ROI on Uchi: Part III - the ESOS issue

It would appear that we have a very interesting situation in Uchi Tech.

We are looking at a stock...

• With a CAGR of 25% over the last 6 years.
• With a CAGR of 18.76% over the last 4 years.
• Last year's net profits grew 17%
• Net profit margins of 56%.
• Nett cash. No debts

But it is considering a tacky 15% ESOS!!

As mentioned by the great, late Philip Fisher:

• the management of a company is always for closer to its assets than its shareholders. And without even breaking any laws, there are number of ways that the management can benefit themselves and their families at the expense of the minority shareholders, for example employing their relatives, buy-and-selling of properties between relatives at above market rates or the issuing common stock options.

Yes, by issuing a 15% ESOS, the directors of the company are putting themselves in a position where they benefit themselves more than the minority shareholder.

Now here is some interesting issue worth considering. Here's what we need to do. Open the wordfile attached to that ESOS announcement

1. See line 3. Maximum no. of Shares to be issued pursuant to the exercise of outstanding Existing ESOS options granted/ which may be granted. Total? 23,445,280 million shares.

Question that begs to be asked. Why is there so many outstanding existing ESOS?
Since there already exist so many outstanding ESOS, why the need for another 15%?

2. See line 5.
To be issued pursuant to the Proposed New ESOS (up to 15%)... 59,375,712.

Now if you add both figures up, you will get 82,820,992 new shares, assuming full exercise of ESOS.

Currently Uchi has 372,392,800 shares. Which means there is a possible dilution in earnings per share of 22% assuming full exercise of all these ESOS.

Now let's be realistic and ask ourselves this... is 22% dilution in earnings per share a lot or not?

Simple way to look at this dilution.

Say U** has a current eps of 100 sen.
Say U** has a possibility to trade at a price earnings multiple of 18x.

Which means U** could be worth some 18.00 in market price.

Now a 22% dilution means... the eps would be 78 sen.
And using the same pe multiple assumption of 18x, U** should be trading at a market price of 14.00.

See how disadvantage to the minority shareholder?

Oh yes, it is mentioned that ESOS is important for a company for it is a proven method to retain talent in a company. No doubt about it. But from a minority shareholder of the company oint of view, do you think it is fair that your earnings per share be diluted by so much?

Now comes the really subjective and tricky part of any review.

Say you really, really hate such a proposal but on the other hand you recognise that this is still a very solid company. How?

Would you forgive Uchi on this and consider this as just one red flag? Are you willing to forgive UCHi and consider this as only just one naughty thingy?

Or would you kick Uchi out of the door?

How?

Oh this issue of flags... LOL... sometimes... I wonder if investing is a game of collecting flags? Like in soccer, you get a yellow card and then a red card! Ahhh.. but do not get me wrong here.. me just ranting on it that's all... lol... just poking fun lah..... :p

Anyhow... at the end of the day... it matters not what I think about ESOS or what I think about UCHi... most important is us making the correct rational decision.

just for the record... Uchi is now trading at 3.30.