TSH released a couple of significant updates over the past 2 weeks:

1. On 16 September 16, TSH announced that a big total payout of S$0.1232 per share of cash will be distributed back to shareholders, comprising S$0.016 in special dividends and S$0.1072 in cash distribution via a capital reduction. Total amount to be paid out is S$29.63 million or almost 88% of its current cash balance of S$33.69 million; and
2. The company had disposed of the majority of its Hibiscus shares earlier on 8 September 16. This means that the cash position it announced on 31 August did not include proceeds from the Hibiscus shares.

Our Take

While not surprised that the Company bumped up the upcoming cash distribution (see previous update) to include proceeds from the property disposal, the quantum of the payout pleasantly exceeded our expectations. Nonetheless, we welcome this very minority friendly approach taken by the Company. Together with the S$0.03 dividend paid in May, total distribution from the Company this year will hit S$0.1532 per share, close to double the original share price when our initial report was posted 5 months ago. Post distribution, shareholders will still retain their original shareholdings backed by a mostly cash net asset value of 1.9 to 2.6 S cts per share, based on the updated cash position which now includes Hibiscus proceeds and assumed Unilink sale price. More upside could even be in store if an RTO materialises. 

We expect the market to react positively to news of the bumper distribution given that the last traded price of S$0.127 is just slightly above the total payout amount. 

Since our last update in which we pointed out the strong possibility of TSH monetising all its assets and distributing the resultant proceeds in the mid to near future, the Company has successfully completed the disposals of most of its key assets in the space of 3 months.

Cash company sitting on cash hoard even before proposed Unilink sale

Having sold its main operating units, TSH is now a cash company as defined by Rule 1017 of the SGX Catalist rules. It currently sits on a cash hoard estimated at S$32.69 million, 90% of which will be held in an escrow account, according to its latest announcement as at 31 Aug 16. TSH will now have 12 months (with an additional extension of 6 months subject to SGX approval) to look for a new operating business which meets SGX’s listing requirements or be delisted, a scenario which should result in a distribution of all its cash. It should also be noted that under the Catalist rules, money in the escrow account can only be used for distributions to shareholders or to pay for expenses incurred in a reverse takeover. This should accord shareholders some assurance that the bulk of the cash will be safe and not be used to pay for ongoing corporate expenses such as directors' fees.

The reported cash position translates to a per share cash value of S$0.136 but does not include proceeds from the yet to be sold 26.5% stake in Unilink Development Limited. While we had previously flagged out that the realisable value of the Unilink stake could be much lower than book if pegged to the recent Metronic transaction, TSH’s management appears to think otherwise as it only adjusted the carrying value slightly downwards to S$2.98 million. A successful sale of this stake close to this price should boost its net cash per share to S$0.148 as the company has already repaid all its debts. 

But net liquidation value slightly lower than previously estimated

Using the management’s value estimation of the Unilink stake and including all residual assets and liabilities currently on its books, the net liquidation value of TSH works out to be about S$0.145 per share[1]. Should the more conservative sale price of Unilink be applied i.e. pegged to Metronic transaction, the net liquidation value is estimated to be S$0.137 instead. Both figures are slightly lower than our previous estimate of S$0.151 per share with the main difference being the slightly lower than expected sale price of the freehold property at Burn Road as well as forex losses and other expenses incurred in 1H2016.

Payout of at least S$0.025 per share expected soon

The Company has already announced previously its intention to distribute 100% of the net proceeds from the sale of Explomo and Wow totalling S$6 million to its shareholders via a capital reduction. This translates into a payout of S$0.025 per share. With no operating business and a cash hoard likely in excess of what is required in a typical reverse takeover, we will not be surprised if the Company decides to dish out further cash distributions in the coming months or bump up the next distribution to include part of the proceeds from the property disposal.

Recommendations

TSH has turned in an impressive performance since our initial report on 31 March 2016 with total returns of 99% over the 5 month period. As with the situation with all cash companies, further upside will depend very much on what and when Company decides to do with the cash pile over the next 12 months. Going forward, we think the share price should be supported by the current net cash per share of S$0.136 until further developments in the sale of Unilink or a new business acquisition is announced. While a potential acquisition could provide a further boost, we see a distribution of substantially all its cash holdings as the more viable and sensible option under existing market conditions. This means that shareholders should realise the estimated net breakup value of between S$0.137 to S$0.145 per share over the next 12 months or so, an upside of between 8% to 14% over the last traded price of S$0.127. 

