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Stock Investment Research with an Asian focus

Pacific Century Regional Developments Ltd (PCRD)- Will Richard Li finally privatise PCRD?

16/4/2015

 
Richard Li (Source: Forbes)
Richard Li
PCRD Key Statistics
PCRD’s share price has doubled over the last 3 years to a multi-year high of S$0.345 as at 16 April 2015 but yet remains very much undervalued. With the Company aggressively buying back its shares and reducing its public float to just above 13%, we think there is a good chance that this will be the year Richard Li finally privatises the Company.

Background

Pacific Century Regional Developments Ltd ("PCRD") has been an integral part of billionaire Richard Li Tzar Kai's empire ever since he acquired control of the SGX-listed company in 1994. Currently, it serves mainly as an intermediate holding company for Hong Kong listed PCCW Ltd, which in turn controls:
  • now TV, Hong Kong's leading Pay TV operator; 
  • PCCW Solution, an IT services leader in Hong Kong and mainland China;
  • 70.8% (92.6%*) of HK-listed Pacific Century Premium Developments Limited ("PCPD"), positioned as a premium property developer with projects in Hong Kong, Japan, Thailand and Indonesia; and
  • 63.1% of HKT Trust and HKT Limited (together "HKT"), Hong Kong’s premier telecommunications service provider and listed in Hong Kong as stapled securities under a business trust structure.

*Note: Even though PCCW holds only 70.8% of the ordinary shares of PCPD, it also owns Bonus Convertible Notes issued in 2012 under an unusual bonus share cum bonus convertible note issue specifically executed to restore the public float of PCPD to more than 25%. The notes have been conferred the same economic rights as the bonus shares and give PCCW an effective economic interest in PCPD of 92.6% instead of 70.8%. 
PCCW group structure and services
Figure 1. PCRD Group Structure and Services

For FY2014, PCCW recorded total revenue of HK$33.27 billion and a profit after tax (PAT) and minority interests of HK$3.31 billion. However, this includes a gain of HK$1.31 billion on disposal of Pacific Century Place, Beijing by its subsidiary PCPD, without which the adjusted PAT would have been around HK$2.00 billion. Further, we estimate that HKT contributed approximately HK$1.93 billion or almost 97% of the adjusted PAT.

Crown Jewel HKT

Of all the assets within the PCRD group, the 63.1% owned HKT (previously known as Hong Kong Telecom) is by far the largest and most profitable.

HKT was first acquired by PCCW in August 2000 at the height of the dot-com bubble for over an estimated US$28 billion in cash and shares. Then, PCCW beat out a rival bid from Singtel, amidst rumours of Beijing's concerns over potentially sensitive telecom assets falling into foreign hands. The acquisition did not initially turn out well and saddled PCCW with massive debts. In subsequent years, PCCW tried disposing of various assets to raise cash in order to pare down its debts including ironically that of HKT's assets. Eventually, PCCW managed to spin off the HKT assets into a trust listing on the Hong Kong Stock Exchange in 2011, raising US$1.2 billion in the process.

HKT is the undisputed leader in telecommunication services in Hong Kong. While it has long been the dominant player in the fixed-line and broadband services segments, its acquisition of CSL New World Mobility Ltd (“CSL”) from Australia-based Telstra in May 2014 for US$2.4 billion further catapulted it to the No. 1 position in mobile services as well. In Hong Kong, it has a market share of >60% for both fixed line and broadband segments and a 31% market share in the mobile segment.

Since listing in November 2011, HKT has performed well operationally. For the year ended 31 December 2014, it recorded total revenue of HK$28.8 billion and profit after tax of HK$ 3.1 billion, registering strong growth in both primarily due to a maiden 7.5 months contribution from the newly acquired CSL. Adjusted funds flow (defined as EBITDA minus capital expenditures, customer acquisition costs, license fees paid, taxes paid, net finance costs paid, and adjusted for changes in working capital), which HKT uses as a gauge for dividend distribution, has also grown steadily from FY2011 to FY2014 at a CAGR of 12%. With a first full-year contribution from CSL in 2015, top and bottom line as well as adjusted funds flow are expected to improve further. 
HKT historical performance chart
Figure 2. HKT's financial performance from FY2011 to FY2014

Other Business Segments

Although the other business segments such as PCCW Solutions and PCCW Media generated sizeable revenues, their contributions have been dwarfed by that of HKT. For FY2014, all the other business segments outside of HKT contributed just 14% of PCCW's total revenues and less than 1% of the group's EBITDA. This means that PCCW is at present in effect a proxy for HKT. That said, both PCCW Media and PCCW Solutions have continued to grow steadily and offer good growth opportunities.

