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Hai-O's second non-core business raises concern
Nov 08, 2010
Source: The Edge Malaysia

Hai-O Enterprise Bhd's latest venture into property investment and development has raised concerns among investors. Its share price has shed 4.6% since it announced a collaboration on Oct 22 with Si­erra Equatorial Development Sdn Bhd (SED). Linder the deal, Hai-O will sell 40% of its wholly owned unit, Hai-O Development Sdn Bhd, to SED, a builder-cum-property developer. SED, whose track record includes the revival of abandoned projects in the Klang Valley, will help obtain approvals from the authorities to facilitate Hai-O's foray into real estate.

SED will also spearhead real estate sales and marketing and offer the necessary exper­tise and skilled manpower to help Hai-O - a wholesaler and retailer of Chinese medicinal products - break into the property market, according to the announcement.

The investment community's response has been less than enthusiastic, with analysts ask­ing whether the venture would further divert Hai-O's focus from its existing businesses. Al­though property development may help gener­ate future earnings and reduce the cash-rich company's dependence on its more volatile multi-level marketing (MLM) business, there is concern that it might "add risk" to the group if it is not well executed.

The group's MIM business has been affected by more stringent direct marketing rules in Malaysia. In addition, Hai-O is still developing its business in Indonesia.

"We think the local MLM operations are still crucial to the group's earnings going forward given that the operations in Indone­sia may take longer than expected to break even while the technology division, on which we are optimistic, would only contribute to its bottom line in two years," OSK Research analyst Eng Kar Mei says in a note to clients on Oct 28.

"The road to recovery for Hai-O's MLM busi­ness is longer than expected as membership growth and buying sentiment among members has slowed down further," she writes.

Meanwhile, Affin Securities writes in a re­port on Nov 2 following a meeting with Hai-O that the new business represents a completely new direction for the group.

"The rationale behind the new venture was to broaden Hai-O's earnings base. This would then help to buffer the bottom line should the core MLM division be subject to any further volatility in MLM regulations or consumer spending," it says.

OSK Research is retaining its "sell" call on Hai-O and values the shares at RM1.61. Affin Investment Bank also has a "sell" on the stock with a higher fair value of RM2.71 while RHB Research Institute has an "underperform" with a RM2.84 target price.

Hai-O managing director Tan Kai Hee de­clined to comment. He is the single largest shareholder in the company with a 9.75% di­rect stake while his indirect equity portion stands at 16.7%.

The group's real estate venture follows its move into the heat transfer technology busi­ness. In August 2009, Hai-O announced a five-year co-operation agreement with the Chi­nese Academy of Sciences to jointly undertake R&D of related technology and products. These products are intended for multi-industry ap­plications, namely in the aeronautics and as­tronautics fields, besides the electronic and energy sectors.

The diversification into real estate and technology comes at a time when Hai-O's fi­nancials have weakened following slower MLM membership growth after tougher regulations on member recruitment were imposed.

Net profit and revenue more than halved to RM7.8 million and RM54.75 million respectively in 1QFY2011 compared to a year ago. Hai-O has guided that new membership growth had de­clined further to 1,000 members a month dur­ing the quarter from between 2,000 and 3,000 in the preceding quarter. Bumiputeras make up 90% of its membership mix.

The company's net assets per share stood at RM1.06. Hai-O is in a net cash position with cash and cash equivalents of RM52.52 million against borrowings of RM17.97 million.

Its list of freehold and leasehold commercial and industrial real estate assets in Selangor, Kuala Lumpur and Sarawak have a combined net book value of RM80.23 million, according to its annual report. Note that the company owns a vacant three-acre parcel of industrial land in Meru, Klang.

Established in 1975, Hai-O was listed on the Second Board of Bursa Malaysia in 1996 at an IPO price of RM3 a share. The stock was trans­ferred to the Main Board in 2007.

Hai-O, which also manfactures pharmaceu­tical products, has over the years established foreign bases in China, the Philippines and Indonesia but it is believed its overseas opera­tions are still in the infancy stage.

For comparison, Singapore-listed rival Eu Yan Sang International Ltd saw its net profit rise 13.8% y-o-y to RM4.13 million in 1QFY2011 while revenue was up 8.6% to RM57.62 million. The better numbers came as the company registered higher retail sales in core markets in Singapore, Malaysia and Hong Kong. Eu Yan Sang also de­rives rental income from its properties.

In August, the company acquired a 14.99% stake in Australia-listed Healthzone Ltd, a dis­tributor and retailer of healthfood products for A$3.6 million (RM11.09 million). Eu Yan Sang's share price has more than doubled this year and traded at 95 cents a share last Wednesday for a market capitalisation of S$346.7 million (RM830.6 million).

While entrepreneurs often diversify their businesses, Hai-O's recent ventures outside its core business have been met with a degree of concern.

Affin Investment Bank notes that diversification into other businesses may help cush­ion impact from changes in retail spending or regulations in the MLM industry in the long term.

"However, in the immediate term, the long adjustment period for the stricter recruitment guidelines (more than six months) will contin­ue to put a dampener on consumer purchases as well as stock sentiment. Risk of distraction from its core retail operations is also a con­cern'" it says.

For now, shareholders will be eagerly await­ing to see if Hai-O succeeds in ventures outside its core expertise.