Time Out for Timeless
24 November 1999
Thursday 25th November sees a small moment in Hong Kong's history as the first two counters begin trading on GEM, the Growth Enterprises Market. One of these is Timeless Software.
Background
Timeless was incorporated on 12-Mar-96 and unusually, there has been no restructuring into a Bermudan holding company prior to the listing. What you get is the original Hong Kong company.
By 18-Nov-97 (two years before listing, which for Stock Exchange purposes is the dawn of time) the company had 10m shares of HK$1 each in issue, 60% held by Encore Holdings Ltd (Encore), 20% by the Chairman, Mr Cheng Kin Kwan, and 20% by the Chief Operating Officer, Danny Cheng Wan Cheung. As far as we know the two are not related.
The company has made several small acquisitions for cash. It acquired Three Principles Computer Service Co Ltd in 1996 for a total of HK$7m. It acquired Expert Consulting Ltd (formerly Expert System Solutions Ltd), buying 60% in Jul-97 and 40% in Jun-98 for a total of $5m. It acquired a publication called IT Magazine in the form of Corp-Vision Publishing Ltd for just $0.3m on 23-Jan-99, and in Sep-98 it agreed to invest $8m in 80% of a joint venture with the Zhuhai Southern Software Park where the JV will be a tenant and hope to sell services to other tenants. The JV does not own any of the property.
By 31-Aug-99, the company had recorded an accumulated loss of HK$45.2m. A large part of this was funded by an interest-bearing loan from Mr Choi Kin Chung, who owns 25% of Encore and was a director from 20-Mar-96 to 30-Sep-97 and again from 24-Aug-98 to 5-Jun-99.
On 21-Aug-98, Mr Laurie Kan Siu Kei invested $2m at the equivalent of $0.05 per current share (allowing for a 20:1 stock split) for 40m shares. He joined the company in Mar-98 as President, and was previously the Managing Director of Microsoft (Hong Kong) Ltd.
This is a busy week for Mr Kan, because (unless there are two people of the same name and age) he is also an independent non-executive director of Pine Technology Holdings, which starts trading on GEM on Friday 26-Nov-99. In the Pine prospectus, he is described as general manager of SINA.COM (Hong Kong) Limited. Can this really be the same person?
On 30-Dec-98, employees were allotted 4m shares (since split to 80m shares) at an effective $0.05 per current share. This was followed on 16-Nov-99 (last week) by a further 60m post-split shares at the same price, of which 28m shares went to directors.
Crimson Asia Capital
On 19-Jun-99 Crimson Investments, Ltd and Crimson Asia Capital Ltd L.P. agreed to invest a total of US$11m (HK$85.25m) in two stages; HK$65m on 7-Jul-99, and HK$20.25m on 2-Nov-99 (just 3 weeks ago) by exercising an option.
In both injections, Crimson bought in at US$1 (HK$7.75) per share, but the stock has since split 20:1 so the effective price is HK$0.3875 per share. The prospectus does not provide this analysis.
By contrast, the issue price in the IPO on GEM (which has been done by way of placing without a public offer) is HK$3.00 per share, and Crimson's stake would be worth $660m at that price. Now forgive us for being stupid, but why is something that the company was willing to sell 4 months ago at $0.3875 now worth $3 per share?
Over-allotment
Crimson is only locked into the holding for 6 months. Indeed, they have signed (along with other shareholders, including management) an "over-allocation" option which allows the underwriters to buy up to 25m existing shares until 18-Dec-99 to satisfy demand for the stock. This provides a novel way of avoiding the 2-year lock-up rule to which management are supposed to be subject, and we wonder if other companies will head this way. Of the 25m shares, 54%, or $40.5m worth, would come from the two Crimson investors, recovering half their cash investment if fully taken up. 19.2%, or 4.8m shares, would come from 3 directors in equal proportions, releasing $14.4m of cash.
This is not an internet company
Let's be clear. This is not what we consider to be an internet company. It is a software solutions provider. It takes off-the-shelf software such as Oracle and customises applications for clients. It designs and programs web sites for clients, but has no real internet properties of its own. There are dozens of companies doing the same thing. It is a people business that relies very much on its programmers and designers.
In the year to 31-Mar-99, over 44.4% (nice lucky number) of the firm's business came from Y2K compliancy work for customers. How much of that do you expect after Y2K? Total turnover was $43.3m, and the IPO values it at $2,250m, or 52 times turnover. You would be lucky in the long-run to achieve profit margins of 30% on software solutions business, and probably less. Your biggest cost is keeping the talented brains behind the keyboards.
The valuation on this business, at 122 times pro forma fully-diluted forecast earnings (or 89 times weighted-average earnings), for the year ending 31-Mar-00, is ridiculous. Even highly-rated Automated Systems Holdings, which has a blue-chip client list and turnover of $605m last year (14 times that of Timeless), trades on "only" around 28x earnings, a figure we find excessive but not ridiculous. That values ASH at $1.14bn, or half the value placed on Timeless. Which would you rather own?
So Timeless is one GEM listing that will not sparkle. All that glitters is not gold.
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