ROMANCE OF THE THREE KINGDOMS - OSKPROP, PJDEV & OSK MERGER SCENARIOS
1. Introduction
I have always wanted to write about the potential merger between OSKProp and PJDev. However, progress has been slow due to the vast amount of details and analysis required.
However, recently, OSK, OSKProp and PJDev had started moving. If I don't start writing, I might miss the opportunity to write about it.
2. Some Background Info About OSK
I have earlier on written about OSKProp and PJDev, but not OSK. Fortunately, the OSK Group is relatively straight forward and easy to understand.
Post disposal of OSK Investment Bank to RHB Cap, OSK holds approximately 10% stakes in RHB Cap (valued at RM2.1 billion), RM359 mil investment properties and RM342 mil capital financing assets.
As at 31 March 2014, the group has net assets of RM2.6 billion, borrowings of RM241 mil and cash of RM50 mil.
Based on 969 mil shares outstanding and share price of RM1.87, market cap is RM1.77 billion.
OLH holds 37.7% equity interest in OSK.
3. Ding Ding ! OSK Is Out In Round 1
If the rationalization exercise involves three parties (OSKProp, PJDev and OSK), then the scheme will indeed be quite complicated as there will be many permutations. It would be difficult to pin down the most likely scenarios.
However, based on preliminary analysis, I am of the view that OSK is unlikely be part of the merger exercise. This conclusion was arrived at after evaluating the options available to OSK in the event of a merger.
CASH OPTION - OSK forks out RM1.21 billion cash to acquire 100% equity interest in OSKProp and PJDev (RM483 mil + RM762 mil = RM1.21 billion).
As at 31 March 2014, OSK only has cash of approximately RM50 mil. Even though based on net assets of RM2.6 billion, the group might be able to raise the RM1.21 billion through borrowings, I find it difficult to believe that OSK will actually proceed to absorb the two property companies with such brute force.
Even based on 6% interest rate, the financing cost of the RM1.21 billion loans will be RM73 mil. OSKProp and PJDev's combined net profit in FY2013 was RM116 mil. After netting off the interest expenses, earnings accretion will only be RM44 mil. It just doesn't make sense for OSK to incur RM1.21 billion to raise its earnings by RM44 mil.
Further more, based on assumption of five year tenure for the loan, principal repayment would be RM242 mil per annum. Add the interest expense of RM73 mil, annual cash outflow over next five years will be RM315 mil. This will significantly stress the balance sheet and cash flow of OSK, even with contribution from the two new assets.
SHARE OPTION - OSK issues RM1.21 billion new shares to acquire 100% equity interest in OSKProp and PJDev.
In an earlier interview with the press, OLH expressed his view that RHB Cap is undervalued and has potential for further capital gain. If this is the case, he would naturally want to increase his equity interest in OSK. This could be achieved by swapping his stake in OSKProp and PJDev (which he holds 76.5% and 30% respectively) for additional stake in OSK (afterall, banks are more valuable than property companies).
This is at least the theory of how it should work out. However, in real life, this strategy doesn't deliver what he desires.
Based on back of envelope calculation, pursuant to a tripartite merger, OLH's equity interest in OSK will increase from 37.7% to 42%, an increment of 4% only (yellow highlighted).
This amount does not seem to be sufficiantly attractive to motivate OLH to pursue the Share Option.
| | OSKProp | PJDev | OSK | TOTAL |
| | | | | |
| Market cap (RM mil) | 483 | 762 | 1,776 | 3,021 |
| | | | | |
| OLH's portion (RM mil) | 369 | 229 | 670 | 1,268 |
| | | | | |
| Minorities (RM mil) | 114 | 533 | 1,106 | 1,753 |
| | | | | |
| OLH's equity interest (%) | 76.5 | 30.0 | 37.7 | 42.0 |
| | | | | |
| Minorities (%) | 23.5 | 70.0 | 62.3 | 58.0 |
As neither the Cash nor Share Option will be able to create tremendous value for OLH, I am of the view that OSK is unlikely to participate in the merger exercise.
