Digimatic and 8VIC – Marriage and Divorce

A friend told me about this transaction and asked for opinion. I was amused by it. Amused because people are really creative in stock market in structuring the transactions. But considering the amount of money that shareholders lost, I cannot see it as amusement. I consider it shocking. But after finding out what happened before, the word shocking does not apply. What is the better word? I don’t know.

One blog (https://investingisbusiness.wordpress.com/) talked about this company Digimatic and gave a detail discussion of the transaction. But unfortunately, the post was asked to remove. (Someone saved the screenshot here – https://imgur.com/a/6LET7). It will be good if the blog can provide follow up on the ending transaction for completion but I guess it’s not gonna happen.

So here, I will do it. Let’s talk about it like a football match to make it interesting. For a start, let’s do a summary of what happened. This is like the first half.

FIRST HALF (2015)

In 2015, 8I bought 51% of CPA Academy for S$1.53 million, and sold part of it for S$14.5 million in total within few months of purchase. The valuation rose from S$3 million to S$63 million during that very short period. 8I realized a profit of nearly S$13 million, so they have recouped the entire investment by more than 8x. The rest of their interest can be considered pure profit. Through share swap or whatever, CPA Academy became Digimatic. Digimatic got IPO shortly in December 2015 and reached market cap of A$270 million! The share price crashed spectacularly after that by more than 90% from the peak to the bottom. That’s the quick summary for the first half, which happened between early 2015 and early 2016.

HALF TIME BREAK (2016 to late 2017)

Next, second half. Oh wait. There is a break between first and second half. During this break from early 2016 to late 2017, Digimatic was reporting financial performance that did not live up to the expectation. (These numbers are taken from the annual report).

The table above stopped at first half of FY2018 because Digimatic merged with 8VIC in second half, and it became difficult to show the numbers that just truly belong to Digimatic.

After IPO in December 2015, the net profit did not grow spectacularly as anticipated. The market cap hit the roof and sky diving. Digimatic lost more than 70% of the market value in 2016. Then came FY2017 financial performance that only showed little growth in profit. Share price continued the diving. Next, Digimatic reported losses for first half of its FY2018 (ending September 2017).

Source: from ASX.com (price adjusted for 1-for-50 reverse stock split)

I call this a break because during this period, Digimatic did not make any big transactions.

But during this break, someone else is trying to do something. 8VIC, running Value Investing College, the education arm of 8I that provides training related to investing, tried to do IPO in 2017. But the plan was scrapped. I don’t know why. That’s probably the cause for the transaction in the second half.

SECOND HALF (late 2017)

In second half, Digimatic started their transaction again. On 28 November 2017, Digimatic and 8VIC merged. The transaction was worded as Digimatic buying 8VIC from 8I Holdings, but what happened was Digimatic issued new shares to pay for the acquisition of 8VIC from 8I. 8VIC was worth nearly A$64 million (1,525,216,000 new shares x A$0.042 price per share at issuance). The newly issued shares represented 70% of the enlarged share capital of Digimatic post-issuance. That means 8VIC is actually bigger than Digimatic by more than 2x. After they merged, 8VIC represented 70% of the combined company while Digimatic represented only 30%. 8I Holdings owned 66.7% (this percentage might be slightly off, but I’m not checking for the exact number) of the combined company, hence it is the parent of all. So, 8I never really sell 8VIC away. 8VIC is their crown jewel, their core, why would they ever sell it away? The media release just used confusing wording for this transaction.

We said earlier that 8VIC tried to go IPO in early 2017 but scraped the plan, or was it?

Normally, the purpose of IPO is this:

1. Raise money to expand the business
2. Shares can be traded on public market, so shareholders can buy and sell the shares freely. Existing shareholders may sell their shares to finally get cash.

8VIC did not scrap the plan to get listed. They did a reverse takeover. 8VIC merged with Digimatic and represented 70% of the combined company. Effectively, 8VIC was listed now under the name of Digimatic. This achieved the second purpose of IPO listed above.