PCCW Media, which includes the Pay-TV business operated under the brand "now TV", has been increasing its own entertainment production following a successful first TV drama series production "The Virtuous Queen of Han", which reached 38 million viewers in China. now TV's international footprint also continued to widen through affiliate partnerships to distribute now TV channels across countries in Asia and North America, with the latest addition being Taiwan.

PCCW was also recently awarded a 12-year licence to operate two free to air TV broadcast channels, becoming the first in 40 years to be awarded a new licence by the Hong Kong government. However, with the market dominated by a strong incumbent in TVB, we think the free TV licence is unlikely to contribute meaningfully to PCCW in the near future.

PCCW Solutions, an IT services leader in Hong Kong, has grown revenue and EBITDA by CAGR of 17% and 20% respectively over the last 3 years and continues to secure healthy orders. As at 31 December 2014, it has secured orders worth US$730 million (about 1.7x its FY2014 revenue) although we note that this is down slightly from the corresponding secured orders of US$819 million as at 31 December 2013.

PCRD trading at a steep discount to the value of its underlying assets

PCRD has only two significant assets on its books, its 21.8% stake in PCCW and a direct holding of 131,626,804 Share Stapled Units in HKT.

PCRD last traded at S$0.345 per share as at 16 April 2015, giving it a market capitalisation of S$945 million. Although its stake in PCCW is carried on its books at S$645 million, it is worth around S$1.45 billion on the market based on the closing price of HK$5.11 per share. In addition, PCRD's direct holding of Share Stapled Units in HKT is worth S$240 million. This means that at the current price, investors buying into PCRD are practically buying its controlling stake in PCCW as well as units in HKT at a huge 44.2% discount off the market value.  

To further establish that PCRD is indeed trading at a deep discount to its intrinsic value, we look at its key underlying asset, PCCW and compare its valuation against regional peers:
PCCW regional comparable companies
Figure 3. PCCW vs regional peers (Source: Bloomberg, company)

As you can see above, PCCW’s current valuation is in line with its peers based on both PE ratio ("PER") and dividend yield. However, to be conservative, we decided to peg PCCW to its implied valuation based on the highest dividend yield (4.5%, Starhub) and lowest PER (15.7x, China Mobile) of its peer group. 
Picture
Figure 4. Fair value computation of PCRD

This resulted in a fair value price for PCCW of HK$4.38 per share. Based on this new fair value price, we established an implied fair value for PCRD of S$0.542 per share. The current price of S$0.345 is thus at a steep discount of 36.4% to its fair value, which we do not think is justified.  

Aggressive share buyback returning value to shareholders in lieu of dividends while concurrently shrinking public float

PCRD has embarked on an aggressive share buyback programme in the last one year, acquiring and cancelling 9.99% of its own shares equivalent to 303,932,200 shares in total and almost maximising the 10% limit allowed under its share purchase mandate approved at last year’s annual general meeting. While share buybacks are not uncommon, we note that this is one of the rare instances in Singapore where any company has actually bought back close to the maximum amount of shares allowable under its annual share purchase mandate. As a result of the aggressive purchases, the public float has shrunk to 13.1%, a level dangerously close to the minimum 10% limit stipulated by SGX.

We note that the Company has proposed a further renewal of the share purchase mandate for its upcoming shareholders' meeting on 24 April 2015. In its latest circular for the shareholders' meeting, it specifically catered for the scenario of a maximum purchase of 3% of its total outstanding shares. We see this as an indication that the Company is prepared to resume buying back its shares aggressively until such time when the public float is close to the minimum of 10%.    
PCRD share purchase mandate FY2015
Figure 5. Extract of share purchase mandate from PCRD circular

Delisting imminent?