(This is not the end of the story. In Section 6 below, I will evaluate the possibility of OSK injecting its investment properties into the merged OSKProp PJDev group. Please read on)
4. PJDev As Acquiror
CASH OPTION - In early 2014, PJDev announced a series of property disposals, which upon completion will bring in closed to RM400 mil cash. These transactions generated a lot of excitement and speculation. Will this be the precursor for a cash take over of OSKProp by PJDev ?
In my opinion, this is unlikely to be the case due to the following reasons :-
(a) PJDev recently announced that it is spending closed to RM400 mil cash to acquire land in Australia; and
(b) OLH only owns 30% of PJDev. By allowing PJDev to acquire OSKProp, OLH's interest in property development will be cut down substantially (in return, he will be sitting on a lot of cash).
As mentioned in one of my earlier article, the Ong family's recent corporate manuaveur gave me the impression that they are in a mood to grow, rather than cashing out.
In addition, based on my observations of corporate behaviours, entreprenuers don't like to hold small stake in listed entities. This is because they believe that after putting in so much effort to create value for a PLC, it doesn't make sense for them to only capture so little of its benefit.
One good example is Land & General Bhd ("L&G"). Due to Mayland's small shareholding in L&G (officially 17%), L&G likes to enter into 50:50 joint venture with Mayland. By virtue of such an arrangement, Mayland will be able to capture 58.5% of the value created for every development project (being 0.17 x 50% + 50%).
In view of the above two factors, we can more or less rule out the possibility of PJDev privatizating OSKProp by cash.
SHARE OPTION - PJDev issues RM483 mil new shares to acquire 100% of OSKProp.
This option is similar to the option whereby OSKProp issues new shares to acquire PJDev. As such, please refer to OSKProp As Acquiror : Share Option (Section 5 below).
5. OSKProp As Acquiror
CASH OPTION - OSKProp acquires 100% of PJDev for cash consideration of RM762 mil (for ease of calculation, assume zero privatization premium).
In my opinion, this is an unlikely scenario as OSKProp only has net assets of RM435 mil. As such, it is not easy to borrow so much to fund the privatization (even after taking into consideration cash holding of RM124 mil).
SHARE OPTION - Under this scenario, OSKProp issues RM762 mil new shares to acquire 100% of PJDev (assume zero privatization premium as it involves share swap).
Post merger, the merged group will have market cap of RM1.245 billion wih OLH holding 48% equity interest.
| | OSKProp | PJDev | TOTAL |
| | | | |
| Market cap | 483 | 762 | 1,245 |
| | | | |
| OLH's portion | 369 | 229 | 598 |
| | | | |
| Minorities | 114 | 533 | 647 |
| | | | |
| OLH's equity int (%) | 76.5 | 30.0 | 48.0 |
| | | | |
| Minorities (%) | 23.5 | 70.0 | 52.0 |
In my opinion, this is the most likely merger scenario.
The reasons are as below :
(a) the merged group's market cap crosses RM1 billion, which will attract institutional investors; and
(b) OLH will own closed to 50% equity interest in the enlarged entity (green highlighted). Just nice.
6. Injection Of Investment Properties By OSK ?
While we are busy contemplating how the merger will work out, the elephant in the room is OSK's investment properties.
In Section 3 above, I formed an opinion that OSK is unlikely to participate in the merger directly. However, according to OSK's FY2013 annual report, the group has RM359 mil investment properties comprises of Plaza OSK (RM157 mil), properties under construction at Jalan Ampang (RM158 mil, believed to be commercial properties) and stockbroking branches.
In the event that those properties are injected into the merged entity, the enlarged group will become as follows :-
| | OSKProp | PJDev | Properties | TOTAL |
| | | | | |
| Market cap (RM mil) | 483 | 762 | 359 | 1,604 |
| | | | | |
| OSK's portion (RM mil) | 0 | 0 | 359 | 359 |
| | | | | |
| OLH's portion (RM mil) | 369 | 229 | 0 | 598 |
| | | | | |
| Minorities (RM mil) | 114 | 533 | 0 | 647 |
| | | | | |
| OSK's portion (%) | 0 | 0 | 100 | 22.4 |
| | | | | |
| OLH's equity int (%) | 76.5 | 30.0 | 0.0 | 37.3 |
| | | | | |
| Minorities (%) | 23.5 | 70.0 | 0.0 | 40.3 |
As set out in Section 5 above, OLH will hold 48% equity interest in the merged OSKProp PJDev group. However, in the event of injection of properties by OSK, OLH's direct stake in the merged entity will be diluted to 37% only, while OSK will hold 22.4% equity interest.