Key Risks 

The major risk going forward is of the Company squandering its cash hoard in a value destroying acquisition. However, with 3 of the 4 board members (Teo Kok Woon-28.4%, Anthony Lye-16.6%, John Wong-3.2%) owning collectively more than 48% of the Company’s shares, we believe the interests between management and minority shareholders are sufficiently aligned in this case to mitigate this risk.

Since our initial write-up on TSH, the share price has surged, returning a total of 86% in less than 2 months. Our initial estimates pegged the value of the shares to the sum of its existing net cash and short-term securities position of S$0.077 rising to S$0.139 (S$0.0107 and S$0.169 respectively before adjusting for the 3 S cts dividend it had earlier paid) should the freehold property be successfully disposed. Recent developments, however, suggest that our views have been too conservative.

We now see a strong likelihood of the company monetizing all its assets and distributing the resultant proceeds in the mid to near future. Shareholders should realize total proceeds of at least S$0.151 per share should that happen. This represents a further 29% upside from the last traded price of S$0.117. We remain long at the current price.  

Key developments since our report

1. TSH announced on 28 April 2016 following its AGM that it had entered into a sale and purchase agreement with Exact Solution Management Ltd to dispose of its Consumer Electronics business carried out under its wholly owned subsidiary, Wow Technologies (Singapore) Pte Ltd. The consideration is US$2.4 million or S$3.24 million. It intends to distribute 100% of the net proceeds from this sale to shareholders. 
2. Concurrently, the Company has entered into a non-binding term sheet with its CEO, Anthony Lye, for the disposal of its Homeland Security Services business, consisting of its wholly owned subsidiary, Starmo International Ltd as well as subsidiaries under Starmo. The consideration shall be in cash and is to be agreed by the Company and Anthony  subject to a valuation report to be prepared and issued by an independent valuer. 
   
3. Company revealed in its annual report for FY 2015 in regard to its 26.5% stake in Unilink Development Limited that “Following the plan of the Company in 2015 to dispose of the investment in Unilink, the Company has followed up with a concrete plan to locate buyer and is of the view that the sale is highly probable to be completed within a year.” Consequently, the value of the Unilink stake has been written down to S$3.127 million as an estimated recoverable amount based on discussions with third parties. 
   

Our Take

Twin disposal of Consumer Electronic Business and Homeland Security Business leaves TSH with no core businesses and removes key cash drain risk

Coupled with the company’s decision not to actively pursue any property development projects after the disposal of its Australian properties, TSH is set to become a cash company upon the completion of the twin disposals of Wow Technologies and Starmo.

We previously flagged out the consumer electronics business, which incurred a loss of S$2.73 million in 2015, as the prime risk to TSH’s cash pile. Thus, we see its proposed disposal as positive news for shareholders even though the consideration of S$3.24 million would result in a non-cash disposal loss of S$0.37 million. The resulting cash distribution from this sale is estimated to be 1.3 S cts per share, representing 11% of the last traded price of S$0.117.

At the same time, we think the disposal of its Homeland Security Business, Starmo, should generate proceeds no less than the net carrying value of its tangible assets given that this division has consistently generated profits, albeit declining, over the last 3 financial years.

However, net realisable value of Unilink stake may be lower than book value

Although the Company has estimated that the recoverable value of the 26.5% stake in Unilink to be S$3.13 million, we note that Malaysia-listed Metronic Global Bhd recently disposed of a 17.7% stake in the same company for just US$551,724. Should the sale of TSH’s stake in Unilink be transacted at a similar valuation, the consideration it eventually receives may be closer to S$1.15 million (US$:S$=1.380), representing an S$1.98 million deficit over its current book value. 

Net Breakup Value is likely to become key share price driver going forward

With the latest announcements, we think that TSH will eventually dispose of all its key assets and businesses and return the proceeds to shareholders. As such, the focus for shareholders should shift towards TSH’s net breakup value as its assets will eventually be converted into cash.