As to the first purpose, raising money, it also somehow did. Before the merger, Digimatic alone had S$11,055,830 (cash + fixed deposits) of cash as at 30 September 2017. Book value was S$15.2 million. After the merger, 8VIC would be able to tap on this cash to expand their business. So, this reverse takeover achieved the two purposes of IPO for 8VIC, but did not raise extra money from the public market. That’s the down side.

OVERTIME (late 2018)

Just as we think that the match ends in the second half, we are surprisingly caught by the overtime. At the start of this post, I say I find it amusing. This is why.

In less than one year after they merged, the combined company sold off Digimatic for only A$2 million (3,031,974 shares at A$0.66 per share) in October 2018 to Digimatic’s founder, Ivan Ong. When splitting the balance sheet, Digimatic got away with S$3.1 million cash and book value of S$2.4 million.

See something interesting? Before the merger, Digimatic alone had S$11 million of cash. But after merger and subsequent split, Digimatic was left with S$3.1 million of cash.

This is the analogy. A man married a woman. Before the marriage, the man had $11 million cash in the bank account. After they got married, they divorced in less than 1 year. The man now was left with $3.1 million cash. The remaining cash was with the woman. Is this man dumb? If he has S$11 million, he can’t be that dumb. But why would he do that?

After the split between 8VIC and Digimatic, Digimatic now is back to being a private company. We will not be able to read their financial performance anymore. Whether they survive or disappear completely, no one in public market will care. Only the internal shareholders will care.

The first transaction was the investment by 8I in CPA Academy, valuing it at S$3 million. The valuation sky rocketed to more than S$60 million in few months, and peak at nearly A$300 million after IPO. It collapsed by more than 90% after that. It merged with unrelated company for a short period before splitting and becoming a private company again, valued at S$2 million. From market value of 3m to 63m to 270m and all the way down to 20m and in the end 2m. That’s the end of the match. No more penalty.

Corporate Governance

Some corporate governance questions here for Digimatic’s directors and management.

1. Why would they agree to merge with 8VIC by issuing new shares at A$0.042 per share?

Some of the shareholders (Champion Star United, for example) paid a high price to buy shares of Digimatic before IPO. They paid at least S$14.5 million for a small amount of shares. During and after IPO, some shareholders bought at freaking high price and high valuation. Ken Chee, CEO of 8I, which is also shareholder of Digimatic, was praising the business of Digimatic and expecting massive growth potential. See this post for his praise. Likely, all these shareholders had anticipated an exponential growth in the company.

The falling share price may be beyond their control but if the growth potential remained valid, then isn’t it a good idea to buy back shares at low price? If shares buy back cannot be done due to illiquid shares, then at least don’t issue new shares at the bottom.

By issuing 70% new shares at A$0.042 per share to merge with 8VIC, the board of directors and management have implicitly agreed to value Digimatic at that very low price of A$0.042. From IPO price to new share issuance price of A$0.042, the original shareholders were losing between 80 to 90% of their money.

2 Why would they agree to split Digimatic from 8VIC with only S$3.1 million cash?

Before the merger, the Digimatic company still had S$11 million of cash. Within less than 1 year after the merger, Digimatic split from 8VIC and was now left with cash of $3.1 million only. The balance of the cash now belonged to 8VIC. How could the original shareholders of Digimatic approve of this?

This is the balance sheet of Digimatic as at 30 September 2017, showing cash balance of S$11,055,830 (cash + fixed deposits) before the merger. Book value was S$15.2 million as at 30 September 2017.

From Digimatic’s FY2017 annual report

This is the combined company’s FY2019 first half report, showing the balance sheet for Digimatic that was sold off. The cash was S$3.1 million. The book value (Asset – Liability) is S$ 2,458,434.

