|Shares Out. (in M):||21||P/E||12||0|
|Market Cap (in $M):||2,681||P/FCF||10.8||0|
|Net Debt (in $M):||742||EBIT||216||0|
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Tekom Technologies: a 40% unleveraged ROE business with Insiders Buying
Our own experience as stock screeners tells us that it is very rare to ever come across a legitimate public company in developed Asia that A) consistently earns a ~40-50% unleveraged return-on-equity, B) pays over 50% of the profit as dividends, C) already has most of next-year’s expenses covered by pre-paid cash deposits, D) has significant tax losses ensuring near-zero effective tax rates some years to come, E) has a recent record of senior-level insider stock purchases, and F) trades for 10-11x free cash flow and a high single digit dividend yield.
Tekom Technologies (Taiwan ticker: 6294), a company we stumbled across in the fall of 2017, was the first company we ever found that matched the above description. Our research, including visits to the company and its business locations as well as secret shopper consumer scuttlebutt suggests obscurity is the key reason Tekom was selling cheaply despite achieving impressive business results.
The name “Tekom Technologies” and the Taiwanese stock ticker “6294” originally belonged to failed electronics manufacturer that, after recording losses for many years, ultimately became a shell through which a completely different business – a top vocational test preparation company – achieved a backdoor public listing. Despite radically improved financial statements (audited by PwC) and a massive dividend hike, very few people appeared to recognize that this was not the same Tekom anymore. For example, as of today Bloomberg still incorrectly describes Tekom as “a manufacturer of digital still cameras” and Tekom’s stock ticker did not exist in the S&P Capital IQ database when we checked in late 2017. This could be why Tekom is by far the cheapest education company listed in Taiwan on a P/E or dividend yield basis.
Tekom Technologies actually owns 100% of an adult-focused test-preparation chain called 志光數位學院 or CEK () with 65 locations across Taiwan. CEK’s founder, Mr. Lin Jinrong (林進榮), established CEK in 1979 in the southern Taiwanese city of Tainan. Rather than compete head-on with incumbent cram schools that focused on K-12 students, Mr. Lin decided early on to define his business niche as helping adults pass the various examinations required to obtain a government job with stable pay.
These exams are mandatory for anyone applying for jobs at places like the Chunghwa Post (Taiwan’s postal service), Taiwan Customs Administration, Taiwan Railway Administration, state-owned banks, local police, etc. And because these mandatory exams were often A) filled with difficult niche content, B) administered to small numbers of test-takers, and C) irregularly scheduled (i.e. not held annually) there was more limited competition in this space from other cram schools. This allowed CEK to grow steadily over four decades and develop a word-of-mouth reputation for above average exam passing rates.
Over the years, adult test-preparation became a relatively large industry in Taiwan. Why? Decades of stagnant wage growth in the private sector has left many workers disillusioned. Rather than work hard for a modest income at a private company that might eventually fail, hundreds of thousands of frustrated or unemployed Taiwanese workers decide each year it makes more sense to find a job in the government for stable pay and working hours. The following industry summary is excerpted from a KGI Securities report dated April 26, 2017:
“In Taiwan, the adult education market consists of government position exams, graduate school exams, professional certification exams, and various job exams. Of them, government vacancies are especially luring as they pay better and feature greater job stability than openings in the private sector. Annually, as many as 320k people sign up for one of two levels of government job exams, with total market value of NT$6.7bn. The professional certification exams attract around 100k testers each year, while the corresponding education market is worth roughly NT$1.8bn. Graduate school entrance exams also attract nearly 100k participants each year, with the corresponding education market worth some NT$1.5bn. Lastly, the various job examinations are taken by nearly 30k people every year, for an education market worth NT$400mn. Combined, the adult education market in Taiwan is worth nearly NT$10.4bn a year, which is evenly split between physical cram schools and online/correspondence education at NT$5.2bn apiece.”
Today, CEK is the leading player in this industry in Taiwan: 5,000 of their students passed their exams in 2016. According to official statistics from the Ministry of Examination (see below), this means roughly 10% of all exam passers were CEK students. CEK’s reputation is so good that, according to Tekom management A) 70% of CEK’s new students were word-of-mouth referrals by former students, and B) in some government departments 50% or more of the current employees are actually former CEK students.
Why has CEK been so successful? First, CEK’s pitch to potential students is compelling. The price of a CEK test-preparation course often ranges from TWD 30,000 to TWD 40,000. Though CEK can’t guarantee students that they’ll pass their desired exams, their tuition prices still compare extremely favorably with the monthly salaries of workers from, say, the Civil Aeronautics Administration (salary range: TWD 46,225 to TWD 61,335) or Chunghwa Post (salary range: TWD 34,320 to TWD 44,010).
Second, CEK course content can be accessed anywhere, either in person at any of CEK’s 65 locations or via the cloud through streaming videos 24 hours a day. This is not only convenient for students, but profitable for Tekom shareholders because, with only some exceptions, CEK courses are not taught by on-site instructors. Rather, most of the course content is pre-recorded and delivered to students via videos shown A) in the classroom cubicles, or B) on whatever device the students use at home. Today the CEK’s tuition revenue split between cloud and classroom course delivery is roughly 60/40, respectively.
In essence, CEK is a correspondence course company that happens to offer physical locations as a convenience to its students, who often don’t have space to study at home. As a result, a single modestly sized CEK branch with an average of 30-40 study cubicles and 3-4 employees can support a much larger student population than its four walls might suggest, leading to very high returns on invested capital.