How should we interprete this scenario ? Is this good, bad or neutral ?
In my opinion. this will be a disastrous outcome and leave a bad taste in minority shareholders' mouths.
Injecting investment properties even at high yield of 7% is equivalent to injecting the assets at PE multiple of 14.3 times (being 1/7 x 100). This will cause significant dilution to EPS post merger bearing in mind that OSKProp and PJDev's current PER is only 8 and 6 times respectively. Share price is likely to underperform post merger due to the lackluster EPS.
Fortunately, in my opinion, the above scenario is unlikely to happen due to the following reasons :-
(a) OLH's direct equity interest in the merged entity will be lower (37% vs 48%). In other words, he is also a victim of dilution.
His effective stake will also be lower. 37.7% of 22.4% equals 8.4%. The sum of 37% and 8.4% is 45.4%, lower than 48% (without the properties); and
(b) it is not advantageous for OSK to hold 22.4% stake in the merged entity. Institutional investors would find OSK to be a very unattractive stock if all it has is 10% stake in RHB Cap and 22.4% stake in the merger property group. There is simply too many layers.
7. The Final Structure - To Streamline Or Not Streamline ?
Based on 2013 figures, post merger, the enlarged entity will derive 69% of its earnings from property development while the remaining 31% (RM37 mil) from cable manufacturing, building materials and hotels and leisure.
Strictly speaking, there is not much synergies between property development and all these other business activities. Should the merged entity go one step further to split those business divisions from property development (by listing the cable + building materials + leisure and distribute those shares to shareholders of the merged group) ?
| (RM mil) | OSKProp | PJDev | TOTAL | % |
| | | | | |
| Property Development | 56 | 28 | 84 | 69 |
| | | | | |
| Cable | 0 | 17 | 17 | 14 |
| | | | | |
| Building Materials | 0 | 6 | 6 | 5 |
| | | | | |
| Hospitality | 0 | 14 | 14 | 12 |
| | | | | |
| TOTAL | 56 | 65 | 121 | 100 |
In my opinion, they should keep the whole group together. This is because the cable, building material and leisure business even though are profitable, have limited scalability (for example, if Swiss Garden is doing well, they can't just start buidling more hotels. Same thing happens to cable business, there is only certain amount of cable TNB needs to use every year).
A separate listed entity for those three business will not be attractive to investors (due to lack of growth potential) and hence will not attract premium valuation. It is better to keep them together with the property division so that the profit and surplus cash flow generated by them can be channeled to the property division for further expansion (property division has better scalability).
8. Concluding Remarks
(a) Recent share price movement of OSK, OSKProp and PJDev has fueled speculation that a merger exercise will happen soon.
In my opinion, it is likely that OSK will be announcing an asset acquisition soon, rather than a merger between OSKProp and PJDev (with or without OSK).
This is because OSK's recent trading volume is high (an indication of something brewing). OSKProp and PJDev on the other hand, has not seen huge increase in trading volume.
Any way, few months ago, OLH has told the press that OSK is actively looking for assets to buy and likely to conclude the deals over next 6 months. So the recent movement in share price could be due to that.
(b) Having said so, I am of the view that merger of OSKProp and PJDev will happen. It is a matter of time.
Based on preliminary analysis, it is likely that the merger will be effected by way of a share swap.
If it is indeed a share swap, I don't expect huge privatization premium as shareholders will be migrating to a new entity and continue to have exposure (huge premium will be paid only if they want to take you out of the picture altogether).
However, OSKProp and PJDev shareholders will still benefit as the merged entity will have larger market capitalization, balance sheets and other resources, thereby justifying a higher valuation multiples.
Let's see how things will unfold over the next few weeks. In the meantime, trade with caution.
Have a nice day.
