Companies involved in multi-level marketing activities are now poised for a shake-up. Although the amendment of the Direct Sales Act, which governs all MLM companies, has been in the works for a while, Hai-O Enterprise Bhd has been the first to show the impact on its earnings.
The proposed amendments will tighten the criteria under which members are recruited. Both revenue and net profit for its 4Q declined 29.4% and 9.8% respectively on the back of lower member-recruitment numbers. Although Hai-O's fundamentals remain largely unchanged, as recently as a few months ago, the company's share price was flying high on a slew of positive reports, strong earnings and plans for breaking into new markets.
In March, Hai-O saw its stock soar and dose at a high of RM4.76. The spike was unusual for the fact that, like most consumer companies, Hai-O was seen as a defensive pick with good dividend potential underpinned by cash reserves of around RM70 million.
At the time of writing, Hai-O's stock was trading close to the RM3.70 level and both RHB Research and OSK Research had "neutral" ratings on the stock.
"In hindsight, people were overly bullish about the company's prospects following the news of its expansion into Indonesia. In addition, the company had seen a significant rise in the number of its distributors, posting a growth of more than 60% in just over a year," says an analyst.
Thus, those who recently invested in Hai-O's growth story are in for a disappointment and undoubtedly questioning the drop in its share price. However, while there maybe limited upside in Hai-O in the short term, according to an analyst, the tightening of member recruitment is a necessary step for the company to take. Hai-O could not be contacted for comment on its recruitment policies.
"Although the Act has not yet become official, it is clear that Hai-O is taking these steps before its members are too many. While there is no need for Hai-O to do so, the company would probably see that it would benefit in the long term in the form of better-performing and more productive members," says the analyst.
To clarify, the Domestic Trade, Cooperatives and Consumerism Minister Datuk Seri Ismail Sabri Yaakob was quoted as saying that the Direct Sales Act would include stricter amendments to prevent the implementation of pyramid and get-rich-quick schemes.
One of the traits of a pyramid scheme is that it rewards the participants for the recruitment of more participants rather than for sales.
"In the end, Hai-O's main aim is to make the process as transparent as possible. The company wants to ensure that the sales are the result of real supply and demand," says an analyst.
Stricter regulation of members would undoubtedly have an impact on other MLM companies as well, say industry players. Among those that have been doing well are jewellery-centric Zhulian Corp Bhd, the Berjaya Group's Cosway operations and sector figurehead Amway (M) Holdings Bhd.
However, according to analysts, while the ruling will result in the curtailing of new recruits, the nature of Hai-O's product composition makes the company stand out.
"It is more obvious to see when the majority of the products you are selling are big-ticket items. In the case of Hai-O, their biggest seller in the MLM segment is their water filters, so it becomes obvious when a member front-loads the buying of the product. In the case of Amway and Zhulian, the smaller per unit selling price makes it harder to detect these kinds of activities," says the analyst.
The analyst is quick to add, however, that Zhulian and Amway have in place a strict set of guidelines to ensure that their members behave ethically and that there is no whiff of a pyramid scheme in their operations.
"Being in the MLM business is tricky. Some companies barely manage to survive, but both Zhulian and Amway have been in the business for decades. Amway, in particular, is an industry stalwart and is still the company that most MLM companies aspire to be," says the analyst.
At the moment, Hai-O is the only company that is showing the pain with this pre-emptive move on new members. OSK has already cut its earnings forecast for Hai-O for FY2011 and FY2o12 by 12% to 18% to RM74.6 million and RM83.6 million respectively. In FY2010 ended April 30, Hai-O registered a net profit of RM70.9 million.
"While the group has put measures in place to boost MLM sales, we believe this division would probably register a contraction in FY2011 before recovering in FY2012. We are forecasting a slight increase in the number of members but lower member productivity in FY2011 given the tighter rules, which translate to around 20% contraction in MLM sales,” says OSK.
RHB cut its forecast for the net member growth of Hai-O's MLM division to zero per month for FY2011 from 1,000 per month previously, and 1,000 per month for FY2012 from 1,500 per month previously.
"The more stringent ruling could affect Hai-O's membership recruitment drive for another three to six months, which could lower members' productivity and even result in memberships being revoked. We are also expecting another rate hike of 25 basis points in September," says RHB.
On a brighter note, OSK points out that Hai-O's other divisions are still healthy, including its retail and wholesale businesses, and the introduction of more house brands augurs well for the company.
While Hai-O should be applauded for its forward thinking, and nipping the issue in the bud, there is no question that some will feel let down by the recent turn of events. Those who bought into Hai-O will now have to face declining growth in earnings and revenue as a result of tighter rules for its members.