Those who have been talking to me for the last 2 years will be familiar with this company. Even my wife (at that time my girlfriend/fiancee), my father, and my father-in-law are tired listening to me about this company. As you will read later, there are a lot of learning for myself in this company; along with CPGT, WINS has been the highlight of my 2014 journey.

WINS is a shipping company that mainly serves offshore market. It is like a contractor company such as TOTL and heavy-equipment operator, only it operates on water, not on ground. Its main income can be derived by two sources: charter income from owned ship and brokerage. For the past few years, WINS has been focusing on purchasing its own ships and moving up to operate bigger and specialized vessels. This will expand the company’s margin.

Competition Landscape
Those who are familiar with offshore industry will realize that the competition for project is different with other type of marine industry. For example, barging in coal industry is extremely competitive, since the barrier of entry is very low. Basically, if you have a ship, it is not hard for you to tender for coal transportation project. However, in the offshore industry, it is not as simple as that. The main barrier of entry comes from the certification requirement, industry track record, cabotage rule, human resources, and capital availability.

The main customers of WINS are the major oil companies and state-owned companies. When it comes to oil companies, they are very particular about safety. These companies are well-aware of how bad a negative publicity can affect their companies when an accident happens. One can just google “major oil disaster” and find out how badly these companies wish that it never happens. First there is an issue of company’s reputations. Second, accidents are expensive. It can wipe company’s multi-year profits. As the result, these companies are very stringent in selecting their supplier. They realize that it is much better to be selective in supplier and lenient in pricing, rather than being stingy and potentially face a major headache.

As a result from these companies’ concerns, they require their suppliers to have certain standard. These suppliers need to have certain set of certification and also a good track record. The certification is notoriously hard to obtain and maintain. Every oil company expects their contractors to adhere to high HSE (Health, Safety, and Environment) standards. There are requirements such as the proper labeling of trash and urine color guide. Technically, if you make effort, you can obtain it. However, this protects the industry against free/easy entry from new players. Another important component is track record. WINS have a long and established track record. Yes, it doesn’t start as an offshore company, but not a lot of companies can boast decades of existence. Aside from major accident prior to the IPO, WINS is a quite well-known operator among the industry players. For a new company to compete with Wintermar, it is not enough to have ship and human resources. It usually needs to tender for project through third party brokerage. Since it has to add another layer of cost, its profitability will not be optimal until it establishes a track record long enough for the oil customers to recognize. Usually this take around five years.

For those who don’t have any idea of what cabotage is, you can read about its implementation in Indonesia:
1. http://www.thejakartapost.com/news/2014/04/16/govt-applies-cabotage-principle-offshore-vessels.html
2. http://www.gbgindonesia.com/en/main/business_updates/2014/upd_cabotage_timetable_for_offshore_vessels_in_indonesia.php
3. http://www.hg.org/article.asp?id=19607

This rule effectively limit the competition in the marine industry. It shields the local market from the better-financed and experienced foreign operators. In our opinion, this is not a good thing, since it stops the local offshore industry from development. However, if this is coupled with a good regulation and investment allocation, this can actually be good for the whole industry. As far as I am concerned about the company, it permits the local dominant players to thrive. They have the “unfair competition advantage”. The flip-side, of course, is that they will be reliant on government to protect them. However, we believe that given the right attitude of WINS’ management, even if one day the cabotage rule is taken away, they will still do well, even though the margin might be disrupted moderately.

Now, cabotage by itself will not produce a moat wide enough to let the company have strong competitive position. It needs to be combined with other factors such as a big market, or other forms of barrier. To use Munger’s term, it needs to be combined with other factors to create lollapalooza effect. In WINS’ case, it is the human resources and capital. Since the offshore industry is terribly underdeveloped, there are not many offshore ships operating in Indonesian water. The higher specs or the more specialized ships, the less number of the ships is. This means that the human resources needed to operate these ships are underdeveloped. Not suprisingly, WINS does have a strong human resources. It is not only able to bring in a higher-spec ship, but it also can find the people to run the ship well. The next component is capital. I won’t spend too much time here; since WINS is listed in IDX and has a good relationship with the capital provider, they don’t have much problem in this area. In fact, its balance sheet is quite solid and it will not be hard for them to raise money. Another point, if you look at the WINS’ interest cost (as a percentage) for the last 5 years, you will be surprised at how low they pay their interest compared to the market. Talk about a good CFO! (Or CEO, if he is the one who decides!)

