MERE months after a major leadership change — its first in two decades — bumiputera equity fund Permodalan Nasional Bhd (PNB) is now looking to break up Sime Darby Bhd, the conglomerate in which the government-linked asset management company has a close to 55% controlling stake.
Sources say PNB chairman Tan Sri Abdul Wahid Omar, who took the helm in August, and CEO Datuk Abdul Rahman Ahmad, who came on board in October, have key roles in the plan to unlock value in Sime Darby, a key dividend contributor.
Details of the corporate exercise are scarce for now, although some quarters say the equity fund is looking to maximise its earnings and manoeuvrability by having more individually listed entities as opposed to a single public-listed parent holding an array of different businesses.
“It’s being done at a high level of PNB and Sime Darby. To make things clear, the plan is not being opposed by Sime Draby’s management; they are working on it together,” a source tells The Edge.
But talk of a possible break-up of Sime Darby, which has a more than 100-year history, is not new. Group president and CEO Tan Sri Mohd Bakke Salleh had openly talked of a long-term spin-off strategy of core businesses to enhance value without providing specific deadlines, although shifting market conditions have been a major hurdle.
But the active desire and participation of its majority shareholder now may inject fresh vigour into the break-up plan.
In fact, the possibility of PNB’s new top brass pursuing this strategy had stirred the market recently.
In a Nov 2 report, Hong Leong Investment Bank suggested that Wahid’s leadership “could mean more asset unlocking/restructuring exercises in a move to energise the major shareholder’s investment portfolio”.
Similarly, Credit Suisse is expecting Wahid to begin work on enhancing the corporate performance of PNB and its stable of companies.
“It would be most time-efficient for Wahid to start with PNB’s largest holdings, which are Maybank and Sime Darby,” Credit Suisse says in a Nov 2 report. “Of the two, we believe Sime has more low-lying fruit.”
As at Nov 10, PNB’s shareholding in Maybank and Sime Darby jointly added up to a market value of RM68.16 billion, representing 26.73% of PNB’s total asset size of RM255 billion, according to its website.
The sheer size of Sime Darby, a behemoth worth roughly RM55 billion in terms of market capitalisation, has put a persistent “conglomerate discount” on its valuation (“Sime Darby undervalued based on total sum-of-parts” on Page 74). This may be due to its diverse businesses, the core being plantation, industrial, property, motor and logistics.
In its financial year ended June 30, 2016 (FY2016), Sime Darby posted a revenue of RM43.96 billion — relatively flat year on year — while net profit rose 2% to RM2.6 billion, according to audited figures in its 2016 annual report. It paid out total dividends of RM1.7 billion, representing a net dividend payout ratio of 71%, the highest on record, according to Bloomberg data going as far back as FY2008.
A 55% share of the dividends means PNB would have received roughly RM935 million from the group in FY2016. Between FY2012 and FY2016, Sime Darby’s dividend payout ranged from RM1.6 billion to RM2.2 billion.
Depressed crude palm oil (CPO) prices and a prolonged coal-mining slowdown in Australia held back earnings in FY2016 with both the plantation and industrial divisions seeing their pre-tax profit hit a multi-year low. Better earnings in the other divisions, for instance motor, mitigated the decline.
Right timing?
This raises questions as to the timing of the whole exercise. Ideally, a corporate spin-off is done when the relevant business units are doing well with a bullish market sentiment on their prospects.
However, that does not seem to be the case for most of Sime Darby’s core businesses. Take the plantation division. Its pre-tax earnings in FY2016 totalled RM1.05 billion, the lowest since the mega-merger exercise nearly 10 years ago.
In terms of operating income, this division made up 34% of the group’s earnings in FY2016, the lowest proportion on record and a steep fall from its peak contribution of 73.5% to group operating profit in FY2008.
While CPO prices, having begun the year below RM2,200 per tonne, are now north of RM2,800 per tonne, a panel of experts at the Palm Oil Trade Fair and Seminar 2016 held in Kuala Lumpur last month had mixed views on the commodity’s short-term pricing outlook.
In a report last month, CIMB Research notes that forecasts from the seminar range from RM2,200 per tonne to RM3,000 per tonne for the fourth quarter through to early 2017. The seminar was jointly organised by the Malaysian Palm Oil Board.
Similarly, the industrial division’s FY2016 pre-tax profit of RM326.3 million was the lowest post-merger. While coal prices have strengthened recently, analysts opine that earnings recovery in the segment would be gradual.
Meanwhile, the property division may have missed the boat for a listing because of poor sentiments on Malaysian properties as a result of an overheated market.
Sime Darby had previously emphasised the importance of maximising valuations as the guiding factor in spin-off decisions. In fact, Mohd Bakke had stressed to the media that the group would only pursue a spin-off listing when market conditions were optimal to ensure maximum value creation.
