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In Part 2 of this article, we broke down the OSIM’s financials at the time of its Brookstone episode in 2008. We wanted to know if OSIM was a company in strong financial health. A company that’s already successful and doing well financially is more likely to survive a crisis when it hits. A poorer company is much less likely too; if it wasn’t already doing well during the good times, how more so during a crisis?
We had a look at OSIM’s key financial figures and ratios and by all accounts OSIM was in great financial shape. They were a successful and extremely profitable company before their Brookstone acquisition. The only question was could they stomach an impairment loss the size of $112.5 million and still return to their former glory? Or would it affect the company permanently and see OSIM never return to their former levels of profitability?
So let’s take a look.
The clues to the answer to that question can be found in an extract of Ron Sim’s 2008 chairman statement:
“Following 3 years of EBITDA growth from US$32 million in 2005 to US$55 million in 2007, Brookstone sales was impacted by the US financial crisis in 2008. Conservative prudent accounting dictates that we make a non-cash impairment for our investment in Brookstone, writing its value in our books to zero. Our US investment in Brookstone was “ring fenced” and so there is no recourse to OSIM. There is, therefore, no cash impact on OSIM, no consolidation of Brookstone losses in the future and there is no obligation for OSIM to out in further money. Notwithstanding that, I am happy to report that Brookstone ended 2008 with US$22.5 million in cash and it has no plans currently for any cash injection in 2009. Writing off this investment has no impact on OSIM’s cash flow and with the full impairment, there will be no need to account for any future share of loss.” – Ron Sim
Based on the extract above, Ron Sim mentioned the impairment loss was a non-cash expense and it had no cash impact on OSIM’s cash flow. The $112.5 million write-off was just a paper loss.
He also mentioned that would be no need to account for the losses make by Brookstone on OSIM’s books in the future as they were writing off the investment entirely. This meant that only the financial results from OSIM, GNC and Rich Life stores (which were still hugely profitable) would be reported going forward and OSIM’s group financial results would no longer be dragged down by Brookstone’s losses.
The impairment loss was a one-time write-off and would never happen again. The hit was temporary and would not impact the long-term growth prospects of OSIM’s core business which was still doing well.
Putting everything together, OSIM was in rude financial health and its impairment loss was a non-cash write-off that didn’t affect the company’s cash or debt positions, or their long-term business prospects at all. OSIM was nowhere near bankruptcy and was in fact “unaffected” by the impairment loss.
Knowing this, OSIM’s stock plunge was huge opportunity to scoop up shares of the company at bargain basement prices.
Realizing that OSIM’s impairment loss, however huge, wasn’t going to affect the company’s long-term prospects or its cash position, there was no question that OSIM was in no danger of going bankrupt and would return to profitability in no time. At 5 cents, OSIM’s stock price had hit its lowest levels ever and it was an opportunity of a lifetime for investors that spotted it.
So what was the intrinsic value of OSIM at the point in time and what was the significant upside?
To calculate OSIM’s intrinsic value, we can use the discounted earnings model. OSIM’s 2008 net loss was a massive $91 million! But as mentioned above, that loss was principally due to the $112.5 million impairment loss which was a non-cash expense. Which means OSIM’s “true” profitability was grossly understated.
If we add the impairment loss back to OSIM’s net loss that year, we derive a net profit of $21.5 million. With 541 million shares in the market, OSIM’s earnings per share was $0.04 per share.
Using a discount rate of 4% and an ultra-conservative growth rate of 0%, OSIM’s intrinsic value back in early 2009 was $0.256. With OSIM’s share price at 5 cents, you had an 80.4% margin of safety – the stock was hugely undervalued.
As of now, OSIM’s stock price is $2.70 – a 5,400% return on investment in five years. To put it another way, every $10,000 invested back in 2008 would make you $540,000 today.
OSIM’s returns are spectacular – even for a fallen angel. But it just goes to show how exceptional your investment returns can be when you spot a fallen angel that has every potential to return to its former levels.
Of course, the tricky bit is in getting our analysis right because like I mentioned in Part 1, it’s a very thin line between a fallen angel that will rise again and one that is headed towards bankruptcy. Utmost care and due diligence must be taken before you put your hard-earned money into such an investment.
With the benefit of hindsight, OSIM’s return to glory looks straightforward enough, but back then when it happened, it wouldn’t be as easy as it looked – even with all the research and analysis that OSIM would have very probably emerged unscathed. There is no sure thing in investing but you can greatly increase your chances of success when you do your homework right. But I do hope that through this case study, we’ve helped you gain a much clearer picture of what needs to be looked at in order to identify and profit from a fallen angel. All the best!