To sum up, in order to dominate in this industry, you will need:
1. Capital
2. Human resources
3. Access to project (track record, certification)
4. Indonesian-domicile (either Indonesian owned, or listed in the IDX)

Our Narrative
What do we expect holding this company for the next five years? We believe that:
1. There will be increasing government opening and incentive in the oil and gas, especially offshore
This is to reduce the country’s reliance of foreign import of oil, and at the same time alleviate the balance sheet by reducing oil subsidies.
2. There will be improvement in the regulation
Our biggest hope toward Jokowi’s administration is that it will clean up the structure in the regulatory body. If this is achieved, many companies will be more willing to put bigger capital investment (bigger ships, bigger projects).
3. There will be increasing number of foreign oil companies that invest in Indonesian projects
4. WINS (possibly along with LEAD) will be in the strongest competitive position in order to take advantage of the rising industry.

The first time we initiate the position in WINS, it is trading around 1x book value, at 6-7x ev/ebitda. Even though we would like to see a stable cash flow, in WINS’ case, we put an exception because it is investing for future earning growth.

Misjudgement

In any good investment opportunity, there are misjudgments that cause the company to be mispriced. I happen to subscribe to the school of value investing, which means that we believe that market occasionally make mistakes and if we can find the mistake and the reason for the mistake, there are opportunities to make money.

Then, what is the misjudgments in WINS’ case? We believe these are some of the mistakes that the market commits and fact that the market omits.

Depreciation
We believe that the market omits the fact that WINS might be under-depreciating their assets. In the financial statement, WINS stated that the useful life of its ship and equipment (which constituted largely for its assets) is 16-20 years. Compare this to other shipping companies:
SMDR    10-25     Transportation Services
SOCI         5-30     Transportation Services (Oil)
BBRM      8-20     Offshore services
TPMA     16-20    Transportation Services (Coal)
TRAM     16-20    Transportation Services
LEAD        20        Offshore services
MBSS         16        Transportation Services (Coal)

In cursory examination, WINS’ number seems to be inline with the industry’s accounting policy. However, even in shipping industry, there are different kinds of beast. It is the same argument that we use for the next point. When analyzing a company, doing a top-bottom analysis will increase our bias toward a company. Just because trucking industry and automobile are tucked under “Vehicle” industry does not mean they have similar characteristics.

Why then we think that WINS is being conservative in using the depreciation number? WINS operates ship that are mostly supportive in nature. For example, in coal industry, ship last much shorter than the ship that operates in offshore. The wear and tear in that industry are fierce. Similarly, in the transportation (be it bulk, cargo, or coal), the utilization of the ship is high since it has to operate continuously. On the other hand, offshore support vessels do not work as hard as the other vessels. For example, tugs are used to pull barges of coal and transport it to other places. They work hard. However, the same “tug” is also used in the offshore vessel to handle the anchors. Anchor Handling Tugs are doing just as the name suggests, they handle, move, tow the anchors for oil rigs. As you can imagine, they do not move and operate as much as the ordinary tug. There are a lot of standby time involved. Another example, barges are used to transport coal (which is later pulled by tugs). The main wear and tear are caused by the backhoe scratching the floor of the barge. The owner needs to resurface the barge quite often. The same word “barge” is also used for accommodation barge. This barge is like a floating hotel. It mainly houses the staff and employee of the oil companies. Its activity is not as mobile as coal barge, but you get the idea that it would last longer than your typical coal barge (Unless it happens to house a group of mischievous teenagers who actively seek to sink the ship).

