understanding on companies such as Urusan Ihsan is that for it to build on something, there must be an economic reason to do that. When they have built some code mechanisms which to RCE is so valuable for it to pay RM18 million, then Urusan Ihsan must have thought of selling its system to more than one company, usually RCE and its competitors. Is RCE into reducing competition due to the "code mechanism"? As I see it RCE only has 2 competitors - BSN and Bank Rakyat.

Is RM18 million worthwhile? The one thing I know is that the owners of Urusan Ihsan stand to make 10x within 1 month from incorporation. Wow!

Why I appreciate better businesses than cheap stocks

There is this quote from Warren Buffett, 'It is better to buy a great company at a fair price than a fair company at a great price.’

If you follow my blog, I am in awe for great businesses rather than cheaper undervalued stocks. As an example, I did say I see greater heights in Nestle, while I have some reservations over RCE Capital despite its valuation is way undervalued and attractive (PE) due to some structural problems. Well, these are my opinion. Nestle's PE is about 29x while RCE's PE is around 5x. Some readers, I noticed prefer value buy - nothing wrong with that.

Now, let me tell you again why I am into great companies. Great companies are built by great business people - at least during the process of building the business, there is at least one individual why has created the DNA of a great company. See Wal-Mart (Sam Walton), Apple (Steve Jobs, of course), Genting (Lim Goh Tong) and even Coca-cola was helmed by several great individuals. Great companies can attract more investors.

Now, think of stocks as a business investment and we as investors put the trust of our decision into the hands of these businessmen. Along the way in the process of building the business, for sure they would have their hands in acquisitions, expansion, divestiture etc. A great leader may have put their skills into test by making decisions that benefit the business in doing that acquisition or divestment. Even in divestment, they would probably know when to divest a business or what their foresight would be like in business decisions that they make. The CEOs literally invest for us besides just managing the company. His / her future action is what you pay for now. Question is, are you willing to pay a premium for a great manager or are you willing to pay below average for an average manager?

Just as an example, Genting Malaysia's foray into Australia, Miami and New York's gaming business. If you are an investor of Genting, your investment is dependent on their decision making on these investments. You are investing into the management as well, not just the company and the brand. In a great company, you are investing into a company which other people are looking to invest as well. Great companies attract more attention. Additionally, owners of great businesses tend not to sell (at fair price) - especially after all the hard work of building it. On the other hand, if the business is just average, the tendency to sell would probably be higher.

Undervalued?

Now, turn it around and let's see a company which is grossly undervalued - Insas. It is now trading at RM0.41. Its book value is RM1.40, hence trading at 70% below book value. If you have invested into the company, you probably have not seen much gain. I have noticed this company for years but to be frank I am probably lucky I did not put my money into it as I was doing a sum-of-parts analysis, and it is attractive now and before. I was really attracted to the idea of buying some stocks - 7 years ago and if I had bought and held it until now, I would probably see no gain.

Let me ask you, are you going to put your money into this company now that you know it is undervalued? Bear in mind, it could have called for a delisting exercise at a slight premium to its price today. You as a minority investor would probably have no say. Again, I probably would not know what is in store for the future but if I have made my decision 7 years ago, I would not have liked it.

On the other hand, if you found a great company with undervalued prices, then you have hit a jackpot!

RCE Capital: Low PE may not mean good value

If you are looking for a really low PE stock, RCE Capital stands out. At its current price of RM0.50, it is trading at PE of below 3.5x! Low enough? I am not too sure of another company in Bursa with such low PE except for some companies with one-year wonder performance.


RCE Capital is not a one-year wonder. It in fact has fantastic growth. Just look at its performance below:

Despite having those growth and such low PE, why is RCE still languishing at 50 cents. Here is a company which 5 years ago Kenanga, Aseambankers (Maybank IB) put a price tag of RM1.20 to RM1.30.

RCE Cap's price never touch RM1.20. Look below.

Why is it languishing? We probably have to trace back to what RCE does and where is its competitive advantage as a business.

RCE is a moneylender which provides hire purchase and personal financing loan to government employees. It is quite unique in the sense that it is the only listed non-financial institutions that provide financial assistance to government servant such as teachers and police. It ties up with with three co-operatives: Koperasi Wawasan Pekerja-pekerja Bhd, Koperasi Sejati Bhd and Koperasi Belia Nasional Bhd.

In minimizing non-performing loans, monthly collections are done via deductions from salaries of these workers. So who are its main competitors? Bank Rakyat, Bank Simpanan Nasional. In fact RCE is so small compared to these two that it only manages to capture less than 2% of the market. In most reports provided by analysts, they mentioned potential upsides which are the low NPL and market share which is a huge potential to RCE.

Here, I would like to highlight 2 main areas which RCE is struggling with.
  

Cost of funds

• While RCE is a moneylender, it is also a borrower. Unlike BSN, RCE's Cost of Funds is not low as it is a non-deposit taking company. The funds that it uses to lend to the government comes from its own equity raised and bond. Against its other main competitor, such as BSN and Bank Rakyat, it loses out here. When your costs are higher than your competitors (and in this case it has no choice due to law and circumstances), overtime it will lose out.

High Rate of financing

• Financing rate RCE charges to its borrowers are around 11 - 12%. What is the market rate charges by the banks to the public? 8%, 9% or even at most 12%. (I would like to think that) Government servants are not stupid. They will find out and look for other means of financing over time although in the short run they may find the ease of getting financing from RCE, Bank Rakyat attractive.

In any case, as in the announcement below, it already shows that KOWAJA is not happy with the terms of financing from RCE. 

RCE wishes to inform that Koperasi Wawasan Perkerja-Pekerja Berhad (“KOWAJA”) had on 8 June 2011 advised that KOWAJA has received approval from Suruhanjaya Koperasi Malaysia (“SKM”) to obtain funding from RCE Marketing Sdn Bhd (“RCEM”), a wholly-owned subsidiary of RCE, subject to a limit of RM200 million (the “Approval”).  KOWAJA is currently the largest borrower of RCEM. KOWAJA provides personal loans to its members who are primarily in the civil service.   

The Approval is subject to stringent operational, funding and other conditions. The funding conditions comprise pricing cap, security/collateral restrictions and structuring limitations. KOWAJA is confident of meeting the operational requirements of SKM and will work towards continuously complying with them going forward.  

RCE does not expect the Approval to have any material financial impact to the Group for the financial year ending 31 March 2012 and on its ability to meet interest and principal payments in respect of its debt obligations.  

However, the impact on the prospects of RCE is dependent on market conditions as well as industry and regulatory developments.   

Despite having written the above, RCE will not lose out immediately in the short run as it will still continue to enjoy the profits it has already lent out some of the funds to its borrowers and government servants may still continue to borrow from them. RCE is still attractive from the perspective of its earnings in future vs the share price. Price to Book Value (Below 1) is attractive as well. Despite the setback from the KOWAJA issues, the effect will only be felt few years down the road. However, as long as it continues to charge higher than the market rate and its costs remain higher than its competitors, this is not a long term stock.

Market anyway probably know this well already, as in the share price.

Serious Investing! 

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