Recommendation

Even though the share price of TSH has surged since our initial report, recent developments suggest that more upside may be installed for its shareholders. The pace of the disposals and distributions would likely drive share price going forward. Nevertheless, shareholders should eventually realise no less than our conservative estimate of TSH’s net breakup value of S$0.151 per share, representing an upside of 29% over the last traded price of S$0.117.

Further upside could come either in the form of a higher selling price of TSH Centre, Starmo or the stake in Unilink as we have assumed undemanding considerations for each of these assets. As an example, should TSH sell its property at say 909 psf which is the current lowest asking price of comparable properties in the vicinity, the net breakup value could rise to S$0.169 or 44% above the current share price.

We continue to be buyers at this price. 

In our report posted on 30 November 2015, we highlighted that IPC, pending completion of the sale of its seven business hotels in Japan and proposed capital reduction, remains grossly undervalued at S$1.750 per share. We also conservatively estimated after taking into account the net proceeds of the Divestment and repayment of all yen denominated borrowings tied to these properties, that the Company would have up to S$0.957 per share for distribution to its shareholders.  

Company distributing more than the net proceeds from the Divestment

On 17 December 2015, however, the Company announced the successful completion of the Divestment along with a much higher than expected cash distribution of S$1.600 per share! This is a pleasant surprise to us as we have assumed that the Company would only distribute proceeds from the Divestment and retain the remainder of its cash hoard for future reinvestment purposes. The market meanwhile has reacted positively to the surprise move, with the share price spiking up almost 10% to S$2.07 before closing at S$2.03 on the same day.

Figure 1: IPC share price has appreciated 16% since our initial report published on 30 November 2015

Recommendation

While we think that IPC can easily afford the cash distribution S$1.600 per share, given its extremely robust net cash position of S$1.633 per share post Divestment in addition to S$0.136 per share worth of listed bond funds, we see the latest corporate move as possibly heralding the Company’s exit from the real estate business altogether. To recap, the value of IPC's remaining assets lies largely in a major mixed development (Xu Ri Wan Huan Yuan) in China. From a strategic perspective, IPC thus has the option to remain as a single asset play, which we think is unlikely. Alternatively, it could either continue its expansion in China and other markets (note that it has more or less exited from both the Japan and US markets) or exit completely. The move to distribute substantially all its excess cash seems to suggest the latter.  

Should the Company go down this path, we posit that there could be further divestment and cash distribution exercises in the future. The gradual monetisation of its assets could well see the share price of the company approach its estimated NTA value of S$2.813 or more.  At the last traded price of S$2.030, IPC remains pretty much undervalued.  

The recent decision by SGX mainboard listed IPC Corporation Ltd to dispose of its remaining Japanese hotel assets (the “Divestment”) warrants a closer look at the stock by value oriented investors. Although its share price has risen by 26% since the announcement was released, it still remains grossly undervalued.

Assuming the successful completion of the Divestment, we estimate that the company will have a balance sheet stuffed with net cash and fairly liquid bond fund holdings amounting to S$1.769 per share, which by itself is already more than the last traded price of S$1.750 per share. Even if we further assume very conservatively that the remainder of its assets consisting mainly unsold Chinese property developments are written down by as much as 40% in value, the shares would still be worth S$2.311 per share or 32% above its last traded price.

As the company had already announced that it will pay out the net proceeds of the Divestment by means of a capital reduction, we think that its shareholders could stand to reap a cash bonanza of S$0.957 cents a share, which should provide further near term boost to its shares. We think that IPC offers compelling value at this price.   

Background

IPC Corporation Ltd (“IPC”) is a property and hospitality group controlled by Singapore based billionaire Oei Hong Leong, son of Indonesian tycoon Eka Tjipta Widjaja of the Sinar Mas group.

On 6 November 2015, IPC announced that it had entered into a sale and purchase agreement with Tokyo-listed Ichigo Group Holdings Co., Ltd (“Ichigo”), for the sale by the Company of its collection of seven business hotels in Japan for a total sale consideration of JPY 14.9 billion or approximately S$172.2 million. Ichigo, which recently upgraded its listing to the First Section of Tokyo Stock Exchange, is a diversified real estate group with a market capitalisation of approximately S$1.9 billion.

