Silverlake Axis has been one of those stocks I've been waiting to add into the portfolio for a very long time. I missed the great run-up a few years ago and I've been waiting since then. Today, I took the opportunity to add them at a purchase price of $0.94 for 12,000 shares.
It appears that given the fierce short selling these few weeks, it does look like I am playing a catch to a falling knife. In any case, I'll present my views given that I have now purchased them as part of inclusion into my portfolio.
I shall not delve too much into the fundamental numbers which EOTS has done a great job on it (Link Here), so I'll touch on the others which he has not.
High Gross & Net Profit Margins
I love companies that has the ability to churn out high gross and net profit margins.
The business models operate in such a way that they do not particularly incur high overhead costs and as such bottom line margins are very strong at more than 55%.
Strong FCF and Low Capex
The majority of their assets consists of the intangible assets which gets amortized from time to time. This adds back into the operating cashflow which is also one of the reason why their free cash flow is so strong. The company also do not require high maintenance of capex and often use their excess cashflow to grow the business through inorganic acquisition phase.
Valuation
Before the previous drop in share price from $1.49, Silverlake was trading at around 28x PER. At the current price I bought, it was trading at around 20x PER. It's still not cheap by any standard but given the extremely strong profit margin, relatively no debt structure in balance sheet and a very strong return on equity, this is a premium that I am willing to pay for its business moat and aggressive expansion. If you are looking to get something cheaper, then you would most likely compromise either of the following or perhaps be waiting for a recession to come to get them cheap.
Some of the other competitors such as Infosys or Oracle are trading at around 20x PER, but take a look at their debt structure.
The other thing to take note is that the company has been very aggressive in their growth with the acquisition and expansion into other region through the placement of shares. Given that the management wants to increase liquidity of its own shares, it seems logical that they are issuing equity instead of using their own internal funds, though is is more expensive to do so.
The management has proposed a bonus consideration of 1 free share for every 5 existing shares held. This is a 20% dilution should EPS remains the same and a big worry to existing investors. Given the track record and aggressiveness of the management, my take is that the company will grow its EPS for next year for more than 20% in order to make the issuance of shares accretive. Some people may not like the way the management operates but there's a lot of other companies who are doing the same strategy. CMPH and 2nd Chance are one of those companies doing almost the same way.
Alleged Accusations?
I've read on the article a few times regarding the content written relating to this.
Obviously, I am not a subject expert on this matter as the writer has done but based on my professional accounting knowledge and experience, I will provide my views.
1.) Acquisition to inflate profits
Based on the article, the writer mentioned that Silverlake acquires some of the related party companies with high profits, high ROE but weak balance sheet. They recognize the huge profits first, then subsequently impaired them as a loss in their balance sheet over time. In other cases, they would book the loss as part of the share of loss in associate, but revenue and profits have already been recognized in the income statement.
My Take - This obviously has implications such that profits in income statement looks overstated if proven true but from the accounting (and auditor) point of view, not to mention layman, it is actually very difficult to ascertain the probability of impairment at the point in time when the audited statement is being done. Now that we look back at what is being done historically, we can easily ascertain what is true and what is not, but the fact that whether they are being done intentionally or not remains in question and the company has obviously denied the allegations.
2.) Timeliness of Revenue Recognition
My Take - This obviously has implications such that profits in income statement looks overstated if proven true but from the accounting (and auditor) point of view, not to mention layman, it is actually very difficult to ascertain the probability of impairment at the point in time when the audited statement is being done. Now that we look back at what is being done historically, we can easily ascertain what is true and what is not, but the fact that whether they are being done intentionally or not remains in question and the company has obviously denied the allegations.
2.) Timeliness of Revenue Recognition
Based on the article, the writer argued that due to the business model they are operating, they are required to collect cash upfront from customers, including regular maintenance fees, before selling the product later on to recognize the gain. This leads up to potential manipulation of numbers in revenue recognition principle as deferred revenue are recognized only when services have been rendered and the rest are amortized over a straight line basis.
My Take - As someone working in this line, I can ascertain that revenue recognition principle is one of those things that is extremely difficult to handle and can be subject to manipulation and still is very difficult to be caught by auditors. This is not solely a problem for Silverlake itself but for many companies since everyone is doing the accrual accounting and not cash accounting method. The thing about this is it is often very grey in certain areas and one end of the stakeholders could have different views from the others, and yet both can still be right.
If this is merely a timeliness issue, I wouldn't be so worried at that. But if these are incomes that are purposely manipulated for future income that will not come, then that will become an issue. Investors will have to note at that more closely when that happens.
Final Thoughts
Everyone is obviously going short on this counter at the moment.
But there will come a point where the share price proves to be an attractive entry once again, as long as the company's fundamentals remain solid. For those who are trying to long this stock, please do your own due diligence.
My Take - As someone working in this line, I can ascertain that revenue recognition principle is one of those things that is extremely difficult to handle and can be subject to manipulation and still is very difficult to be caught by auditors. This is not solely a problem for Silverlake itself but for many companies since everyone is doing the accrual accounting and not cash accounting method. The thing about this is it is often very grey in certain areas and one end of the stakeholders could have different views from the others, and yet both can still be right.
If this is merely a timeliness issue, I wouldn't be so worried at that. But if these are incomes that are purposely manipulated for future income that will not come, then that will become an issue. Investors will have to note at that more closely when that happens.
Final Thoughts
Everyone is obviously going short on this counter at the moment.
But there will come a point where the share price proves to be an attractive entry once again, as long as the company's fundamentals remain solid. For those who are trying to long this stock, please do your own due diligence.
