Ernest Lim: Sapphire Corporation – If HKICIM Becomes a Substantial Shareholder

Sapphire Corporation (Sapphire) surged 11.5 percent to touch an intraday high of $0.340 on the morning of 20 October upon an announcement posted on SGX during the night of 19 October. It closed $0.01 higher at $0.315.

What Happened?

Two of Sapphire’s largest shareholders, namely Best Feast Limited and Ou Rui Limited are swapping a combined 27.96 percent stake in the company with new shares to be issued by Hong Kong-listed Hong Kong International Construction Investment Management Group (HKICIM). According to an announcement by Sapphire, the above share swap represents Sapphire’s share price of approximately $0.51 per share. (Sapphire’s implied share swap price without any premium to HKICIM share price is around $0.39-0.40.)

Why Sapphire?

I have been following up on Sapphire’s corporate transformation plans over the last few years. Personally, I believe potential investors and possibly, HKICIM was attracted to the post-turnaround Sapphire due mainly to its existing core infrastructure business operated under its principal subsidiary, Ranken Infrastructure Limited (Ranken).

a) Sapphire’s Successful Transformation Bears Fruits

For those who have followed Sapphire, under the stewardship of the Group CEO and Managing Director, Mr Teh, since his appointment in October 2013, Sapphire has divested its legacy steel business in 2014 and disposed of its 81 percent stake in its mining services in early 2017. Mr. Teh has successfully turned around the company from a loss-making position to a company which posted Rmb47.2 million (converted from S$) and Rmb20.5 million net profit for FY16 and 1H17 respectively.

Such transformation has not gone unnoticed as Sapphire announced on 28 November 2016 that it has received Hong Kong-based Capital Weekly’s “Listed Enterprise Excellence Award 2016” – the first public listed company not quoted on the Hong Kong Stock Exchange to secure the prestigious accolade. This acknowledges the success of Sapphire’s corporate turnaround strategies under the leadership of Mr Teh. Readers can refer to my earlier write-up (click HERE) on the significance of this award.

b) Acquisition Underscores The Intrinsic value In Ranken’s Licences And Track Records

Sapphire has always mentioned in their press release that their wholly-owned subsidiary Ranken is one of China’s largest privately-owned integrated rail transport infrastructure construction groups and the only privately-owned operator in China which has obtained the prestigious full AAA-certification for design, construction and project consultation in the rail sector. The acquisition by Sapphire underscores the intrinsic value in the licences held and track records achieved by Ranken.

c) Significant Synergies May Be Reaped

It appears that HKICIM believes that Ranken’s capability in rail and infrastructure engineering procurement and construction could complement that of HKICIM. Furthermore, with this acquisition, it will facilitate HKICIM in taking advantage of the industrial development opportunities bought forth by the “One Belt, One Road” development strategy of the PRC.

A Personal View On The Transaction

This acquisition gives a strong vote of confidence to Ranken’s capability under Sapphire’s capital market platform, its track records and licenses; and obviosuly, the industrial prospects. In addition, there may be other commercial points to note:

a) Possible Larger Pipeline Of Projects

Looking at HKICIM’s profile and its networks, it is likely to have a larger portfolio of projects which may bode well for Sapphire/Ranken over the medium to long term, further strengthening its existing good business fundamental.

b) Financial Target Of Rmb64.75 Million In The 12 months Ending 30 June 2018

Although Sapphire mentioned that it has not done any independent review on the above financial target for the HKICIM deal, I find it encouraging that the financial target is around Rmb64.75 million for the 12 months ending 30 June 2018. To put this into perspective, 1H17 net profit which ends 30 June 2017 was only Rmb20.5 million.

c) More Stake In Sapphire – Perhaps In The Long Term

I am making a wild guess here, if HKICIM and Sapphire/Ranken can work well together with significant synergies, HKICIM could further up its stake in future – as the current interest of about 28% under the deal is very close to trigger the 30 percent threshold for a general takeover offer.