Figure 1: Two of the seven business hotels due to be sold to Ichigo Group

The seven hotels are located throughout Japan in the following cities: Tokyo (2), Okayama, Matsuyama, Kumamoto, Naha and Osaka, and carried on the company’s books at JPY10.4 billion (S$119.4 million). IPC is expected to generate a net gain of JPY2.7 billion (S$31.1 million). This translates into net proceeds of JPY13.1 billion (S$150.5 million). While the Company did not explain the significant difference between the gross and net proceeds, our guess is that a large part of it could be attributed to Japan’s capital gains tax which could cost well over 30% for assets held for less than 5 years. 

Completion of the transaction is expected to take place on 17 December 2015. The Divestment follows the sale of its two Sapporo hotels, incidentally also to Ichigo, for S$29.6 million in December 2014 and heralds IPC’s exit from Japanese hospitality assets, representing a turnaround from the Company’s stated aim of expanding its Japan hotel portfolio in its FY2013 annual report.

Our Views

This latest corporate action did not come as a surprise. Afterall, IPC had been mulling the sale since at least as early as March 2015 when it announced that it was in negotiations for the proposed disposal for a then total consideration of S$150 million. The Company subsequently announced in June 2015 that it will not proceed with the sale under those terms. With the latest agreed consideration at a significant premium to both the previous consideration as well as the market valuation of S$119.4 million, we believe this represents a good opportunity for IPC to cash in on the assets it had amassed between June 2010 and October 2013 at a healthy profit.

Equally motivated buyer should ensure successful deal completion

On the other hand, Ichigo may appear to be getting the short end of the stick having to fork out an additional JPY4.5 billion (S$52.8 million) over market valuation for the acquisition. However, we note that Ichigo had in October established a new hotel J-Reit, Ichigo Hotel REIT, scheduled to be listed on TSE on 30 November 2015. Ichigo Hotel REIT’s initial portfolio consist primarily of 9 hotels that Ichigo sold to the REIT, includng the two Sapporo hotels which it had earlier acquired from IPC. We further note that these two hotels were sold at a combined valuation of JPY3.6 billion, a significant premium over the JPY2.7 billion it paid IPC just 10 month prior. Similarly, we expect Ichigo to inject the seven hotels into Ichigo Hotel REIT in due course at favourable valuations. At a total consideration of JPY 14.9 billion, the seven hotels would also provide a significant boost to Ichigo Hotel REIT’s portfolio, currently worth about JPY 20.4 billion. It is thus also very much in Ichigo’s interest to see the transaction through. 

Our belief that both parties are motivated to complete the sale is further reinforced by the presence of a significant JPY 0.5 billion (S$5.8 million) break fee for the transaction, which should serve as a sufficient deterrent against potential deal default by either side.

Balance sheet to strengthen considerably post completion, shares are currently undervalued

IPC has typically maintained a strong under-geared balance sheet. Its net debt to equity over the last 10 quarters has not been more than 25%, with the latest figure at 5.3% as at 30 September 2015. 

Figure 2: IPC has consistently held high levels of cash coupled with a low net gearing on its balance sheet (Source: company, stockresearchasia)

  Post completion, we expect its balance sheet to strengthen even further to a net cash position of S$139 million or S$1.633 per share. In addition, IPC also holds S$20.3 million of financial assets consisting mainly listed bond funds and unlisted debt investments in a China property company. We estimate that the listed bond funds, which should be fairly liquid, amount to about S$11.5 million or S$0.136 per share, giving the company S$1.769 per share of value in net cash and listed bond funds alone.

The remainder of IPC’s assets consist largely of:

• Xu Ri Wan Huan Yuan (completed in 2014 and comprising hotel, kindergarten, club house and car park) 
  
• Minority investments in three property investment in China, including Aenon International Plaza and Ju Ren Da Sha.
  
• Unsold Oiso Condominium Units in Japan
  

Amongst the above assets, Xu Ri Wan Huan Yuan is by far the most sizeable with a net book value of S$77.4 million[i]. As little information on the status of this property has been disclosed, we conservatively assume that it is currently 100% unsold and illiquid. 