The group’s proposed listing of its motor arm by early 2015 was a case in point. The proposed spin-off came close to fruition but was eventually shelved as market conditions turned sour before it could be completed.
The valuation bandied about at the time was US$500 million to US$900 million (roughly RM1.6 billion to RM2.9 billion then), according to news reports.
Given this perspective, the timing of PNB’s renewed interest in pursuing plans to start demerging the group soon may seem counter-intuitive and raises eyebrows.
Logically, soft market conditions would pour cold water on any urgency to unlock value via flotation exercises as the shareholders may get less than optimal returns for their troubles. So, the question is, why is PNB choosing to pursue the exercise despite the current weak climate?
To be fair, it may be argued that PNB is simply preparing in anticipation of market conditions turning positive, whereby all that would be left to do is pull the trigger.
Paths to a break-up
With all parties keeping information close to their chests, it is unclear how PNB will eventually go about breaking up the conglomerate. But first, it must decide whether breaking up Sime Darby is ultimately the better option in the long run.
The case for a break-up hinges on unlocking the depressed value of the group’s businesses as seen from the persistent conglomerate discount (see accompanying story).
In an optimal scenario, floating Sime Darby’s different divisions would fill PNB’s coffers through an offer for sale, which would boost dividend payments to its unit holders.
Alternatively, PNB may decide to keep the group intact and try to unlock value by improving the operational performance of some divisions, such as plantation and property, which are seen to lag behind industry peers (see story on the Synergy Drive merger).
That said, this alternative route is slower and more complicated. And if PNB is in a hurry, it may not be feasible. Going for a break-up means PNB is likely facing three major execution scenarios. The most straightforward would be to separately float all five core businesses with PNB as the controlling shareholder. This means doing away with the listed group entity, Sime Darby Bhd.
While this scenario frees the outperformers from the shadow of those facing an industry downturn — for example, property’s shining star would not be dimmed by a plantation slowdown — critics may argue that this removes an important synergy: size and diversification.
Proponents of the conglomerate structure have argued that Sime Darby’s huge collective balance sheet has been a strong supporting element in the individual divisions’ competitiveness and staying power as they have been able to tap the capital and cash flow of their sister divisions in the group.
It may even be argued that this safety net provided by the conglomerate structure and balance sheet is critical to motor and industrial, which are essentially dealership businesses for principals such as BMW, Ford and Caterpillar, to name but a few. Removing this safety net may impact the staying power and prospects of these segments.
Should PNB wish to keep this element on the table, it can do so by keeping the listed holding entity as the common thread linking the separately listed business divisions. However, this then begs the question of whether the holding entity is redundant as its function would merely duplicate that of the boards of the listed divisions.
In turn, the listed holding entity would represent an additional layer between PNB and dividends from the listed business divisions, which may cut into the cash dividends flowing from the divisions to the ultimate shareholder.
An interesting consideration here is how PNB chooses to treat the Sime Darby brand itself, which would be diluted across the different divisions without a holding entity.
Independent brand strategy and valuation consultancy, Brand Finance, ranked Sime Darby as Malaysia’s sixth most valuable brand in 2015 with an estimated value of US$1.69 billion, behind the likes of Petronas, Genting, Malayan Banking, YTL Corp and CIMB Group Holdings, in its report released in November last year.
Abandoning the Sime Darby brand is tantamount to discarding billions in brand value.
Selective listing
A compromise between the first and second scenarios would be to list some of the core businesses while keeping others inside the existing group entity. This third scenario is also consistent with Sime Darby’s previously mentioned strategy to spin off its units one by one when market conditions permit.
The question for PNB would then be, which divisions to list and which ones to keep private for now?
The standout candidate for listing would be the plantation business, given its sheer size — the group’s CPO production accounts for 4% of global output.
The property arm also stands out, given its huge land bank across Malaysia as well as long history as a major property developer stretching back four decades. The Sime Property brand is a recognised brand with multiple awards under its belt and a growing global profile due to its participation in the Battersea Power Station redevelopment venture in the UK.
However, the timing does not seem right for these two divisions as market sentiment for either sector is still on the softer side.
The industrial division does not seem a viable spin-off candidate given its battered financial performance in recent years, although to be fair it is still turning in annual profits. This means it may not be able to excite the market sufficiently to obtain a desirable valuation range, which may also be the case for the logistics and motor divisions, given their fluctuating earnings over the past few financial years.
Ultimately, these scenarios hinge on an underlying presumption that a break-up, partial or otherwise, would unlock value within the group by removing the conglomerate discount.
The contrarian position here would be to ask: What if a demerger instead destroys value in the long run after the excitement tapers off?
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