Maybank Kim Eng 2015-08-27: Silverlake Axis - Simulating for Transactions.

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SILVERLAKE AXIS LTD 5CP.SI

Simulating for Transactions 

• Market concerned that profits have been artificially inflated by interested-persons transactions. 
• Profits could fall 49-64% if we adjust for these under three scenarios. 
• Company needs to reassure investors that private entities are not subsidising its costs. Maintain HOLD & SGD0.61 DCF TP pending clarity on the transactions. 

What if we adjust for transactions? 

• We believe the market is worried that SAL’s profits have been artificially inflated by its interested-persons transactions with private entities under its Chairman. We attempt to quantify the downside to its profits by adjusting its financials for these transactions, under three scenarios. 
• Our analysis suggests that simply removing all revenue from related parties could result in a 49% decline in its net profit. If we also increase costs charged to these parties by 100%, SAL’s net profit could be 64% lower than reported, in our simulation. 

SAL needs to prove earnings sustainability

•  Three points in its response to a recent short seller’s report  are: 
  1. it is seeking legal advice and will take the necessary actions; 
  2. it does not have undisclosed contingent liabilities; and 
  3. it has engaged Deloitte Singapore to review the allegations independently on its transactions and associated profit margins. 
• While engaging an independent party to review the allegations would help address concerns, we believe SAL also needs to improve its disclosures. Management will need to assure investors that the private entities are not subsidising the costs of the listed company as this may not be sustainable. 
• Until disclosure is improved, we expect a cap on its share price. 
• Maintain HOLD and SGD0.61 TP (30% discount to DCF; WACC 9.3%, TG 3%) pending further clarity on its interested-persons transactions. 

Adjusting for the transactions 

• We believe the market is concerned that SAL’s profits have been artificially inflated by its interested-persons transactions with private entities held by its Chairman. We run a scenario analysis to assess possible downside to its profits by adjusting its financials for these transactions. 
• Our analysis suggests that simply removing all revenue from related parties could result in a 49% decline in its net profit. If we also increase costs charged to these parties by 100%, its net profit could be 64% lower than reported.

Derrick Heng CFA | http://www.maybank-ke.com.sg/ Kim Eng 2015-08-27

HOLD Maintain HOLD 0.61 Same 0.61