All in, the other assets held by IPC amounted to S$107.0 million or S$1.254 per share, giving the company an adjusted NAV post DIvestment of S$2.81 per share.

However, in order to satisfy ourselves with a conservatively derived value for IPC, we decided to apply a stress test[ii] to the value of these other assets which we deem to be largely illiquid by applying various discounts of between 20% to 40%. The results show that even at a maximum discount of 40% which should provide us with a healthy margin of safety, IPC would still be worth about S$2.311 per share.

Figure 3: IPC’s intrinsic value is still significantly above the last traded price even if its other property assets were heavily discounted

IPC shareholders to be rewarded with cash bonanza estimated at S$0.96 per share

Aside from trading at a steep discount to its intrinsic value, we also expect IPC’s share price to be given a near term boost once the Divestment is completed as expected by 17 December 2015. This is largely due to the fact that the Company had already announced its intention to distribute the net proceeds to its shareholders via a capital reduction exercise. With the net proceeds at approximately S$150.5 million, we estimate conservatively that upon repayment of its borrowings related to the seven hotels, IPC will have S$81.6 million available for distribution to shareholders. This is equivalent to S$0.957 per share representing a sizeable 55% of the last traded price of S$1.750.

Bullish purchases by Oei Hong Leong further reinforces our views that the shares are undervalued  

Figure 4: Oei Hong Leong, IPC’s controlling shareholder, made bullish purchases this year (Source: Forbes)

  On 1 April 2015, Oei Hong Leong, the controlling shareholder of IPC and one of the most watched investors in the Singapore stock market, acquired 6,319,200 shares (pre-consolidated basis, equal to 631,920 shares after the 10 to 1 consolidation on 9 June 2015), thereby triggering the mandatory conditional takeover offer of IPC at S$0.17 per share (equivalent to S$1.70 post consolidation). The mandatory offer is triggered when a shareholder first takes his shareholding across the 30% mark in a SGX-listed company. The offer ultimately did not succeed and Oei’s stake remained at 30.56%.

On 3 August 2015, Oei further acquired 850,000 post-consolidation shares albeit at a lower average price of S$1.53 per share, thus bringing his holdings to 31.56%. We note that this is the maximum amount that Oei can acquire within any six month period without triggering another takeover offer. The bullish purchases by Oei further reinforces our view that the shares are undervalued.

Recommendations

We believe IPC to be grossly undervalued. At the latest closing price of S$1.750 per share as at 27 November 2015, it is trading at below the value of its net cash plus listed bond holdings of approximately S$1.769 per share assuming the successful completion of the Divestment. Even if we were apply a very conservative 40% discount to the book value of all its other assets, the shares would still be worth at least S$2.311 per share or 32% above the current share price.  

With the Company announcing that it will distribute the net proceeds from the Divestment to its shareholders in the form of a capital reduction estimated to be as much as S$0.957 per share, we think that the share price could also be due for a near term boost. Still further upside could come from positive developments from its China properties.

With a healthy margin of safety, we see compelling value in IPC at S$1.750 and are definitely buyers at this price.

Key Risks

Non completion of the Divestment or lower than expected distribution from the Divestment could have short term adverse impact on the share price.

In our last report on MIIF (link) 3 weeks ago, we highlighted a mispricing in MIIF's shares and a potential arbitrage opportunity arising from the company's intention to redeem its remaining outstanding shares at 8.25 S cts per share following the close of its disposal of South China Highway Development (H.K.) Ltd.

As anticipated, on 14 September 2015, the company announced that the Proposed Divestment had achieved a financial close. Trading in its shares will be suspended from 18 September 2015, and the share redemption will be effected on 21 October 2015.

We further note that MIIF traded between 7.8 and 8.0 S cts from 24 August to 14 September 15. Investors who had acquired the shares during this period would have effectively locked in unlevered gains of between 3.1% and 5.8% for what would be a maximum holding period of 2 months while taking what we deem as very low risk. 

Investors can refer to the company announcement for more details and key dates. 