One other direct effect of the aggressive buybacks has been the tightening of Richard Li and his Pacific Century Group's control on PCRD. 
Richard Li's shareholdings % in PCRD has increased
Figure 6. Richard Li’s control over PCRD on 15 April 15 vs 14 Mar 14

With Richard Li and the Pacific Century Group controlling almost 87% of PCRD’s total shareholdings and with the shares trading at a steep discount to its underlying intrinsic value, we think there is a good chance that this could be the year that Richard Li finally pulls the privatisation trigger. We see little justification now for PCRD as a de facto intermediate holding company within the Pacific Century Group to remain listed and incur unnecessary compliance and listing costs.

PCRD should continue to return sustainable value to shareholders even if privatisation does not take place

While we see a good chance of the Company being privatised, we also considered the possibility of PCRD remaining listed despite the low public float. Under this scenario, we think that the Company could possibly resume paying cash dividends to shareholders.

For FY2014, PCRD returned almost S$76.9 million of capital through share buybacks alone. With the free float at only 13%, it is only a matter of time when the Company maxes out on its share buyback limits. What next then? For a start, we should note that the PCRD is an investment holding company with no other core operations on its own. This means that it does not have much need for capital or operating expenditures other than to maintain its listing and other corporate expenses.

Its main sources of cash income are derived primarily from its stake in PCCW and its holdings in HKT. 
PCCW has consistently paid out dividends
Figure 7. PCCW's EPS and DPS from FY2010 to FY2014 (^Note: Payout ratio and EPS for FY2014 has been adjusted to account for the one-time gain from the disposal of Pacific Century Place, Beijing by PCCW's subsidiary PCPD)

PCCW has consistently paid out a good chunk of its earnings as dividends (payout ratio >70%) over the last 4 years. In FY2014, its full year dividend payouts amounted to HK 20.2 cents per share. This translates to S$57.5 million worth of dividends for PCRD. In addition, PCRD also received S$8.9 million in dividend income from HKT directly. This gives it a potential cash income of S$66.4 million annually if the dividend payments are sustained. As an illustration, if all these cash were to be paid out as dividends to PCRD shareholders, it would translate to an annual dividend yield of about 7.0%.

As we previously indicated, the bulk of PCCW's earnings come from HKT and HKT's earning should continue to grow in the near future with the full consolidation of CSL in FY2015. Hence, we believe that both HKT and PCCW's dividend payments are sustainable.

While there is no assurance that PCRD will elect to receive its dividends from PCCW in cash (it opted for scrip dividends in FY2014 and cash in the preceding two years), or that it will resume paying cash dividends in future, the benefits from the cash income from PCCW and HKT should eventually accrue to shareholders in one form or the other. 

Recommendations

We believe PCRD to be deeply undervalued. Based on its latest closing price of S$0.345 per share as at 16 April 2015, it is trading at a steep discount to the market value of its underlying stakes in PCCW and HKT. Even if we were to peg the value of its stake in PCCW to the lowest valuation metrics within its peer group, PCRD would still be trading at a discount of 36.4% to the conservative implied fair value of S$0.542 per share.

With the Company also aggressively buying back its shares and boosting Richard Li's control to 86.7% while simultaneously reducing public float to 13.1%, we also believe this year to be an opportune time for Richard Li to finally pull the privatisation trigger.

Should Richard Li elect not to privatise the Company, shareholders would also benefit, in one form or the other, from PCRD's stake in PCCW and cashcow HKT. Sans share buybacks, if the Company elects to pay out its cash income derived mainly from the dividends collected from PCCW and HKT, we think that the Company would be able to sustain an attractive dividend yield of about 7.0% based on the last traded price of S$0.345 per share, further reinforcing our conviction that the stock is selling at far below its fair value.

Key Risks

Further share buybacks will heighten trading liquidity risks going forward. This is somewhat mitigated by the fact that the Company has at present a sizeable share base of more than 2.7 billion, such that even a minimum 10% float amounts to more than 270 million shares. This should be able to sustain some healthy trading activity going forward.

PCRD has high asset concentration risks as its prospects are predominantly tied to HKT. However, HKT's business model has proven to be resilient over the years especially given its market leadership position in Hong Kong. This should help to ensure that PCRD's earnings going forward remain relatively stable.  

(SGD:HKD X-rate of 5.70 assumed)

Kejuruteraan Samudra Timur Berhad ("KSTB")- What to make of the Takeover offer?

