The Valuation Feasibility of Military Companies IPO in Egypt: Analysis of the Strategy and Tactics.

Article about The Valuation Feasibility of Military Companies IPO in Egypt: Analysis of the Strategy and Tactics.

Feb 29, 2020

“Strategy without tactics is the slowest route to victory and tactics without strategy is the noise before defeat”- Sun Tzu

Couple of days ago, London School of Economics “LSE” hosted an event to discuss Yezid Sayigh latest book “Owners of the Republic”. Released in mid-December 2019, the book is considered a comprehensive research anatomizing the Egyptian military economic activity. The research based its analytical methodology on numerical figures mentioned by official statements regarding companies’ performance. According to the book, the military economy constitutes around 1%-2% of the Egyptian GDP. Upon the book release, the Egyptian political leadership announced its intentions to launch an IPO program for some of the military companies. The statements beside the book’s findings and conclusion raised a heated debate among local and international reports. Some doubted the feasibility of undergoing an IPO program while others contemplated its success yet subject to some conditions. The conditions coincided with one of the book’s main findings. It specifically includes cost efficiency, transparency and financial engineering to halt losses utilizing comprehensive economies of scale structure.  Hence and post monitoring the latest official statements, is it feasible to launch an IPO program and properly evaluate the military companies? What could be the tactics for a financial restructuring strategy?

To answer the feasibility question, we have to tackle the transparency and the companies’ valuation worthiness if compared to Egypt EV/EBITDA expected figure. Earlier this month, the Egyptian Ministry of Military Production “MOMP” announced the military companies’ financial performance. During 2019 fiscal year ending on June 30, MOMP companies’ revenue aggregated to EGP 13.2 Billion recording a growth of around 12% and 215% if compared to 2018 and 2015 fiscal years respectively.  In addition, the companies’ profits recorded an amount of EGP 235 Million during 2019. Since the companies’ financials are not published, a detailed analysis of the financial components and breakdowns is not applicable. Nevertheless and by default, undergoing an IPO process necessitates publishing the financial statements. Hence, the valuation verification and analysis could be conducted easily fulfilling the transparency requirement. The IPO program announcement did not reveal a solid time frame for implementation, so 2019 financial figures might not be the base year for evaluation. However, the author opted to utilize these figures for the sake of the valuation argument. As a result of lacking a detailed income statement, the bottom line of EGP 235 Million is assumed to be the companies EBITDA. Also, it is assumed a projected horizon of 5 years with a no growth scenario for unlevered company. Upon discounting the EBITDA cash flows using the Egyptian 3month T/Bills, industrial manufacturing goods beta of 0.9 and EGX30 return for 1 year, the calculations yielded EV/EBITDA of 7.73 indicating an enterprise value of around EGP 1.82 Billion. If compared to Egypt expected EV/ EBITDA of 5.68, the companies valuation appears lucrative and feasible. However, each military company EV/ EBITDA might vary due to changes in industry beta calculations according to its activity classification in the Egyptian stock market.

To answer the strategy and tactics question, we have to correlate it with Sun Tzu quotation mentioned above. In military literature, a successful strategy is the one that utilize sound tactics optimally in the right timing. Yezid research criticized the military financial performance especially cost efficiency in some main aspects. Administrative cost, technological advancement, know how transfer and increasing the local component. The MOMP announced the reduction of administrative cost ratio from 56% in 2015 to 20% in 2019. Hence, the strategy was reducing administrative costs by implementing tactics on two phases. First, increasing revenue volume followed by organizational restructuring. On the other hand, an effective production cost strategy requires endorsing some tactics. One could think of a simple tactic by stripping idle assets to generate cash. This could be done either through direct sale to record capital gain or leasing to secure a steady cash flow stream. In January 2020, Yezid Sayigh tweeted a suggestion for the military companies to embark partnership with some other companies rather than conducting business with Chinese. The suggestion if juxtaposed vis-à-vis some tactics could explain the reasons behind choosing China. Post local currency devaluation in 2016, the Yuan exchange rate is considered favorable where Yuan is quoted at EGP 2. Hence, it is cheaper to import Chinese machinery achieving the required know-how transfer mentioned in Yezid research and allowing 100% local component production. Secondly, China trading mechanism might be to some extent flexible regarding payment currency. Conducting transactions utilizing the local currency of both countries could preserve the foreign reserve denominated in US dollars. In addition, launching the commodity market is another tactic to achieve production cost efficiency. Stipulating free market dynamics based on clear pricing mechanism will curb unjustified inflation, hence, elevating unnecessary cost burden from some military companies’ financials.

Finally, some reports contemplates that IPO program could be oversubscribed if more shares are allocated to retail investors and common people counting on the military popularity among Egyptians. On the other hand, some reports contemplate more shares allocated to institutional investors to boost partnership with private sector under the Public Private Partnership “PPP” umbrella. Which scenario will prevail, time will tell…