Amidst the current carnage in the equity markets, interesting opportunities in the space of arbitrage and special situations are beginning to emerge owing to the widespread and indiscriminate selling. MIIF is one such opportunity that has caught our eye.

MIIF, an entity listed on the mainboard of SGX but structured as a closed ended fund, had announced on 15 May 2015 the sale of its sole remaining asset, an 81% effective interest in Hua Nan Expressway Phases 1 and 2 (HNE) to Topwise Consultants Limited, an existing minority shareholder in HNE, for a total cash consideration of S$110 million (the “Proposed Divestment”). Post completion, MIIF intends to distribute the net proceeds and any excess cash it holds by way of a share redemption, following which it will be delisted from SGX.

The share redemption is expected to take place by 30 October 2015 provided that the Proposed Divestment is completed by its long-stop date of 15 September 2015 and investors will be returned around 8.25 S cts per share based on MIIF estimates which we deemed to be reasonable. This gives investors a potentially low risk return on investment (ROI) of 3.1% over what is likely to be a maximum two-month holding period or an equivalent return of close to 20% annualized.

Brief Background

In December 2012, MIIF made the decision to initiate the disposal of all its then existing assets following a strategic review. In subsequent years since, MIIF successfully completed the divestments of Taiwan Broadband Communications, Changshu Xinghua Port and Miaoli Wind and returned 54 S cts per share to its shareholders. HNE is currently the sole investment held on its books.

MIIF’s interest in HNE is held through its 90% owned subsidiary, South China Highway Development (HK) Ltd (“SCHK”), which in turn holds a 90% interest in HNE. This gives MIIF an effective interest of 81% in HNE. Topwise Consultants Limited (“Topwise”), the proposed buyer owns the remaining 10% of SCHK. The proposed transaction involves the sale of MIIF’s 90% share of SCHK to Topwise for a total consideration of S$110 million. Little is known and has been announced of the buyer except that in 2007, Topwise, together with Precise Management Ltd, sold the same equity stake to MIIF for $295.7 million[1].

Figure 1: HNE's existing ownership structure

HNE is a dual-carriage urban toll road in the city of Guangzhou, China and acts the city’s main artery for north-south traffic. The interest in HNE comes with the exclusive rights to operate and collect tolls up to 2026. In the last two full financial years, namely FY2014 and FY2013, HNE contributed S$12.3 million and S$12.1 million in dividends respectively.

Figure 2: Hua Nan Expressway, Guangzhou. (Source: MIIF)

Investment case

3.1% returns over a two-month period sufficiently attractive under current market conditions

We believe that MIIF would make for a sensible arbitrage opportunity returning around 3.1% based on the last traded price per share of S$0.08 over an estimated period of 2 months or about 20% annualised. While a 3.1% return may not be much to shout about under normal circumstances, we think that this would be a sufficiently attractive opportunity for investors seeking short term stable returns with excellent downside protection especially given the current turmoil in the stock markets.

Low execution risks and high probability of deal completion

While the completion of the Proposed Divestment was originally envisaged to be on 5 August 2015 and has since been delayed, we still believe that there is a high likelihood that the transaction would be completed in due course and before the long stop date of 15 September 2015:
                

1. The key condition precedent for the transaction is the approval of MIIF shareholders, which has already been obtained on 27 July 2015. 
2. As a long time existing shareholder of HNE, Topwise does not require any due diligence and accordingly, the Proposed Divestment will not be subject to conditions typically expected from other third party purchasers and includes only limited representations and warranties.
3. As one of the two previous owners of the HNE stake, we expect that there will be little or no regulatory risks regarding the transfer of the ownership to Topwise as is sometimes the case for Chinese acquisitions.
4. While little is known or has been announced of Topwise and their financial standing, we believe that financing is unlikely to be an issue given that Topwise, together with Precise Management, had received a much higher consideration of S$295.7 million when they sold the stake to MIIF in 2007. In addition, Topwise has remained as a minority partner in HNE since the original sale and MIIF is likely to have done its part in ensuring that Topwise has the necessary financing lined up before entering into the sale and purchase agreement. 
   