Our purpose here is not to discuss different kind of ship here. WINS doesn’t even have accommodation barge. Our point is that the accounting system is limited in helping us to know the nature of the business. Here, we have to look beyond the financial statement to understand the nature of the business. A lot of analysts miss this point. And we believe this is a misjudgment from the market. The accounting system does not differentiate between different kind of business and the market which rely heavily on the financial information will miss this. It is either offshore industry is too conservative, or the rest of shipping industry is too aggressive. If WINS is conservative, to what extend its accounting is underestimating the useful life of the ships? That we are uncomfortable to answer here. Depending on your expertise in the industry, you will have different view. However, to leave you with something, from 2007 to 2012, WINS had spent around USD 210 m in capital expenditure (including maintenance capex). The depreciation charge increased from USD3.20m in 2007 to around 18.68m in 2013; that is an increase of USD15.48m. That means the investment of USD210m was being depreciated on the assumption that the useful life of 13.5 years. We are aware that this is a debatable way of analyzing this, and we welcome any counter perspective.

Shipping is a bad industry
We believe that Indonesian investors do not like shipping companies, until the second half of 2014. In the course of the duration we hold this counter, many people warned about the danger of shipping companies. It is not rare to find people referring to BLTA when warning about the danger of shipping companies.

In fact, we believe that the investors’ distaste for shipping companies can be understood. After all, shipping is a cyclical industry that requires high capex. Even WINS, as a company who benefits from the cabotage rule, can ‘only’ produce 8% return from its total asset. However, it is important to note that 8% is unlevered and its income is mostly derived from USD. A lot of shipping companies make money by trading the ships; buying them and ordering them when cheap, and selling them when expensive. The business profit, after deducting operation, is not a lot. Therefore, it is not hard to find the owner of shipping companies sometimes levered their balance sheet in order to drive up the return, or to get excess profit. One of the extreme example is of BLTA, and the ending is not pretty. WINS, however, is not such company. It is actually making enough profit to justify its business model, partly helped by its dominance and cabotage rule. It can still make money by trading ship, but even without trading activities, the business is making a decent amount of money without excessive leverage.

We think that the market is giving too much fear toward WINS just because it is a shipping company. WINS is a truly different company with most other shipping companies. In fact, we made a comment in stockbit forum that if a person cannot differentiate between WINS and BLTA (and paint them with the same brush), then that person might as well be blind. Careful analyst will not do that; even their managements are of different league (more on that later).

Illiquidity is a concern
We first bought WINS at 430. At that time, it is hard to find many shares sold in the market. Many point out that the share is illiquid, therefore it is risky. We reckon that the risk posed by the low volume of the share is a real concern. However, we do not believe that this risk is properly understood and applies to all investors. We suspect that a fund manager who is managing a billion USD says that buying a USD 50m market capped company is a risk for him because the share is illiquid, and this saying is repeated over and over again without its proper context until it reaches the other spectrum of investors.

For a investor who has less than $10m in his portfolio, WINS illiquidity should not have posed high risk. Yes, it is true that it is not easy to purchase the share, but over the course of time (more than 1 years), we think that it is possible to build a significant position. This is actually helpful because it helps us to think in the longer time horizon. Furthermore, sometimes the notion of illiquidity is only true most of the time; there are times when for no reason, there market will provide a lot of liquidity just because the stock is popular. We don’t actually need the stock to be liquid the whole year. On this matter, we believe that private investors (those who manage own money, or friends and fools’ money) do have advantage over the fund managers who are evaluated on quarterly basis. For most investors, the WINS’ illiquidity should not be considered a high risk.

That being said, we are aware of the risk of the exit. We are aware that the exit might not be possible over a short term period for the position we have accumulated over the period of two years. How do we then take this into account in our investment? First, we think that there is a more than sufficient discount on the valuation. If the company is worth 100, and we can get it for 80, while the bid/ask spread is 5-10%, then we think this is viable. The same principle applies on many illiquid counter in IHSG (yes, we love illiquid quality companies) such as PANS and MFIN. Secondly, a more important and harder principle, is that we are more careful in our emotion management. When we decide to exit the company, our emotion went through a period of test. It is not easy (more on later part). These principles do not prevent us from making losses, but it will help us to limit our losses.

