Bull Stock: Venture Group 1 comments

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If there is such a thing as a defensive tech stock, the first one on the SGX that should come to mind is Venture Group, formerly known as Venture Manufacturing. Although I have written on this before in my HotStocksNot blog (see article link), it was purely on grounds of excessive valuation in context, not on fundamentals. In terms of critical mass, track record and management pedigree, Venture is widely acknowledged as world-class.

Venture Manufacturing was incorporated in 1984, and only listed on the SESDAQ in mid-1992 on FY91 topline and bottomline of ~$80M and <$5M respectively. For all practical purposes, it is worth tracking its progress starting from 1989, when the company acquired significant mass with the merger/acquisition of Multitech Systems Pte Ltd and Technocom Systems Sdn Bhd.

An investor holding Venture Manufacturing from its IPO (~$0.30) till now would have had multiplied his money by ~160 times, taking into account all splits (original shares outstanding of ~65M versus current 270M shares outstanding). At its peak in 1999-2000 during the tech boom, the lucky IPO investor would have multiplied his capital by 400 times, if he had cashed out at $30. That is the kind of return which has made Venture one of the Singapore stock market's best performing stocks of the 1990s.

As always, a steady earnings track record earns (pardon the pun) the stock the right to such prodigious multibagging. Over 1989-2000, the topline and bottomline grew at an almost straight upward trajectory; the CAGR (compounded annual growth rate) for topline was ~45% while bottomline(profit after tax) was 70%. Even while the rest of the electronics world suffered from the post-binge effects in 2001-03, the group continued to grow profit and sales at phenomenal rates until it began to slow down in 2004 (and since then). By then, it had annual sales of >$3B and profits of ~$200M.

The key underlying trend that has propelled Venture Manufacturing's rise is outsourcing. Specifically, it is the outsourcing of manufacturing (high volume, low profit operations) by various electronics OEMs over the 1990s. In the early Eighties, contract manufacturing, as this model is known, was still in its infancy; however by the late 1990s it was a US$100 billion a year industry (and projected to grow 25 to 30 percent annually over the next five years.... ultimately it didn't pan out). The industry was an offshoot of the rapidly rising PC and peripherals industry, that would form what is now known as the technology sector. Although traditional preference at most OEMs was to manufacture products in-house to ensure quality control, surging demand for PCs in the early Nineties, together with growing sophistication of electronic equipment, led smaller OEMs to outsource their simplier, more labor-intensive tasks and spill-over work to contract manufacturers, while they concentrated on the higher value-add, upstream design and engineering processes. The arrangement proved so successful that larger electronics companies such as IBM, HP and Compaq soon began shipping out work to industrial outsourcers. Buildup of critical mass at contract manufacturers such as Venture allowed them to progress beyond mere product assembly, to providing a host of services to OEMs, including process design and testing of products. In addition, some contract manufacturers (in particular, Venture) worked with OEMs in the actual design of new products (the ODM model).

Before the rise of China, Singapore was a big beneficiary of this trend, thanks to a longstanding openness to direct foreign investment as well as strong hard (logistics, communications, supporting industries) and soft (skilled and relatively cheap manpower, legal) infrastructure. It already had a track record in being the hard disk drive manufacturing capital for the world, and hence was a natural choice. The key customer for many Singapore contract manufacturers was Hewlett-Packard, which had had a strong Singapore presence for decades, and which moved aggressively to contract out production in the 1990s --- it farmed out so much work to Singapore that it created a market for local contract manufacturers. Venture's CEO, Wong Ngit Liong, was himself a HP alumnus.

Venture Manufacturing rode this trend throughout the 1990s, together with several other local contract manufacturers that would come to dominate the Singapore electronics manufacturing industry. What set Venture apart was its high profit margins, one of the best in the business. While other local manufacturers were operating on sub-5% profit margins (pre-tax), Venture was consistently achieving 7-10% margins. The key was that it provided high value-add --- the ODM model was adopted for many products, where the company also designed most of the products it manufactured, allowing higher prices to be charged. It was possible due to the company's diverse, low-volume product mix. At the same time, the company also provided supply chain management services, what it called e-fulfilment ---- another value-add. Although it was not the biggest local contract manufacturer by sales in the late Nineties (that honour belonged to Natsteel Electronics), it was probably the most profitable.

Oldtimers will remember the flurry of takeovers of local electronic contract manufacturers during the wild last few years of the old millenium, which hollowed out the local manufacturing scene. NatSteel Electronics, JIT Holdings, Li Xin Industries, and Omni Industries were acquired by bigger, global contract manufacturers like Flextronics, Solectron, Celestica, keen to build mass (in a period where revenue seemed more important than profits --- inspired by the dot-coms) at irrationally exuberant valuations (~30-40X PE) which now looks like perfect timing by the founders who cashed out. By virtue of its abovementioned ability to maintain high profit margins, Venture opted out and chose to go on its own. From the share investor's point of view, it may have been the wrong move; however one can hardly argue with the results. As the big contract manufacturers foundered in the wake of the dot-com crash, the company's earnings growth remained strong. However, since valuations for electronics contract manufacturers have since gone down as people realised that the earnings streams were not as defensive as first thought(it was originally conceptualised that a tech industry downturn should benefit contract manufacturers, as OEMs look to outsource more work to help cut costs), Venture's PE has been re-rated downward successively despite its sterling earnings track record post-crash and now looks further in trouble because its profitability also appears to be slowing down. Nevertheless, it is one of the truly world-class technology companies around, with a global manufacturing footprint and strong design capabilities making it a strategic partner to companies like Cisco, HP, Philips..... maybe Creative can give it a fight for top Singapore tech stock? Just joking.

References:
(1) Forbes article: Singapore Fling
(2) CFO Asia Feb 1999: The Man with the Midas Touch
(3) Businessweek Jul 04: Singapore's Venture Shows The Big Guys Another Way