BEST WORLD is like a beauty queen who becomes more attractive with time. Year in, year out, since its listing in 2004, the company has delivered strong profit growth, as reflected in the title of a recent press release, “Best World delivers fourth year of consecutive growth since listing”.
As I dig deeper into the financial figures and familiarize myself with the business, I discover how well this company has done for its shareholders. Since its IPO, total shareholder return (that is, capital appreciation plus dividends) has been more than 600% as at Feb 29 this year, according to Bloomberg.
The company has stepped up its dividend payment now (final dividend of 2 cents, interim dividend 1.212 cents a share) when many companies are reducing theirs in times of uncertainty. For FY 2007, Best World increased its payout ratio from 34.8% in 2006 to 45% of its net profit. Better still, the higher percentage is on a higher base, as Best World’s net profit rose 13.9%.
Best World chairman Doreen Tan is a co-founder of Best World along with Dora Hoan.
Despite its fabulous business and shareholder orientation, Best World is a stock that some people hesitate to invest in simply because it is a multi-level marketing (MLM) company. A lot of people wrongly perceive it as pyramid selling, which is illegal in Singapore and many parts of Asia.
There are dubious businesses in the MLM industry, which focus their efforts on recruiting “sales representatives” who end up buying products for their own use and for inventory.
The reputable MLM businesses, on the other hand, mainly employ part-time, or sometimes full-time, sale representatives who use personal relationships and one-on-one selling to market products. The evidence points to Best World being a reputable MLM business.
Its compensation program, called ENP, does not make millionaires out of ordinary folk. However, it enables sales representatives to make decent money to add to their family’s resources. At least, one aspect of a “pyramid scheme” is at work in the Best World compensation plan. Thousands of individuals become its sales distributors to simply buy products at the “wholesale” price in order to use the products.
That’s why there’s only one sales distributor who is making S$500,000 and a few more who are making S$100,000 per year. These super distributors have a full-time commitment to sales and recruiting. Best has an estimated 2,000 such full-timers. On average, Best World’s active sales distributors earn sales commission of S$2,000 to S$2,500 per year.
The commission of top earners (which Best World terms as Silver, Gold and Platinum Directors) ranges from S$70,000 to S$500,000 per annum.
Best World sets a low consumption hurdle for members to sustain their membership. This gives me confidence that reported sales are quite close to actual consumption. In contrast, some competitors have higher entry-level sales hurdles to encourage aggressive selling by the agents.
Although sales growth is superior initially, the structure would leave unconsumed inventory stuck within the distribution channels eventually. According to its latest update, Best World has 148,428 distributors, of whom only 2,000 are full-timers. Best World's distributors consume about 75% of the products they buy.
Their demographics provide telling information about its main target market – females above 30 years old. About 95% of the full-time distributors are business builders.
Gross margins of more than 75%
This business model is undoubtedly compelling. It enjoys gross margins in excess of 75% without any corresponding huge need for capex. The sales force is independent and self-managed. Best World usually enters a new market when existing distributors start selling Best World products in this new market.
Membership has grown rapidly in recent years.
These distributors seek the Company’s permission to set up a Lifestyle Centre (“LC”) at their own expense. This centre acts as a storage and distribution point for the sales distributors. A certain percentage of sales is rewarded to these aggressive distributors for setting up LCs. When sufficient sales volume has been achieved, the company would set up a Regional Centre to enhance the marketing efforts of the products.
Best World has minimum receivables as all products are paid before they are sold. But the company does provide credit terms for some of its best sales people in regional markets. Best World has minimum working capital requirements.
Because of this unique market penetration strategy and the minimum working capital requirement, the company can continue to scale up the business without substantial requirements for working capital, property, plant and equipment.
In FY2007, its cash conversion cycle (that is, the time between the purchase of goods and the collection of payment) was shortened to 115 days as the company tightened collection days and inventory control. This compares well with FY 2006’s 110 days and FY2005’s 147 days.