MIIF's manager has 17.4 million reasons to see through transaction

MIIF’s manager, Macquarie Infrastructure Management (Asia) Pty Limited (MIMAL) stands to enjoy a big windfall of S$17.4 million upon successful completion of the transaction as the total cumulative proceeds from all its divestments including HNE will exceed the minimum S$694.9 million threshold thereby triggering the success fee. This gives MIMAL extra motivation to see through the transaction.

Excellent downside protection even if deal falls through

In the unlikely event that the Proposed Divestment falls through at this late stage, MIIF would still be able to continue benefiting from the stable cashflows HNE generates going forward. For FY2014 and FY2013, HNE contributed  S$12.3 million and S$12.1 million respectively in dividends to MIIF.  This helped MIIF maintain a dividend payout of 0.9 S cts for FY2014. We believe that MIIF should be able to pay out a similar amount going forward even if they were forced to retain the HNE stake. This is supported by KPMG's view as the Independent Financial Adviser to the MIIF for the Proposed Divestment that "based on an 85.0% dividend payout ratio of MIIF’s estimated dividends on an undiscounted basis, it would take approximately seven to eight years for Shareholders to realise the estimated net proceeds of 8.25 S cts per share."

Our Recommendations

We believe that MIIF shows all the characteristics of a good short term arbitrage opportunity: high probability of deal completion, decent returns over a two month holding period with potential to be magnified with leverage, and excellent downside protection even if the deal fails at this late stage.  For investors seeking a respite from the current carnage in the equity markets, we would recommend this as a viable investment opportunity and are buyers at at S$0.08 and below.

Risks

A prolonged closing of the Proposed Divestment could negatively affect the risk-return dynamics although at the moment we would assign a low probability to this happening given the background of the buyer.

(All preceding amounts in SGD unless stated)

[1] Actual amount paid. The original consideration of S$329.5 million included a contingent payment S$33.8 million which was never paid as conditions for payment were not met.

Key developments since our first report:

1. Two weeks after our report published on 16 April 2015, Business Times ran a similar article on 30 April 2015 highlighting the potential delisting of PCRD as well as a possible restructuring of the group:http://business.asiaone.com/news/pacific-century-headed-delisting (note: link is to the said article reproduced on asiaone.com as Business Times operates a paid platform that might not be available to all readers)
2. In the same two-week period, PCRD's share price has advanced more than 28% to close at $0.445 on 30 April 2015. It has since cooled slightly to $0.435 as at 4 May 2015. 
3. On 2 May 2015, PCRD released an announcement clarifying that "it is not aware of, and has not received, any proposal in relation to privatisation of the Company. In addition, the Company is not aware of any restructuring plan involving the Company and its subsidiaries."
4. PCRD has successfully obtained a fresh mandate for share repurchases up to 10% of its shares and gone on to record its first purchase on 29 April 2015 at $0.405 per share, a sharply higher price than its previous purchase at $0.365 per share a week before.   
   

Our Views

We do not see the company's response as anything more than routine and it does not in our opinion reduce the likelihood of a privatisation happening in the future. It merely confirms that an offer or restructuring proposal has not been tabled or discussed officially as at the announcement date. 

Under the current regulatory regime, there are a few ways that PCRD's privatisation could take place: through a general offer, a scheme of arrangement, a voluntary delisting or a forced delisting by SGX due to low free float (<10%) coupled with an exit offer. Based on current circumstances, we see the last two as the most likely options. Both would require a reasonable exit offer to be tabled and the appointment of an independent financial adviser ("IFA") to opine on the fairness of the offer as stipulated in the SGX listing rules. We note that IFAs tend to benchmark fair value of a company's shares to the market prices of its underlying assets where such values are available as in the case of PCRD. As such, we do not expect any exit offer, if it materialises, to deviate greatly from the fair value computed using this methodology in order to obtain a positive recommendation from the IFA. 

Recommendations

We continue to believe that PCRD is undervalued although we note that the valuation gap between the current market price of $0.435 and the implied fair value of $0.542 which we previously computed has closed significantly to 19.7% (vs 36.4%). Downside risks though, should be limited as the Company has reconvened its share repurchases at a sharply higher price of $0.405 per share lending further support to the share price.  

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%. 

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. 

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:

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. 

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%.    

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. 

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. 

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)

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.

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.

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.

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. 

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.