Hong Leong Industries Bhd (HLI) shareholders may be glad that Tan Sri Quek Leng Chan, its executive chairman and major shareholder, is making an effort to enhance the company’s earnings prospects.

Last week, HLI proposed to acquire several building material companies from Quek. It proposed to acquire Hume Industries (M) Sdn Bhd for RM235.2 million from Hong Leong Manufacturing Bhd to venture into building materials.

HLI will also invest RM175 million cash in Hume Cement Sdn Bhd for the subscription of up to 175 million six-year 2% non-cumulative irredeemable convertible preference shares (ICPS). Hume Cement will eventually be a 75%-owned unit of HLI upon the full conversion of ICPS on the sixth anniversary of the issue date.

At the same time, HLI will distribute its 60.23% equity interest in Malaysian Pacific Industries Bhd (MPI) back to shareholders for free, effectively de-merging the two entities.

To finance the asset acquisitions, HLI has proposed a rights issue to raise RM231.6 million from shareholders on the basis of one rights share for every two existing shares held. The company said the proposed acquisition was expected to enhance HLI’s earnings base and provide a steady stream of future cash flow.

With the asset injection and de-merger, HLI will no longer be seen as just a proxy to semiconductor player MPI — and be exposed to the volatility of the sector.

Investors warmed up to the deal, sending shares of HLI up 10% last Thursday and Friday.

If this is a good deal for HLI, guess who got the shorter end of the stick? It may not be Quek, although his privately held firms are the seller of the assets.

Indeed, former shareholders of the now delisted Hume Industries (Malaysia) Bhd may start wondering if they had actually made the wrong decision to accept the takeover offer made by Quek just a few months ago at RM4.50 per share.

What does HLI’s proposal have to do with Hume Industries which was delisted from Bursa Malaysia in April?

Under the proposed scheme that was announced last week, HLI would be buying many of the assets previously held under the now delisted Hume Industries.

To recap, in January this year, Quek proposed to privatise Hume Industries, in which he and parties acting in concert owned a 64.94% equity stake.

The offer price was initially RM4.30 per share, but it later raised to RM4.50 after criticism that the valuation was too low. The revised price was still substantially below its net assets per share of RM5.17, which included cash per share of RM1.90.

By paying some RM280 million for shares he did not own, Quek took Hume Industries, which had a cash pile of RM362 million, private. And now, the tycoon is injecting the building materials assets in Hume Industries into HLI.

Among the companies that HLI has proposed to acquire are Hume Concrete (EM) Sdn Bhd, Hume Concrete Marketing Sdn Bhd, Hume Cemboard Industries Sdn Bhd and Malex Industrial Products Sdn Bhd. These were subsidiaries of the former listed Hume Industries, according to its annual report.

The major assets of the former Hume Industries that will not be injected into HLI are the substantial cash reserves and a 41.5% stake in Southern Steel Bhd, which was also, ironically, the target of another privatisation attempt by Quek.

Another highlight of the HLI restructuring is Quek’s decision to enter into cement manufacturing. In fact, the integrated cement plant licence is owned by Hume Cement Sdn Bhd, which was also a unit in the de-listed Hume Industries. This will now be parked under HLI.

In the announcement to Bursa Malaysia, HLI said Hume Cement was building a new clinker and cement plant with a capacity of 5,000 tonnes of clinker per day in Kinta, Perak.

That plant needs a capital outlay of RM700 million. HLI’s proposed injection of RM175 million cash, in return for a 75% stake, would come in handy to finance the project.

It does make sense to start upstream cement activities as they will complement the downstream concrete products business that HLI is buying under the proposed plan.

One need not look far to see the prospects of the cement business than to take a look at Tasek Corp Bhd, a cement manufacturing company also owned by Quek’s family.
Tasek Cement is now the cash cow of Singapore-listed Hong Leong Asia Ltd, the flagship of the Quek family stable.

In February, Tasek Corp sprang a surprise by declaring a special dividend of 20 sen per share, plus a capital repayment of 33 sen per share on top of a final dividend of 10 sen.
For 3QFY10 ended Sept 30, Tasek Corp’s net profit jumped 40% to RM27.9 million. It reported a net profit of RM63.3 million for 9MFY10 ended Sept 30, up from RM50.8 million a year earlier.

The government’s plans for large-scale infrastructure projects under the 10th Malaysia Plan augur well for the demand forcement and building materials.

Should Hume Cement excel like Tasek Corp, this could well be a cash cow for HLI in the longer term, but after initial heavy capital investments.

All these appear promising for HLI’s longer-term future prospects. However, it raises the question as to why didn’t Quek utilise the cement licence when Hume Industries was a listed entity not that long ago?

Moreover, Hume Industries was then sitting on a large cash pile of RM362 million with minimal borrowings, which would have come in handy to kickstart the cement project.
With some gearing and strong annual cash flows from its building materials business, the former Hume Industries would have been in a comfortable position to fund the entire project.
In contrast, HLI is now undertaking a cash call of RM231.6 million. With total capital expenditure for the cement plant expected to be in the region of RM700 million, shareholders of HLI may be right to ask if there will be further cash calls ahead.

A large part of Hume Industries’ cash pile came from the sale of its fibreboard manufacturing business to Evergreen Fibreboard (M) Bhd for RM231 million cash in 2008. After that, the company did not actively look for new businesses to fill that vacuum. Then came the privatisation offer from Quek.

Having said that, for the former shareholders of Hume Industries, the die was cast when the privatisation deal was completed. They have moved on.

But as former shareholders, they must be wondering if they made the right decision to part with their shares then at low valuations. They will probably also ask why these assets have resurfaced so quickly — in a matter of just seven months.

If the Hong Leong group has a grand plan to build up the cement and building materials business, why wasn’t it done under Hume Industries earlier? After all, Hume Industries was the building materials arm of the group.

Quek may argue that with the cash received from the privatisation offer, Hume Industries’ former shareholders can always buy HLI shares to ride on the success of the restructuring plan.

“The whole is greater than the sum of its parts,” says the ancient Greek philosopher Aristotle.

That saying, however, may not hold true in Malaysia’s inefficient stock market, where a large number of smaller companies trade below their underlying asset values. Whole companies here are valued much lower than their break-up value, creating opportunities for tycoons to privatise and relist their companies in various forms.