Financial Adviser: 5 Things to Know About Edward Lee's CTS Global Equity Group's IPO and How to Profit from It

Stock brokerage firm CTS Global Equity Group (PSE: CTS) will be the fourth company that will go public this year after it recently obtained approvals from regulators to raise up to P1.375 billion in an initial public offering (IPO).

CTS will sell up to 1.375 billion primary shares to the public at a price of P1.00 per share.

The offer shares will comprise about 20 percent of CTS’s projected market capitalization of P6.87 billion after the IPO.

The offering period of CTS shares will run from March 29 to April 4 with a target listing date on April 13, 2022.

CTS will be the third listed financial service company with significant business exposure in the Philippine stock market. The other two listed companies are COL Financial Group (PSE: COL) and Vantage Equities (PSE: V).

Bear in mind that when you buy the stock, you are also investing in the business. It will be good to spend some time understanding the business of CTS and evaluate its growth opportunities.

Once you are aware of the fundamentals of the company, you will have a better handle on the risk and return that you can expect from investing in the IPO.

Here are the top five things every investor needs to know about CTS’ Global Equity Group’s IPO:

1| Know the background of the company

CTS Global Equity Group was formerly known as Citisecurities, a leading stockbrokerage firm and member of Philippine Stock Exchange owned by veteran stockbroker Edward Lee.

Citisecurities was primarily established as a broker to engage in the business of buying and selling of securities on behalf of its customers, but through the years, it shifted its focus as a dealer by initiating trading transactions for its own account.

The change in business model from brokerage services to proprietary trading signaled the change in the company’s name to CTS Global Equity Group.

CTS’ core trading competency extends beyond Philippine stocks to include other overseas stock markets such as United States, Hong Kong and Japan.

CTS currently has a pool of over 30 individual traders who actively manage a combined capital amounting to P550 million. Each trader is considered as a business unit with its own unique trading system.

CTS has developed an elaborate risk management infrastructure throughout the years, which has allowed the company to earn an average return of 22 percent per year since 2015 at the lowest comparative risk.

2| Know the earnings prospects of the company

CTS derives 79 percent of its total revenues from gains from trading securities, with the balance of 21 percent coming from interest, commission and dividend income.

Because a bulk of its revenues come from trading gains, which is unpredictable, its operating margins have been volatile in the past three years.

For example, in 2018, CTS operating margin was 14 percent, but in 2019, this went down to negative 5 percent only to improve again to 58 percent in 2020.

Moreover, since more than half of CTS’ trading business is in the global markets, it is also exposed to significant foreign exchange volatility.

In 2018, CTS booked a foreign exchange gain of P8.5 million, but in 2019, it incurred forex loss of P6.6 million. In 2020, its forex losses more than doubled to P14.6 million.

Because of these two volatile factors, CTS reported net losses in 2018 and 2019 with P8.3 million and P32.5 million.

It was only in 2020 that CTS was able to report net income of P46.9 million because of the huge total revenues of P172 million it earned during the year.

In 2021, CTS’ nine-month total revenues reached P107 million, which increased by 32.6 percent from P81 million in the same period the previous year.

The increase in total revenues was also supported by forex gain of P21.7 million, giving a net income of P27 million, which was three times better than the P8.8 million net income it earned in 2020.

The high volatility of CTS’ revenues due to the nature of its proprietary trading business model and exposure to foreign exchange make it difficult to estimate its net income prospects.

3| Know the stability of earnings and cash flows

One of the drivers commonly used in valuing a company is its operating cash flow.

The operating cash flow is used to derive a company’s free cash flow after deducting its capital maintenance expenditures. This cash flow is then used to project into the future based on a company’s growth prospects in order to compute its intrinsic value.

In the case of CTS, because its revenue and earnings prospects are unpredictable, forecasting its cash flows to value the company is difficult.

For example, in 2018, CTS reported a net loss of P8.3 million but its operating cashflow was negative P131.3 million. In 2019, the company reported net loss again of P32.5 million, but its operating cash outflow was even bigger at P211 million.

It was only in 2020 when CTS finally booked a positive operating cash flow of P11 million, but still fell short of its net income of P46.9 million.

Ideally, the operating cash flow of a company must be larger than its reported net income.

Last year, while CTS reported nine-month net income of P107 million, it incurred negative operating cash flow of P140 million. 

The lack of stable income and cash flow stream make CTS a high-risk business.

4| Know how the proceeds will be used

CTS intends to use about 91 percent of the IPO proceeds or P1.2 billion to expand its global trading operations.

The company plans to leverage its proprietary trading system that it has developed over the years and skills of its seasoned trading team by increasing its investment trading portfolio with the proceeds from the IPO.

For the past 10 years, CTS has allocated only a capital of P200 million for proprietary trading. It has only increased it to P550 million in 2021, which helped increase its trading revenues.

CTS plans to deploy the fresh capital from the IPO to increase its investment exposure in achieving 25 percent trading revenues from Philippine market and 75 percent from the global market by 2025.

Assuming a revenue to capital ratio of 20 percent, CTS could earn additional revenues of P246 million per year, boosting its total net income by about P70 million.

CTS also intends to increase its commission revenues, which currently contributes only three percent to the total by developing its client account management unit.

CTS is allocating P20 million from its proceeds to hire new talents for its client acquisition and support infrastructure.

The balance of P100 million, representing about 7.4 percent of the proceeds will be used as stand-by fund by the company for general corporate purposes.

5| Know the pricing multiple comparables

Based on a 12-month trailing net income of P65 million against its projected market capitalization after IPO at P6.8 billion, CTS has a Price-to-Earnings (PE) ratio of 105 times.

Even if we assume the company’s net income to double at P130 million next year with the fresh capital from its proceeds, CTS’ PE ratio will still be comparatively high at 52 times.

The growth expectations of CTS will be very risky considering that its volatile earnings and cash flows.

Investors will need to have extra investment return to compensate for the additional risk of the stock, which will lower its intrinsic value in the long-run.

The closest listed financial service company that we can compare to CTS is Vantage Equities (PSE: V), which has a similar exposure to equities trading through its mutual funds.

V has financial assets of P7 billion under its balance sheet, which is three times larger than the asset size of CTS, but its net income is more predictable because over 90 percent of its total revenues come from money transfer and changing services, mutual fund income and interest.

And yet, V’s Price-to-Earnings (PE) is only six times. It is also trading at a huge discount of 68 percent to its book value of P2.46 per share.

If we price CTS at the same risk of V, the market price of the stock should eventually trade at 68 percent discount to book value, which should be P0.68 per share.

Moreover, if we price CTS at double of V’s PE ratio of 12 times, assuming the company will have P130 million net income, which we generously assumed, the stock’s target price will only be P0.23 per share.

Henry Ong, RFP, is an entrepreneur, financial planning advocate and business advisor. Email Henry for business advice [email protected] or follow him on Twitter @henryong888