Financial Adviser: 5 Things to Know About the IPO of Converge ICT Solutions Inc.
Broadband internet service provider Converge ICT Solutions, Inc (PSE: CNVRG) will be the third company to go public this year after it recently obtained approvals from regulators.
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CNVRG aimed to make the largest initial public offering in Philippine history by raising as much as P29 billion for 23 percent stake in the company, overtaking the P28.75 billion raised by SM Investment (PSE: SM) in 2005.
CNVRG will be only the fifth IPO in 20 years that will have an offering size of at least P20 billion.
The other large IPOs in recent years, aside from SM, were Cemex Holdings’ (PSE: CHP) P21.8 billion in 2016; Robinsons Retail Holdings’ (PSE: RRHI) P26.8 billion in 2013, and Cebu Pacific’s (PSE: CEB) P23.3 billion in 2010.
CNVRG earlier planned to sell its shares at P19 per share, but after book-building activities last week, the company lowered its IPO price by 11.6 percent to P16.8 per share.
CNVRG shares is currently being offered to the public starting yesterday, October 12, to October 16, with a target listing on October 26 in the main board of the Philippine Stock Exchange.
The market capitalization of CNVRG is expected to reach at P126.4 billion, making it the third biggest telecom player in the industry after PLDT (PSE: TEL) and Globe Telecoms (PSE: GLO), which both have a market size of about P280 billion.
Interestingly, this IPO could also put Dennis Anthony Uy, the founder of CNVRG, among the top 20 richest people in the Philippines with an estimated net worth of $1.7 billion.
As in any IPO, it is always wise to spend some time understanding the business of the company and evaluate its growth prospects.The more you know about the fundamentals of the stock, the better your chances in handling your investment risk and returns.
Here are the top five things every investor needs to know about Converge ICT Solutions’ IPO:
1| Know the structure of the IPO offering
CNVRG will raise a minimum of P25.2 billion by selling 1.5 billion shares to the public at P16.8 per share. Out of the total amount of P25.2 billion, only one-third of the proceeds or roughly P8 billion will go directly to the company for expansion.
The balance of the offering, which is about P17.2 billion will go to the owners of the company.
About 19 percent of the proceeds or P3.3 billion will go to the founder, Uy, who controls 71 percent of the company, while 81 percent will go to its foreign investor, Coherent Cloud Investments, which owns 29 percent.
In the event of oversubscription, the owners of the company will sell 225 million more secondary shares to the public, raising its total proceeds by P3.8 billion more to P29 billion.
After the IPO, assuming the overallocation is exercised, Uy’s ownership will fall from 71 percent to 63 percent of CNVRG, while its partner, Coherent Cloud Investments’ ownership will go down to 13.8 percent from 29 percent.
2| Know the business of the company
CNVRG is the largest high-speed fixed broadband operator in the Philippines with a 55 percent market share for download speeds of 25 Mbps and higher.
Over the past three years, the company has been dominating all the new fixed broadband subscriptions capturing almost 60 percent of the business to date.
CNVRG operates two businesses: the residential business, which contributes 77 percent of its total revenues, primarily offers high speed fixed broadband internet services; while the enterprise business, which comprises the balance of 23 percent, offers high-speed fixed broadband connectivity solutions to companies.
Using its proprietary end-to-end network, the company has the most extensive fiber backbone in the country with over 35,000 kilometers that covers over 200 cities and municipalities across Luzon, including Metro Manila.
As of the first half of this year, CNVRG currently services about 28 percent of 4.1 million households in Luzon.
3| Know the financial track record of the company
CNVRG’s total revenues have been growing rapidly by an average of 69 percent per year from P1.9 billion in 2016 to P9.1 billion in 2019.
This strong growth in revenues has enabled the company’s net income to increase by an average of 49 percent per year from P574 million in 2016 to P1.9 billion in 2019.
This year, despite the outbreak of the coronavirus pandemic, CNVRG’s total revenues for the first six months continued to grow by 64.6 percent to P6.5 billion from P3.9 billion in the same period last year, while its net income increased by 52.6 percent from P824 million in 2019 to P1.3 billion.
Although business has been growing fast, it is notable that average profitability margins have been declining as the company embarks on aggressive expansion.
Average gross margins of CNVRG has declined from 65.4 percent in 2016 to 51.4 percent in 2019, while net profit margins decreased from 30.3 percent in 2016 to 20.8 percent last year.
This year, based on first half results, average gross margin slightly improved to 53.5 percent but net profit margin continued to fall to 19.4 percent.
The declining margins also mirror the decreasing returns on equity from 28.9 percent in 2016 to 13 percent this year.
Return on total assets, which is computed as earnings before taxes and interest divided by total assets, has also been declining from 20.8 percent in 2016 to only 9.1 percent this year.
4| Know the risk and opportunities of the company
CNVRG plans to spend a total capital expenditure budget of P30 billion over the next 15 months to further expand its domestic network and international connectivity.
The company has recently secured proprietary access to 5Tbps of international bandwidth capacity from Telstra International Limited of Australia, which will increase its current leased bandwidth capacity by seven times.
CNVRG expects to finance its capital requirements through a combination of its IPO proceeds, operating cash flows and additional long-term debt.
The debt-to-equity ratio of the company has been increasing as capital expenditure requirements build up with expansion from 12.7 percent in 2016 to 58.5 percent this year.
Although this is still conservatively low given the average debt-to-equity ratio of 300 percent in the telecom industry, there is no doubt that higher investments in capital expenditures should bring forth higher earnings in the future.
But the rise in financial leverage in the short-term may put tremendous pressure on profitability, as well as returns on investments.
5| Know the prospective valuation of the company
Based on the last 12-month earnings of the company, CNVRG has a trailing Price-to-Earnings (PE) ratio of 54 times, which is way above the average pricing multiples of TEL and GLO at only 12 times.
If we annualize CNVRG’s financials for 2020 based on first half results, the stock will still have relatively high PE ratio at 43.5 times based on projected income of P2.9 billion by year-end.
Assuming total revenues grow by 100 percent in 2021, keeping the same interest expenses from 2020, which is unlikely given the company’s plan to borrow more, the stock’s estimated PE ratio at IPO price will still be comparatively high at 22.5 times.
Now, the other way to look at this, since CNVRG is heavy in capital expenditures, is to price the stock using Enterprise Value (EV)-to-EBITDA ratio.
Instead of measuring the company based on equity, enterprise value measures the total value of the stock by including debt and cash.
EBITDA, on the other hand, measures the “cash earnings” of a company by adding back non-cash item like depreciation expenses and interest expenses to net income.
Given the company’s projected market capitalization plus its current debt of P10.5 billion minus its expected IPO proceeds, CNVRG’s EV-to-EBITDA multiple comes out at 16.8 times, which is three times higher than average EV-to-EBITDA ratio of TEL and GLO at only 5 times.
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Although CNVRG’s growth prospects, being a focused broadband operator, are more exciting than its mature competitors like TEL and GLO, the premium it deserves seems to have already been priced into the stock’s IPO valuation.
Henry Ong, RFP, is president of Business Sense Financial Advisors. Email Henry for business advice [email protected] or follow him on Twitter @henryong888