The Receivables Issue And Megan

My Dearest Moo Moo Cow,

I made this following post to you and I know realize that there's so much more I wanted to add to the posting, so I have decided to make a brand new post on it.

Do you visit Mr. David Webb's website, Webb-Site.com? One of his older postings written last year is a posting called, Blackout on Receivables.

The following passage was extremely interesting in my opinion.

• Do you remember why Peregrine Investment Holdings Ltd collapsed? It was because of a very large bridging loan, made in the ordinary course of business, on normal commercial terms, to an Indonesian taxi company. That's the kind of information which, if disclosed to investors, would indicate that their company may be taking large amounts of concentrated credit risk, and would be likely to affect the share price.
  

  Other examples of accounts receivable leading to difficulties include the recently delisted Wanasports Holdings Ltd (8020), a retail franchisor, which collapsed after supplying large amounts of inventory to franchisees for which they were not paid. The accounts receivable were disclosed in this announcement.
  
  In another case, the rule was breached by Thiz Technology Group Ltd (8119) which belatedly admitted on 18-Apr-05 to having given credit to a single customer amounting to 84% of Thiz's market value. That was after we pointed out the probable breach in our article of 21-Mar-05.

Can you relate this to the posting, Auditing Megan?

• Do you know that the (Megan Media) trade receivables compounded at an whopping 66.4% per annum since its fy 2003?

Well they say that growth is finite. And if that is the case, then in Megan's case, this insane receivables bubble will burst SOON. And when it does, 430.354 million of trade receivables will cause SEVERE DAMAGE to the company!

Consider the following issue. Let's go back in time to March 2004. The following is an excerpt from Surf 88 (an independant investment website which no longer exists)

• Exceptional boost. Megan Media (RM3.32, stock code 7101) recognised RM12.8M negative goodwill in its Nov 03 – Jan 04 quarter from the acquisition of MJC (Singapore) Pte Ltd (MJCS), propelling a more than doubling in sequential net profit. This is also the case on cumulative nine-month basis (May 03 – Jan 04 against May 02 – Jan 03).
  
  Excluding the exceptional item which had no cashflow implications, Megan Media still posted a commendable performance within our expectations. Nine-month sales more than doubled from the corresponding period last year on the back of continual capacity expansion, offsetting pricing pressures from DVD-R to still drive pretax profit 36% higher. Note that the nine-month results included about one month contribution from MJCS, without which turnover would have still expanded by 127%.
  
  Still promising outlook. The outlook for Megan Media remains promising as the merged entity (with MJCS) continues to raise capacity to strengthen its industry positioning while improving economies of scale. This would compensate lower prices for DVD-R, while CD-R prices are expected to be stable in comparison.
  
  Incorporating MJCS, Megan Media’s production capacity has increased by 50%. Meanwhile, the first production line in its new factory, which will add another 1.5x capacity upon full commissioning, is expected to start commercial production soon. The new factory can house 22 lines eventually, of which 10 lines will be installed in stages for 2004. The new lines are switchable between CD-R and DVD-R production, although Megan Media plans to focus more on DVD-R which it expects to outpace the growth of CD-R next year.

This one sentence caught my attention.

• Note that the nine-month results included about one month contribution from MJCS, without which turnover would have still expanded by 127%.

So Megan's purchase of MJC drew a lot of flak because it was a related-party transaction, in which Yeo Wee Siong (Executive Director and substantial shareholder of Megan) and Yeo Wee Koon (substantial shareholder of Megan) jointly controlled MJCS.

In another posting by Surf 88,

• …while raising net debt to 1.9x shareholders’ funds. At the same time though, one would have to keep a closer watch on Megan’s post-acquisition balance sheet. On its own and following aggressive expansion, Megan’s net debt has been raised to RM101M, or 62% of shareholders’ funds as of Jan 2003. Servicing ability though looked well manageable with pretax interest cover of above 4x in the latest quarter ended Jan 2003. Post acquisition, Megan would have to take on RM97M in purchase funding, as well as another RM135M borrowings currently under MJCS. On a pro-forma basis, group net debt would be raised to about 1.9x shareholders’ funds, after incorporating MJCS’ proposed sale of Megan shares.

The point was the Yeo's sold their company to Megan and along with it rm135 million in borrowings.