Now, after the split, the original shareholders of Digimatic own the 8VIC business. If we want another analogy, it’s like this. The original shareholders of Digimatic paid $1000 to buy 3 apples (Digital marketing business) because they believes the 3 apples could be sold at much higher price in future. The fruit basket contained 3 apples. But the price of the 3 apples sky dived to $100. The management of Digimatic agreed to swap the bad apples (digital marketing business) with some oranges (investing training business). The basket now contained 2 oranges and 1 apple. In less than one year, the management decided to sell the only apple away at low price, like $10. Ta da! The original shareholders of Digimatic, who bought the shares because it’s digital marketing business, now own investing training business, entirely different business from what they set out to invest in the first place. Their fruit basket of apples are completely swapped with oranges, and in the process, the shareholders lost lots of money.

I can’t think of a good reason why Digimatic’s shareholders would do this. They are worse off after the merger and the split.

From another perspective, there is also corporate governance question to 8I directors and management. 8I is the parent of the combined company between 8VIC and Digimatic. The combined company sold off Digimatic to Digimatic’s founder, Ivan Ong, for about A$2 million only when Digimatic’s book value was about A$2.4 million. Why would 8I sell Digimatic below its book value? Is Digimatic such a lousy company? 8I’s CEO, Ken Chee, just praised Digimatic and Ivan Ong in mid 2017, but now sold off Digimatic in late 2018 for just A$2 million. Is this transaction done at an arm’s length?

Original Shareholders of Digimatic

For this whole football match, the original shareholders of Digimatic, except 8I, were the biggest losers. 8I already recouped their initial investment by more than 8x after selling some of the shares to Champion Star United. Champion Star United and those shareholders who bought after IPO, are the biggest losers. What mistakes did they commit?

1. Bought at very high valuation

They bought the shares of Digimatic at sky high valuation that can not be reasonably justified. They are destined to lose money.

2. Hold the position throughout without cutting loss

From the start of 2016 until now, it’s 3 years. If they did not sell out to cut loss, they are suffering the maximum pain so far.

3. Agreement not to sell, if any

Some people say that the shareholders were restricted from selling. If it’s true, then it’s another mistake. Why would they agree on such terms??

4. Issuing more than 2x new shares and valuing 8VIC at A$64 million for the merger

Digimatic issued new shares to merge with 8VIC. A total of 1,525,216,000 new shares were issued at price of A$0.042 per share. That’s worth nearly A$64 million, giving a high valuation to 8VIC. Digimatic represented only 30% of the combined company. This high valuation for 8VIC diluted the ownership of the original shareholders of Digimatic in the combined company.

This is like the original shareholders of Digimatic falling from 10 floors. After hitting the ground, they were further stepped and stabbed. They have suffered a large fall in share price. Now, they merged with 8VIC and valued 8VIC at high price, which effectively means they were giving more and getting back less.

But issuing so many new shares at bottom price, we can also say they have “realized” their losses.

5. Permanent loss, not temporary loss

If the shareholders are still expecting to recoup their initial investment after all these, they are seriously mistaken. They have realized their losses when they issued new issues to merge with 8VIC. The directors and management have all agreed that the value was only worth that much at the new issuance price.

After 8VIC and Digimatic split, the original shareholders of Digimatic, except Ivan Ong, now own 8VIC, no longer Digimatic. Their losses in Digimatic was permanent. They are now owning a small part of a completely different company from what they set out to invest in.

If they think they got back something valuable in 8VIC, that’s ignorance + naive, which is lethal. They were exchanging their ownership in Digimatic with small part of the ownership in 8VIC. But because they valued 8VIC at high price, they got back very little. Anyone could have bought the shares of the combined company after the merger if they see potential in it. At current price, they could buy at far cheaper price than when the merger happened. So, the original shareholders were paying a high price for owning a small part of 8VIC.

Champion Star United probably own 3.1 millions shares of the present 8VIC. Out of total of 40.5 million shares, that’s just about 7.6% ownership. At current 8VIC market cap of A$24 million, Champion Star United’s ownership is worth just A$1.82 million. That’s a far cry from the at least S$14.5 million they paid to 8I.