Notably, Best World generated free cash flow of about S$14 million in FY07, compared to S$10.3 million in FY06.
Best World makes product quality a key priority. It sources for innovative products from its pharmaceutical GMP-certified OEM suppliers which are mostly based outside Asia. It plans to launch 10 new products every year. Sales growth is less driven by the number of launches and more by the emergence of the next blockbuster. While there is no guarantee of future product success, I see an emerging success.
Its DR’s Secret sold 200 sets/month when it was first launched in 1990. Currently, more than 5,000 sets are sold every month. Dr’s Secret sells for $384 per set, placing it among the mid-high tier of skincare product segment. My girlfriends say SK II sells for S$500+. A blockbuster product, the Negative Ionizer, costing S$750 sold pretty well in Singapore over the past 2 years. This same product was launched in Malaysia in May 06.
Best World keeps its SKU (or Stock Keeping Units) below 100 to make the sale proposition relatively simple for their mostly part-time independent sales force.
Hardly any receivables
Best World’s business is attractive because it is extremely cash generative and scalable. In FY2007, Best World's debtor days were 45 days, compared to payable days of 14 days. Receivables are tightly controlled by Best World.
Best World’s gross margins are attractive at 70-78%. The company sells its products to the distributors at a fixed Distributor Price (“DP”). Its distributors can sell the products onward to non-members at a 20% mark-up or Retail Price (“RP”).
However, the majority of the products are consumed by its own members. The company only books revenue at DP and prices its products at about 4-7x cost of goods sold (COGS). Historical margins were around 75%, which are higher than Amway’s 27%, Nu Skin’s 28% and the margins of traditional retailers such as Robinson and Metro. This implies that Best World’s products are priced at the mid-high range. This premium pricing reflects the quality of its products.
SPRING chairman Philip Yeo visiting Best World's HQ at Changi.
Selling and distribution expenses are the biggest cost component for Best World. These expenses are largely commissions for distributors to motivate them but there is a cap to ensure that selling expenses do not escalate out of control. The ENP program ensures that the company does not pay out more than 50.5% of revenue at any point. Instances of 50% payouts are rare, occurring only if all the distributors within a downline become optimally productive.
The beauty of MLM is the low capex requirements. There is little need to spend on fixed assets to run the business. As such, Best World’s free cash flow should be pretty close to its reported earnings. In Best World’s case, FY2007 net profit of S$13.5 million is close to FCF of S$14 million – and this pattern has prevailed in the past. With strong free cash flow, the Company can support sustainable dividends payout. The management has a policy to pay out 30% of its net profit as dividends to shareholders.
In FY2006, the Company paid S$4.125 million, or 2.5 cents per share, as dividend. For FY 2007, the Company increased it to S$6.125 million, or 3.212 cents, per share. I am sure the company can pay more in the future as it has a cash hoard of more than S$35 million and capex plans can be financed by its strong cash flow.
Ideally, Best World should consistently pay out more than 50% of its net profit as dividends, similar to Eu Yan Sang. This would help attract more institutional interest to the company, just as Eu Yan Sang has Aberdeen Asset Management as its anchor investor.
Future Plans
The management looks pretty focused, having publicly stated the markets that it would be expanding to in future. South Korea and the Philippines will be the new markets in 2008, while Japan and India will be next in 2009/2010. Given its track record in Indonesia, Malaysia and other markets, I believe the company should be able to execute its plans – with, hopefully, no more than a few bumps here and there.
A lot has been said about Best World’s expansion into China, touted to be the largest consumer market in the next five years. While there is no doubt that China, with its 1.3 billion population presents enormous opportunity for the company, I also believe that this is not an easy market.
Challenges will come along with opportunities. Let the management execute its plans in China the next 1-2 years and we will see how it grows along. In the meantime, if you are able to shake off any prejudice that MLM companies are bad eggs, this company is worth a second look, at least.
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