Playing Devil’s Advocate

With (almost) all announcements pertaining to such nature, we can view it positively or negatively. Some readers may have the following questions which I have put in my personal views:

a) Are The Substantial Shareholders Ou Rui and Best Feast Cashing Out Of Sapphire?
In my opinion, after this transaction, Best Feast will still have 17.33 percent of Sapphire, thus it still has a significant stake in Sapphire.

Ou Rui which is 100-percent owned by Mr Li Xiaobo is a private and sophisticated investor, thus it is natural for him to exit if he deems fit. However, HKICIM will replace him as a substantial and, more importantly, a strategic shareholder.
Overall, I would think this is still a positive outcome on a net basis.

b) Controversy Surrounding HKICIM
Although there may be some controversial news surrounding HKICIM and its related companies, I am focusing more into the potential significant synergies which Sapphire/Ranken could gain given HKICIM’s profile and its networks.

Sapphire’s Existing Business Remains Very Promising

Notwithstanding the above transaction, Sapphire’s existing business looks very promising. Last Thursday, it announced it clinched Rmb856 million contracts and lifted its order book to a record Rmb3.4 billion!

These Rmb856 million new railway contracts came from Dalian and Urumqi. In my opinion, there are 5 noteworthy points in this contract announcement namely,

a) Sapphire has clinched Rmb1.1 billion of contracts from 12 September to 12 October 2017. To put this in perspective, Sapphire’s order book was Rmb2.6 billion before this string of contract wins in the past one month;

b) Year-to-date contract wins amounted to Rmb1.9 billion which already surpasses the Rmb1.7 billion contracts won for the calendar year 2016;

c) Since the acquisition of Ranken, this is the first time that Sapphire’s order book has risen above Rmb3 billion. This is indeed a significant milestone;

d) On 12 September 2017, Sapphire mentioned that its order book has increased to Rmb2.8 billion. With the new contract Rmb856 million contracts announced on 12 October 2017, Sapphire’s order book has increased to Rmb3.4 billion and not Rmb3.6 billion. Based on my personal interpretation, this may mean that Rmb200 million has been “digested” in just one month. Although some of these Rmb200 million may not translate immediately to revenue (for example, it may be recorded first as “contracts work in progress”), it does show that things seem to be moving faster in 3Q and beyond vis-à-vis 1H17 based on my personal view;

e) Contract momentum remains very strong as there are various opportunities such as the Taiyuan City Metro Line which Sapphire highlighted in Section 10 of their 2Q17 financial statements. Furthermore, according to the 12 September 2017 press release, Sapphire is evaluating a potential consultancy contract for a metro rail project in Bangladesh. Sapphire has been operating in Bangladesh for some time, thus I hope it can clinch this potential consultancy contract in time to come.

Chart analysis

Based on Chart 1 below, Sapphire has to first make a sustained close above $0.310 with volume to negate the bearish feel in the chart. For the chart to turn bullish, Sapphire has to make a sustained close above its downtrend line established since November 2014 (currently around $0.340) with volume. Meanwhile, there are some tentative positive signs such as

a) Sapphire has breached its 3.5-month trading range of $0.285 – 0.310 by making an upside breakout. However, it remains to be seen whether it can make a sustained close above $0.310;

b) 20D and 50D exponential moving average (EMA) have stopped declining and have turned higher. In fact, 20D is on the verge of doing a golden cross with 50D EMA;

c) Indicators such as RSI, MACD, OBV are strengthening. For example, OBV is near a 10 year high.

Near term supports: $0.310 / 0.300 / 0.285

Near term resistances: $0.340 / 0.350 / 0.365

Chart 1: Possibility Of Golden Cross Formation; $0.340 Still A Key Resistance

Source: Chartnexus 19 October 17

Conclusion

In a nutshell, with the emergence of HKICIM as a potential substantial shareholder, coupled with record order book and strong order momentum for the Sapphire Group, Sapphire seems to have completed its turnaround story from a loss-making firm to an up-and-coming infrastructure player of significant scale. Let’s stay tune to its upcoming 3Q17F result, scheduled for release on or around mid-November.

P.S: As with all investments (most investments carry at least some degree of risk), readers should carefully evaluate each investment decision with care. Readers who wish to know more about Sapphire can refer to their informative website HERE.

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