Now that's not all. That's old news. What I wanted to focus on is the receivables issue and note when this receivables really started to snowball.

Since MJC started contributing earnings to Megan back in March 2004, I would just do a simple before and after comparison.

22nd Dec 2003. Quarterly rpt on consolidated results for the financial period ended 31/10/2003 ( Receivables at 88.933 million)

30th March 2004. Quarterly rpt on consolidated results for the financial period ended 31/1/2004 (Surf 88 stated that MJC started contributing earnings for this quarter. Receivables is now at 158.130. Receivables ballooned by 69.197 million. How much was it contributed by MJC? )

29th June 2004. Quarterly rpt on consolidated results for the financial period ended 30/4/2004 (receivables now at 189.964 million)

How?

Again my question is simple. How much did MJC contributed to this receivables issue?

Which is why in Re Megan again I brought up the issue that Yeo Wee Siong is now longer a majority shareholder! And given what had transpired, it's not too difficult to understand why! See how Yeo had sold his company which had high debts to Megan? See how Megan's receivables started to inflate after this MJC purchase?

Anyway, back to the receivables issue. I remembered this morning that I had posted on this issue before. ( see http://everything27.blogspot.com/2006/02/trade-receivables.html )And this is what I wrote back then.

• I believe I have mentioned several times on the issue of trade receivables issue in Megan Media. (see Megan: Part VIII )
  
  I was shifting through some of my old market notes and issues on our listed shares, I came across this incident regarding Bintai Kinden.
  
  Have a look inside the following quarterly earnings announcement. Click on the attached excel worksheet attached.
  
  Quarterly rpt on consolidated results for the financial period ended 31/3/2005
  
  Look into the balance sheet and look for the trade receivables amount. It showed Bintai Kinden had a huge trade receivables amounting to 373.841 million versus 215.411 million. Which is a good example of a company's having a build-up in their trade receivables.
  
  Just for the record, that quarterly earnings was announced on 31st May 2005 and Bintai Kinden announced a net loss of 13.843 million for fiscal year 2005.
  
  A couple of months later, 29th July 2005, Bintai Kinden made another announcement. See below:
  
  Variance between audited and unaudited results for the financial year ended 31 March 2005
  
  The Board of Directors of Bintai Kinden Corporation Berhad ("the Company") wishes to announce that the Group's audited loss after tax and minority interest for the financial year ended 31 March 2005 was RM19,149,000 as compared to the unaudited Interim Report for the same financial year announced on 31 May 2005 of RM13,843,000.
  
  The deviation was mainly attributable to the trade receivables due from a sub-contractor to a subsidiary company of the Group whose sub-contractor's agreement with the subsidiary company was terminated during the financial year. Subsequently, the subsidiary company made an allowance for doubtful debts of RM6.5 million notwithstanding that the company is in the process of recovering the amount due from the sub-contractor.
  
  The issue here is not on Bintai Kinden but the deviation in earnings attributable to the trade receivables, forcing an allowance for doubtful debts of 6.5 million to be made.
  
  Point is .. when trade receivables keeps on increasing each single quarter, then it is utmost prudent that the investor be on the alert... for these trade receivables can easily be re-classified as doubtful debts! Which ultimately means the company did not earn as much money as it reported it did!
  
  So when a company's earning report keeps showing an increase in trade receivables... then it's best we be on the alert!
  
  Remember the old salesman saying again... a sale is not a sale until the money is pocketed!

See how the trade receivables were re-classified as doubful debts? So do note.

• Point is .. when trade receivables keeps on increasing each single quarter, then it is utmost prudent that the investor be on the alert... for these trade receivables can easily be re-classified as doubtful debts!

And for Megan's case, this trade receivables is now at 430.354 million.

How much is 430.354 million?

How about these comparisons? The receivables is now 15x Megan's cash on hand. The receivables is now 48.4% of its total borrowings. Scary?

Now consider this.

We know that these receivables which has COMPOUNDED at a rate of 66.4% since 2003.

We know that such growth is clearly not sustainable and sooner but not later it will go burst and when it does, the question that needs to be asked is how much of these receivables will be classified as doubtful/bad debts?

And when this happens, mark my words, the damages will be severe!