Good governance is not an important factor
All of our thesis here could be nullified by the bad governance. Depreciation thesis won’t be valid if they buy overpriced ship. The moat will be useless if they actively transfer the profit to a private cost center outside of the company. There are so many ways you can screw the shareholders; in fact, we believe that a big portion of the companies exist in the exchange in order to extract value from the minority shareholders’ pocket to the owner or management’s pocket. Hence, for us, a good governance and good will are extremely critical.

We believe that WINS’ good governance and good will are not well appreciated. After all, most of investors expect themselves to be ‘robbed’ to a certain extent. We should be willing to reward the company with a good governance. As investors, we believe that monetary should not be a sole aim of a company. It should also promotes a good governance, an ethical way of treating the investors, suppliers, and employers. After all, we do not invest solely for monetary gain; our money is also our tool to vote to reward company that adds value. You might think it is a bit too much, but we believe that in what we do, we allocate capital to the good companies, and at the same time we disseminate our values and philosophies.

That being said, through this post, we also want to ask fellow investor to think beyond the numbers. We should be willing to reward higher valuation toward a company that is committed to good corporate governance. We have seen how bad a company can destroy shareholders’ value. It is horrifying.

Changes in Thesis
Driven by so much goodness, we have invested the company for two years. We would have held the counter for a longer period if our thesis did not change. In fact, previously, we believe that the company should be able to grow its income at least 20% for the next five years.

The cause of our thesis change has nothing to do with the company itself. It has more to do with the macro factor. Most of you would have already guess it. The collapse of oil price has changed the playing field. In our narrative, most of the key points are nullified when you have a low oil price. We have talked about oil price in our previous post, so we won’t talk about it here. With the current oil price, the government doesn’t need to do much to lightened its balance sheet. Jokowi’s administration removed the oil subsidies and reduced the retail oil price (twice!) so easily. We think he is one lucky president.

The same thing can’t be said in regard of offshore industry. In our thesis, the investment in offshore is driven by two factors, the government’s pressure to reduce subsidies and the high oil price, which incentivises investment. Now, you have the first one gone, the second one doesn’t give much hope either. At the current price, it might make more sense to import oil instead of developing oil production capacity. It is the same situation regarding importing from China. Why build the factory domestically, if you can buy the ready-product much much cheaper from China? This is even truer for offshore projects, since typically they need higher oil price to break even, compare to the onshore oil. Over the longer term, however, it will be prudent to keep investment to develop the offshore at a moderate level, since we believe that cheap oil won’t last. Like many commodity cycles, eventually oil prices will recover and revert to the mean. How long, and when, that we do not know. What we fear is that there is a high possibility that it will impact WINS’ cash flow for the next five years. We will know more at the next financial report (Annual report 2014).

Under this condition, WINS will still be a good buy at 1x book value. However, our main concern is in the ability to keep the operation cash flow going. The last quarterly report has shown that the operating CF has reduced quite significantly; we would wait until the latest financial report to judge whether this is a temporary trend, or it is just a reflection of the oil glut.

Post-investment:
As we have said, we decide to exit the company last year due to the uncertain fundamental in the oil industry. As we have committed many time and thoughts in the company, we are attached to it. Every seasoned investor would be well-aware of this fact, and we, who are not seasoned yet, are thankful to realize this early in our development. This decision is even harder to do, considering that WINS is a company with a good management and aligned interest with the shareholders, a rarity in Indonesia market. Our decision to quit the investment is more about the external reason rather than the internal. At the end of the day, we have to be rational. The drop in the oil prices has affected our thesis, at least the cash flow for the next five years will be extremely uncertain. If we find any hint of recovery, or change in our current thesis, we will take the chance to be invested in this wonderful company again.

Disclosure: At the moment, we hold less than 100 shares of WINS (that we got from the share dividend). We may initiate a position in the next few weeks if then valuation is compelling.