ReTech Technology

Republished By Plato

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ReTech provides online learning and educational
services to companies in China. They plan to raise 22.5 million through the
prospectus by selling 20% of the company via the IPO, giving a total post IPO
market capitalization of 112.5 million. The business has three main arms, an E-learning
business where they provide training courses to businesses for staff, a newer e-training
partnership area where they will partner with established education entities (they
have a memorandum of understanding with Queensland TAFE) and a proposed e-course
direct area where they intend to sell courses direct to companies and individuals.
According to the prospectus, e-learning is a rapidly growing industry, with a
growth rate of 32.9% between 2010 and 2015. While this seems high, service and
knowledge based jobs are exploding in China, and online education is one of the
fastest and cheapest ways to train staff. Having had the misfortune to complete
a few work-mandated e-learning courses in my career myself, it’s not exactly an
exciting industry, but the benefits they offer companies are clear. The prospectus
lists a few of the courses which ReTech owns the intellectual property rights
to and looking at names like “how to introduce the gear box” and “how to
recommend vehicle insurance for clients,” you can almost imagine a bunch of
bored car salesmen sitting in an office somewhere in China clicking through
multiple choice questions.

The IPO funds will be used, amongst other things, to
set up an office in Hong Kong. This means that unlike Tianmei, the IPO I
reviewed most recently of another Chinese company, the final parent company
isn’t located in Australia. While I’m no expert on Hong Kong company law, I
think this is a mark against ReTech. With an Australian company, shareholders have
the recourse of class actions or potential moves against the board if things go
wrong. I’m not sure how easy those things would be to organize against a Honk
Kong based company.

Company
background

According to ReTech’s website, ReTech was originally
founded as a website development company in 2000 by a guy called Ai Shugang while
he was still a university student. Since then it has grown and expanded into several
different technology and internet related areas. Instead of just listing as the
original entity, the founders decided to create a newly incorporated company
called ReTech Technology to list on the ASX. They injected their own capital
into the business, and then sold/transferred significant amounts of the intellectual
property and existing E-Learning contracts to the newly created company. To
make things more complicated, at the same time the founders also created
another company called Shanghai ReTech Information Technology (SHR) which as
far as I can understand will remain wholly owned by Ai Shungang. SHR has also
had a significant number of E-Learning contracts assigned to it from the
original ReTech entity. SHR has signed an agreement with ReTech regarding these
contracts where ReTech will provide the services on SHR’s behalf, in exchange
for 95% of the resulting fees. If this all sounds a bit confusing you’re not
the only one.

My concern with all of this is that ReTech is in the
sort of industry where a founder siphoning off business is a major threat,
meaning another business still operating owned by the original founder is a big
risk. In the prospectus, ReTech list
expertise and their existing client list as two of their four main competitive
advantages, two things that would be easy for the founder Ai Shungang to poach to
SHR. Although Ai Shungang does own a significant stake in ReTech, he owns 100%
of SHR’s parent company, so the motivation for him to do this is there. The prospectus
points out that both Ai Shungang and his companies have signed non-compete
contracts, guaranteeing they will not operate in the same sector as ReTech, but
I know how hard to enforce these contracts are in Australia, and can only
imagine what the process would be like in China.

Finding out what exactly this separate company will
be doing given they have committed to not entering the online education sector proved
difficult. I eventually found a legal document on ReTech’s website that states
Shaghai ReTech Information Technology is going to focus on software and
technology development and technical management consulting. To make things even more confusing, they also seem to be still using identical
branding to ReTech, based on what I found on a management consulting website. If you trust the founders of the company, probably none of this would bother you
but for me these are considerable issues.

Before looking at any of the financial information
for ReTech it is important to remember that the company was incorporated in its
current form in May 2016, and the final part of the restructure was only
completed in November. This means that all historical profit and loss figures
are pro forma only, estimates of what the contracts, intellectual property and
assets now owned by the ReTech Group earnt before the company was split. This
is a massive red flag for me. I’m sceptical of pro forma figures at the best of
times, and when they are used by an unknown company in a prospectus where the
unadjusted figures are not even provided it’s a massive concern. To give just
one example of how these figures could potentially be distorted, education
software development costs could be written off as not part of the business, while
the associated revenue is counted towards ReTech’s bottom line. Examining the pro
forma figures doesn’t exactly assuage my concerns either. Have a look at the
below table taken from the prospectus, in particular the profit before tax to
revenue ratio. In 2015 off revenue of just 6.9 million the profit before tax is
listed as 4.2 million, meaning for every dollar of revenue the company made 61
cents of profit. Of course, I understand that profits can be high in the
technology sector, but a profit to revenue ratio of .61 is extraordinary,
especially when you consider that this is a young company in a growth phase.

Most young companies with growth rates this large are running at deficits as
they re-invest into the business, not earning profit margins that would be the envy
of booming mining companies.

Even with these relatively major concerns put aside,
the valuation appears expensive. The pro forma Net Profit after Tax for FY 2015
was only 3.6 million, which against a valuation of 112.5 million is a Price/Earnings
of just over 31 (annualizing the profits from the first half of 2016 doesn’t
give you much better numbers). Full year profits for FY2016 are expected to be
5.8 million, a P/E of 20, but if there is one thing I am more suspicious of
than Pro forma historical accounts it’s prospectus profit forecasts, so I have
little inclination to use these numbers to try and justify the valuation.

Management
personnel

When I started digging around on the management
personnel, one of the first things I noticed was the strong link to
Investorlink, a Sydney based financial firm that seems to specialize in
assisting Chinese companies list on the ASX. In addition to being the corporate
advisors to this listing (for which they will be paid $380,000), Chris Ryan, an
executive from Investorlink is one of the five board members of ReTech. I was
already sceptical of this IPO at this stage, but this was the final nail in the
coffin. Chris Ryan’s CV is like a checklist of bad Chinese IPOs. Ryan was and
apparently continues to be the chairman of Chinese Waste Corporation Limited, a
Chinese company that reverse listed in 2015 and was suspended from the ASX in mid-2016
for not having “sufficient operations to warrant the continued quotation.” He
is currently the chairman of TTG Fintech Limited, a company that listed on the
stock exchange at 60 cents in late 2012, inexplicably reached as high as 4
dollars in mid 2014, and is now trading at 7 cents and he has been on the board
of ECargo Holdings, a company that listed at 40 cents in late 2014 and is now
trading at 20 cents. I spent some time looking at the various Chinese IPO’s
that Investorlink has advised on, and was unable to find a single IPO whose
shares aren’t now trading significantly below their listing price. If ReTech
are indeed a legitimate company, it’s hard to understand why they would seek to
list through Investorlink given this track record.

To put it bluntly, I wouldn’t buy shares in ReTech
if I could get them half price. Everything from the odd restructure to the lack
of statutory accounting figures, the high valuation and the awful track record
of the Corporate Advisor makes me want to put all my money in treasury bonds
and never invest in anything speculative again. Of course, it’s possible that
Ai Shungang is going to turn out to be the next Mark Zuckerberg and I’m going
to end up looking like an idiot (to the handful of people who read this blog at
least), but that is one risk I am happy to take.

The offer
closes on the 9^th March.

Source: http://theiporeview.blogspot.com/2017/02/retech-technology.html

Time Stamp: February 6, 2017