We are comfortable in assuming that CEK is an established franchise that deserves to exist. Our own visits to CEK outlets and the secret shopper experience of a consultant we hired to enroll in an actual CEK cloud-based class did not give rise to any concerns about the existence and validity of the business model.
Instead, our primary concern when deciding to invest in Tekom was the fact that CEK achieved a public listing via a reverse merger, otherwise known as a backdoor listing (i.e. when a private unlisted business merges with a publicly listed shell). Much has been written about the many fraud scandals involving mainland Chinese backdoor listings. Those frauds have since tainted our perception of almost any reverse merger. After all, if a business is legitimate, why should it have to go public via the backdoor?
In the case of Tekom and CEK, however, we realized there were several legitimate reasons for listing via the backdoor. First, the injection of an extremely profitable unlisted business (CEK) into a publicly listed shell full of historical accumulated losses (Tekom) was a very shrewd tax maneuver. The merged company ended up with an effective tax rate of zero, and it should stay near zero for years. The value of the tax shield from the backdoor listing was enough to pay for multiple front door IPOs, so CEK should be applauded.
Second, the particular way CEK was injected into Tekom gave us comfort that shareholders of the resultant listed company (still named Tekom) would not be disadvantaged. What effectively happened over multiple years was that the controlling shareholders of then-unlisted CEK (chiefly, Mr. Lin) gradually bought control of publicly listed Tekom, paying cash for multiple tranches of newly issued shares. Once Mr. Lin had firm control of publicly listed Tekom, he then used Tekom to gradually acquire all the operating assets of his privately-owned CEK for cash. In other words, Mr. Lin used Tekom – which he controlled – to buy CEK from himself, almost as if his left hand was buying something from his right hand.
Because Mr. Lin was both the ultimate buyer and seller, he had little incentive to inflate the price Tekom (the listed company) was paying for CEK (the unlisted company). In fact, Mr. Lin was apparently incentivized to do the opposite. Cumulatively, only a few hundred million Taiwan dollars of cash outflow was spent by Tekom in acquiring the assets of CEK. These assets consisted primarily of goodwill, which the company and its auditors seem to have gone out of their way to mark at a low valuation. In short, the total consideration paid by Tekom for CEK implied a very low single-digit P/E multiple.
The other key reasons that gave us enough comfort to invest in a reverse merger stock were as follows:
A) Mr. Lin has been increasing his stake in Tekom, and bought more shares on the open market as recently as November 2017 and January 2018. These repurchases equal roughly US$750,000 which is likely more than his after-tax annual dividends received last year.
B) The non-refundable pre-paid deposits on Tekom’s latest balance sheet are still growing, and importantly, already equal to most of next year’s operating expenses.
C) Over the long-term, Tekom’s CEK test preparation business appears to be counter-cyclical to the overall economy. As you can see on the following pages, the greatest number of registrants for government exams were recorded in the years following the Lehman crisis as throngs of frightened or fired workers sought safe-haven in government jobs. If there is another crisis like Lehman, we don’t think it would be crazy to expect a similar result.
D) Since Mr. Lin took control of Tekom, substantial cash dividends have been paid; given that the test-preparation business does not require much reinvestment of capital, we would expect this to continue.
While Tekom could run into future difficulties, especially in the push for additional growth, we still count ourselves lucky to be able to buy the stock today at TWD 126 per share, which works out to a historical P/E of 12x (or a P/FCF of ~10-11x) and a dividend yield of 6% (the ex-date is July 26, 2018).
Unique risk: we are not 100% comfortable with the fact Mr. Lin and his ownership group still own a small, unlisted, online-only test-preparation company that exists outside of this publicly traded company. We would prefer they merge this into the public company at some point but that is beyond our control today.
 According to Bloomberg, as of July 18, 2018 Taiwan-listed education companies Samebest and Dadi Early Education trade at historical P/E’s ranging from 18-28x and dividend yields ranging from 0-3%, whereas Tekom trades at a historical P/E of 12x with a dividend yield of 6%.
 See and
 CEK maintains a current active student count of roughly 20,000, which means the company’s effective exam passing rate – 5,000 passers / 20,000 active students – is much higher than the national average of about 10% (see Ministry of Examination statistics on the following pages).
 Potential students can be anyone from unemployed single mothers desperate for a job to frustrated mid-career job-switchers. See an official CEK promotional video:
 CEK compensates the course instructors by effectively paying for the “right” to record and broadcast their classes. This payment is often an upfront single payment, with no concept of trailing royalties regardless of how many times the course content is viewed.
 A single CEK outlet can cost TWD 3-5 million in upfront investment cost. This is a small outlay considering that A) Tekom’s 2016 consolidated EBIT of TWD 217 million works out to roughly TWD 3.4 million for each of the 63 CEK outlets, and B) that this is a negative working capital, zero ex-cash equity business model where non-refundable, pre-paid tuition deposits fund the operations and growth.
 There’s even a movie about them:
 The goodwill from acquiring CEK is still carried today at a value of only TWD 188.3 million. In the footnotes to Tekom’s audited accounts, it says this valuation was estimated based on a discounted cash flow projection assuming a long-term growth rate of 0% and a WACC or discount rate of 19%. These strike us as overly conservative assumptions.
Further growth. Further dividends. Further insider purchases.
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