7/4/2015

 
KSTB has recently been the subject of a takeover attempt by its co-founder, Dato' Chee Peck Chia, an oil and gas industry veteran who together with his concert parties, announced a conditional voluntary takeover  offer (the "Offer") on 23 March 2015 for all remaining shares not owned by them. The offer price of RM0.48 per share is at a small premium to the last traded price of RM0.46 a share before the takeover announcement and a significant discount to its last reported NTA of RM0.67 per share as at 31 December 2014. However, taking into account the timing of the offer and the adjusted NTA per share of RM0.44, we do not think this is necessarily a bad development for KSTB shareholders.

Background

Up until 2014, KSTB had been engaged in the core business of providing tubular handling equipment and running services as well as tubular inspection and maintenance services for companies in the oil and gas industry. It was also in the business of providing land rig services. 

However, that began to change in November 2013 when it entered into an agreement with Bursa-listed Destini Berhad to dispose of its entire interest in Samudra Oil Services Sdn Bhd ("Samudra Oil"), through which it had been conducting its tubular handling equipment business, for RM 80 million. The consideration was satisfied fully in new Destini shares to be disposed of via a placement exercise. The disposal of Samudra was subsequently completed in April 2014 following which the Destini consideration shares were placed out at RM0.35 each[1].

Concurrently with the disposal of Samudra Oil, KSTB also entered into two separate agreements with Indonesian drilling services provider, PT Duta Adhikarya Negeri, to dispose of its 2 land rigs for a total consideration of US$10.5 million.
Tubular inspection and maintenance services
Figure 1. Part of KSTB’s tubular inspection & maintenance services

With the disposals, KSTB effectively exited both the tubular handling and land rig businesses, leaving it with a relatively small tubular inspection and maintenance services business which is currently operated by its wholly owned subsidiary Samudra Timur Sdn Bhd. As a result, the Company triggered Practice Note 17 ("PN17") of the Bursa listing rules giving it until 2 April 2015 to acquire a new core business in order to maintain its listing status. The Company subsequently triggered Practice Note 16 of the Bursa listing rules as a cash company on 27 February 2015. On the basis of its PN16 status, it has applied to seek an extension of the deadline to acquire a new core business to 26 February 2016. The outcome of this application is currently pending.

For the half year ended 31 December 2014, the group recorded after-tax profit (PAT) of approximately RM3.67 million, translating into a fully diluted EPS of 1.61 sens per share[2]. PAT was up from RM0.13 million in the previous corresponding period in 2013 with the increase largely attributed to foreign exchange gains of RM2.45 million and interest income of 1.65 million. Revenue was RM5.85 million.

Conditional Voluntary Takeover Offer by Dato' Chee and Concert Parties

On 23 March 2015, Dato' Chee Peck Kiat, his son Chee Cheng Chun and Darmendran a/l Kunaretnam (collectively "Joint Offerors"), an Executive Director of the Company, made a conditional voluntary offer for all outstanding shares not held by the Joint Offerors amounting to 76.72% of the total outstanding shares of the Company.  The all cash offer was  RM0.48 per share. Concurrently, the Joint Offerors[3] also made an offer of RM0.18 for all outstanding warrants of the Company not held by them amounting to 69.92% of the total warrants in issue. The Offer is conditional upon the Joint Offerors achieving a minimum shareholding percentage of at least 50% by the close of the Offer. In addition, the Joint Offerors have indicated their intentions to keep KSTB listed.

Our Views

Success of the Offer lies in the hands of a few shareholders

With sizeable stakes in the Company concentrated in the hands of a few key shareholders (We will call them “Key Shareholders” here), the success of the Offer depends very much on their willingness to accept the Offer terms.

KSTB's shareholding spread
Figure 2. A few significant shareholders hold the key to the Joint Offeror’s success in the takeover Offer. Joint Offerors are shaded blue and key shareholders highlighted yellow.

These Key Shareholders include long time shareholders, Innoteguh Sdn. Bhd.  and Trance Equity Sdn. Bhd. (not to be confused with Trance Rex Sdn Bhd) as well as Sterling Honour, Seamless Excellence and Oval Triangle, all of whom became shareholders by virtue of converting their ICULS[4] holdings. The Key Shareholders altogether hold 39.50% out of the 76.72% shares not owned by the Joint Offerors and have yet to give any indications as to their intentions with regards to the Offer.

