Silverlake RaymondKwong GohPengOoiSilverlake MD Raymond Kwong and Founder-Chairman Goh Peng Ooi. Photo: CompanySILVERLAKE AXIS has been one of those stocks I've been waiting to add to my 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 it at a purchase price of $0.94 for 12,000 shares.


Given the fierce short selling these few weeks, it does look like I am catching a falling knife. In any case, I'll present my views given that I have now purchased the stock.

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 have the ability to churn out high gross and net profit margins. 

Silverlake operates in such a way that it does not 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 intangibles which get amortized from time to time. This adds back into the operating cashflow which is also one of the reasons why their free cash flow is so strong. The company also does not require high maintenance of capex and often use their excess cashflow to grow the business through inorganic acquisitions. 

Valuation

Before the drop in share price from $1.49, Silverlake was trading at around 28x PER. At the 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, almost no debt in the 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 are waiting for a recession to come along to get them cheap.

Some of the competitors such as Infosys or Oracle are trading at around 20x PER, but take a look at their debt structures.

The other thing to take note is that Silverlake has been very aggressive in their growth with the acquisition and expansion into other regions through the placement of shares. Given that the management wants to increase liquidity of its own shares, it seems logical that they issue equity instead of using 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 remain 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 next year at more than 20% in order to make the issuance of shares accretive. Some people may not like the way the management operates but there are a lot of other companies who are using the same strategy. CMPH and 2nd Chance are among them.

Allegations

I've read a few times a certain article that made allegations about Silverlake's accounting practices. Based on my professional accounting knowledge and experience, I will provide my views, as follows.

1.) Acquisition to inflate profits
The writer mentioned that Silverlake acquires some related party companies with high profits, high ROE but weak balance sheets. They recognize the huge profits first, then subsequently impair 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 of associate, but revenue and profits have already been recognized in the income statement.

My take - Profits in income statement look 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 done. Now that we look back at what has been done historically, we can easily ascertain what is true and what is not, but whether they are being done intentionally or not remains in question and the company has obviously denied the allegations.

2.) Timeliness of Revenue Recognition

The writer argued that due to the business model, the company is required to collect cash upfront from customers, including regular maintenance fees, before selling the product to recognize the gain. This leads to potential manipulation of numbers in revenue recognition 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 the accounting line, I can ascertain that revenue recognition principle is one of those things that are extremely difficult to handle and can be subject to manipulation and still are very difficult to be caught by auditors. This is not solely a problem for Silverlake but for many companies since everyone is doing accrual accounting and not cash accounting. The thing about this is it is often very grey in certain areas and different stakeholders could have different views, and yet are still right.

If this is merely a timeliness issue, I wouldn't be so worried. 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 attractive 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.

BrianHalimThis article was recently published on A Path to Forever Financial Freedom, and is republished with permission. The writer (left), who is in his late 20s, has a MBA degree.




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