Sunday 25 July 2021

Another Serba Dinamik? Look Deeper into ARB Berhad

Uncover ARB Berhad (7181)

Did some thorough research on ARB Berhad and I finally understood how the company works and the company's ambiguous financial statements.

ARB Berhad is currently selling at very low valuation, hence many investors are trying to figure out what are the reasons for such discount to exist. There certainly are lacked of information regarding the operations of this company, and the management are not very public about the business operations.
So, I tried my best to understand the company from their annual reports and whatever resources I can find online. Most investors have pointed out 2 reasons for the discount in valuation:
1. Dilutive effect of ICPS issuance
2. High receivables    
These 2 reasons are true, but not entirely correct for the discount. Here is my view.


Dilutive Effect of ICPS

First, the dilutive effect of ICPS issuance. Many people already wrote about this and I am not repeating here. In short, I think issuing ICPS is a very good capital allocation decision by the management, and I give them credit for this decision.
This is because when the company ventured into the ERP and IoT segment, they need fresh funds to finance their venture. The management has 2 choices, either through debt or equity. They know that bankers will charge high interest rate if they take on debt because no one know if ARBB will succeed in their venture. 
Hence, they took the equity route and issued ICPS to fund their new venture. This works because they pay no interest, and the capital market are willing to hand them money as long as the market believe ARBB venturing into new segment will create value in the future. (speculative nature in the market) The greatest part of ICPS is that they get money whenever investors convert. This way, they can confirm that they will not be short of money until the ICPS expires.
Good thing, but still dilutive. So we should just dilute the company fully when we evaluate the company. Simple.

High Receivables

Now, to the second reason: High receivables.
This is where things become tricky. Many have pointed out that the company's receivables increase too fast and too much. Such as the recent case for Serba Dinamik. People are speculating that fishy things are happening in the company because of this. In my opinion, I think there are some truth to people's concerns. 
After studying the company, I will share how I think the company operates and how the accounts are being recorded based on the operation. 
From my understanding, the company will first sign a contract with their client to provide ERP service. The contract will state that ARBB will setup ERP service for their client without charging them. Then, ARBB will set a sales target to achieve after the implementation of their ERP service. If ARBB achieve the sales target, their client will need to share profit with ARBB.
There will also be a project/contract value assigned to the collaboration. This is how ARBB recognise & profit revenue on their financial statements. The revenue & profit recognised are based on the installation progress of their ERP service. But, since they can only received money/share profit from their client when they achieve their sales target, ARBB will not receive any money even though they already finish their ERP installation. So, the revenue recognised will flow into the receivables account, and the company will not receive any cash from this transaction.
We can see that ARBB financial statement has very high revenue, high profit & high receivables. This reflects their business model. The question lies in, whether we can trust the revenue, profit and receivables figure? The answer depends on whether ARBB's ERP software are actually that good to be able to achieve the sales target they set. 

If they can successfully achieve their target, then the recognised revenue can actually turn into cash flow for the company. But if their software is not as good as they claimed, then the high revenue & profit is just a beautiful bubble. The bubble will pop when all the receivables become impaired. 


I think the market's concern on ARBB is valid. Until we get more light on the company's operation and competitive edge, the company will continue to sell at a discount. 

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