We do not think any of the Key Shareholders holding significant shares have any compelling reason to put up a competing offer with the offer price already at a premium to adjusted NTA per shares. Should they wish to thwart the takeover attempt by the Joint Offerors, inaction may be the best course of action as the Joint Offerors still need to acquire another 26.72% of shares just to make the Offer unconditional. Furthermore, the board of KSTB had also announced on 25 March 2015 that it does not intend to seek an alternative offer.

Offer Price is at a premium to adjusted NTA representing a decent valuation of the remaining tubular inspection and maintenance business  

The offer price of RM0.48 per share is only at a small premium of 4.3% over the last traded price of KSTB prior to the Offer announcement. It is also at a significant discount of 28.0% to its last reported NTA of RM0.67 per share as at 31 December 2014.

However, taking into account adjustments from shares issued arising from conversions of the ICULS issue and warrants as well as its recent dividend payout of 4.5 sens per share, we estimate that the offer price is actually at a premium of 9.8% to KSTB's adjusted NTA of RM0.44. See Figure 3 below for computation.
Picture
Figure 3. Computation of adjusted NTA of KSTB

For the past 5 financial years, the remaining tubular inspection and maintenance service segment has contributed between RM 8.77 million to RM11.11 million in revenue and RM 0.72 million to RM 2.78 million in profit before tax, or an average of RM 1.53 million equivalent to a fully diluted pre-tax earnings per share of just 0.6 sens. 
Picture
Figure 4. Historical segmental results of the remaining tubular inspection & Maintenance Service business

As such, the offer premium over NTA of RM0.04 per share implies a valuation of approximately 7 times profit before tax for the tubular inspection and maintenance services business, which is neither too expensive or cheap in the current environment.

Takeover timing needs to be taken into consideration too

Further taking into consideration that the Company is already past the first deadline of 2 April 2015 for submission of a regularisation plan to Bursa Securities to continue its listing status and with the further extension of such deadline to 26 February 2016 uncertain, we believe existing KSTB shareholders should see the Offer as a welcome insurance in the event that the Company is forced to delist. According to the Malaysian takeover rules, the offer document has to be sent to shareholders within 21 days of the takeover announcement on 23 March 2015 and the Offer will need to be open for acceptance for at least another 21 days after the offer document has been despatched. This should buy some time while shareholders await Bursa's response to the Company's request for extension of time to acquire a new core business.

Recommendations

We believe shareholders should wait and see if the application by KSTB to extend the deadline to acquire a new business to 26 February 2016 is approved before making a decision on the Offer. As the Offer will be open for a minimum of 21 days after the Offer document has been despatched to shareholders, they will likely have between 3-4 weeks time while awaiting Bursa's decision. In the event that the extension is rejected by Bursa and the Company faces the prospects of being delisted, we believe that the RM0.48 cash offer provides an adequate compensation for shareholders to exit their investments. Should the extension be approved, KSTB will have until 26 February 2016 to acquire another new business to stay listed. In this case, even if shareholders decide to hold on to their shares, we believe that the downside will be limited given that the bulk of KSTB's assets consist of cash.

For investors not vested in the Company as yet, there is little risk but limited upside in buying in at the current price of RM0.48 per share pending acquisition of a new core business.

[1] Although the Destini consideration shares were placed out at the same consideration of RM0.35 at which they were issued, we note that this price was at an unusually large discount to the then prevailing share price of between RM0.57 and RM0.69 during the placement period even if we account for the low trading liquidity.
[2] Adjustments include interest and interest savings from the warrants conversion proceeds and ICULS conversion.
[3] On an unrelated but interesting note, we noticed that Chee Cheng Chun and Darmendran had also amassed a sizeable 18.64% stake in another Bursa listed company, Rex Industry Bhd, from 23 February 2015 to 5 March 2015 just prior to the Offer announcement. There are no indications as of now that the two transactions are related though.
[4] KSTB issued RM12.0 million worth of 5-year Irredeemable Convertible Unsecured Loan Stocks ("ICULS") to Maybank Berhad as part settlement of debt pursuant to a Debt Settlement Agreement dated 3 September 2013. It is not disclosed if Sterling Honour Sdn Bhd, Seamless Excellence Sdn Bhd and Oval Triangle Sdn Bhd are entities related to Maybank.
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