(Stocks Discussion) SGX: Creative Technology (SGX: C76)?

Creative is currently debt free and has a large pile of cash. However the business has been floundering and despite creating a relatively good wireless ear phone, its fortunes has not been changing as it is unable to challenge Apple's marketing team. In my opinion, Apple has a technologically more inferior wireless ear phone than Creative, however Apple's marketing team has been doing an awesome job selling lousy stuff. On the contrary because of Creative's poor marketing on its good products, Creative technologies has been constantly reporting losses and been generating negative cash flow. This has caused it to have a lower cash pile year on year

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The company is currently surviving on its IP by suing other companies and earning royalties. Personally I feel Mr Sim should just call it a day, close the company and sell off its valuable IP portfolio and distribute the cash to shareholders.

TL;DR Revenue and net profit don’t look very rosy for Creative. There is also risk in that most of their revenue comes from the same kinds of products. A competitive environment also doesn’t help.

What is Creative’s business?

Creative Technology plays on the global stage, but is actually a Singapore born company. With the HQ here, they also have offices in Shanghai and Silicon Valley among others. Most of their products are sound and video consumer electronics which to my personal experience, are quite high quality. They started off with humble beginnings, and the story of how they won Apple in a $100m lawsuit is a good read.

Growth Prospects

Competitive Market Place

With decreasing sales and weak cashflows, I don’t expect the company to do very well in the future. The market is also looking very competitive, with many different players competing with the same market share. As I elucidate below, I don’t think more consumers will buy more consumer electronics over time.

Concentration Risk

Creative faces this risk because almost all its revenue comes from the same kind of product. This means that in the event of a downturn in this market, Creative will be affected very heavily. Of course the upside is that if the products are very popular, Creative will do very well but this is not the case. This lack of diversification in what Creative sells is also probably why revenue has dropped over time.

Diversified Across Regions

Thankfully, Creative seems well diversified across the globe, with sales from different regions. This reduces the risk of earnings being too heavily affected if one region does not do well.

What do their financials tell us?

Income Statement

Revenue has actually decreased consistently over the years from FY16 onwards. This is quite a worrying sign. The consumer electronics space have become increasingly competitive with offerings from boutique competitors that offer a wide array of high quality products as well. I believe that smart phones now also provide better ear pieces, so fewer consumers will buy ear phones outside.

Despite decreasing revenue, R&D and selling and admin expenses have not decreased with it, which led to decreasing profitability over the years.

Even though Net Profit is actually positive, this was actually due to a gain from a litigation settlement with an equipment vendor to recover damages for a wireless broadband project. I believe that this should be seen as a one-off event, such that without this lawsuit, net profit would still be negative, which is quite a bad sign.

Balance Sheet

With a current ratio of more than 5, Creative’s short-term liquidity is very strong. This means that the company can meet short-term financial obligations very well. In fact, most of the company’s current assets as in Cash. But with this large amount of cash pile, the company should have spent it on other strategic initiatives to grow the business.

The company does not seem to hold much debt as well, as seen by how debt and interest expenses don’t even appear on the financial statements.

Cashflow

Like net profit, cashflow from operating activities was positive due to the law suit. Without this, cashflow here would be negative too, just like the previous year. The way the business operates is working capital (inventory, receivables, payables etc) also doe not generate more cash flow.

Cashflow from investing activities seems to be propped up by the sales and purchases of financial assets. There was also lesser purchase of property and equipment, probably reflecting the decrease in orders of the company.