MTQ Corporation

[changwk]

Decent results announced yesterday for 2QFY13, but what is interesting, and perhaps of concern to shareholders, is the proposed acquisition of NMS with potential cost of A$48m - this means significant debt to be introduced onto the balance sheet.

The 2Q 2013 results were not as good as I'd expected, as it shows that the synergies from purchasing PSL are fading out in 2Q, though 1Q showed a rather strong revenue increase. With Bahrain still in "start-up phase" and loss-making, it's worrying if MTQ can pick up the momentum and show some contribution from their Bahrain side of Oilfield Engineering. Singapore's operations should be chugging along fine, and not much was mentioned of Engine Systems at all, so I'd assume the division is still earning a return below its cost of capital (i.e. they should consider divesting it).

MTQ's Balance Sheet is currently slightly levered, with a net debt position of about $11m, and cash of $26.3m. The transaction for purchasing 100% of NMS is inexplicable to me at this point in time, and clarity will only be established after receiving and reading the circular on the proposed acquisition when the time comes for the EGM to be convened. In fact, MTQ could end up forking out as much as A$48.2m for the entire acquisition. Considering NMS is still loss-making, this does seem like an expensive transaction, and is also made slightly above the NTA/share (6.4%) of NMS.

Assuming MTQ goes ahead with the funding of A$37m from UOB and pays the rest using cash (A$11m), this would increase debt on the Balance Sheet significantly, and swing the Group into a deep net debt position, possibly with much higher financing costs.

A quick check showed that MTQ generated about $7.5m worth of FCF for 1H FY 2013, and a simple gross-up would mean about $15m worth of FCF for FY 2013. Assuming about 4c/share of dividends (about $1.7m assuming same scrip take-up rate), the cash flow left over for payment of debt would be about $13m. This implies about 3 years of payoff period assuming FCF levels remain at current levels.

Optimistic Scenario - PSL works out to be strongly cash generative, Bahrain picks up in momentum and NMS turns around successfully and becomes cash-flow positive. FCF for the Group could potentially rise significantly and allow MTQ to pay down the debt much faster than expected.

Pessimistic Scenario - PSL struggles to integrate with MTQ and cross-selling of products is not very successful, resulting in lower FCF. Bahrain takes off but not in a big way, and limps along for the next 1-2 years as oil prices slump. NMS continues to bleed cash. This may result in a very heavy financing and debt burden to MTQ, though it is unlikely they will go bankrupt as a result of low borrowing rates. But they may have to service the debt for a long-time on purchasing a non-performing asset.

Realistic Scenario - PSL integrates fairly well with MTQ, Bahrain takes off and generates positive FCF; and NMS manages to break-even after 2 years. Debt can be paid down progressively assuming constant dividends, and the Company should be able to continue as a going concern, though its valuation would be affected by how fast it can integrate all its acquisitions.

(Vested)

The management must very confident abt turning NMS around.
In the latest NMS full year results, losses has been slashed compared to previous year after MTQ substantial stake. Management believes there are lots of cross selling NMS services to their current customers and new customers.

Of mtq continue with their free cash flow generation,
They shld be able to repay back the debt in no time.
Would this come at the expense of lower dividend?

Judging from the share unmoved price after the NMS acquisition,
Investors seems to be pretty confident abt management decisio