This article first appeared in The Edge Malaysia Weekly on May 2, 2022 - May 8, 2022

S P Setia Bhd is making a cash call to raise RM1.18 billion five years after its previous one in 2017.

The property developer’s latest plan is to undertake a renounceable rights issue of new class C Islamic redeemable convertible preference shares (RCPS-i C).

Its major shareholders Permodalan Nasional Bhd (PNB) and AmanahRaya Trustees Bhd have given their undertaking to subscribe in full for their entitlements.

PNB holds a 26.06% stake while AmanahRaya Trustees has 35.44% in the property group.

The reason for the fundraising exercise is to redeem all outstanding RCPS-i B, which were issued in December 2017, and to repay borrowings provided there are excessive funds after the redemption.

Currently, the group has 1.176 billion RCPS-i B amounting to RM1.035 billion. The top five holders are PNB and its units, the Employees Provident Fund Board (EPF) and Kumpulan Wang Persaraan (Diperbadankan) (KWAP).

PNB and its units, including Amanah Saham Bumiputra and Amanah Saham Malaysia,  collectively hold 78.12% of the RCPS-i B. KWAP owns 7.77% of the RCPS-i B while EPF has 6.2%.

Based on the holding of the RCPS-i B, PNB and its units will receive some RM808 million from the redemption.

To recap, the renounceable rights issue of the RCPS-i B was coupled with a two-for-15 rights issue of shares at RM2.65 per share to raise over RM2 billion to finance the acquisition of I&P Group Sdn Bhd, property development costs of new and ongoing projects of the enlarged group and for working capital.

PublicInvest Research commented in its research note that the cash call is in line with the group’s de-gearing initiatives and is aimed at optimising its capital structure.

The raising of fresh capital to redeem the RCPS-i B is expected to potentially yield annual gross interest (profit) savings of RM13.4 million.

It is a move that the property group has to take considering the RCPS-i B, which carries a preferential dividend of 5.93% a year, comes with a stepped-up preferential dividend rate (PDR) of 1.0% per annum on the fifth anniversary of the issue date.

The redemption of the outstanding RCPS-i B means it will avoid paying the stepped-up rate, which could climb to a maximum of 20% as stated in the shareholders’ circular.

Furthermore, the RCPS-i C will bear a lower PDR of 5.43% per annum, which will enable SP Setia to save more.

“We are positive on the deal as the new issuance of RCPS-i C with a lower PDR rate of 5.43% to redeem the RCPS-i B with a higher PDR rate of 5.93% could save RM5 million to RM23 million in preferential dividend payments per annum. Based on the maximum scenario, its net gearing could improve,” CGS-CIMB comments in its research note. CGS-CIMB has an “add” call with a target price of RM1.84.

TA Securities analyst Thiam Chiann Wen says that the proposal did not come as a surprise because it will allow the group to take advantage of the current low-interest-rate environment to refinance the RCPS at a lower rate.

Thiam points out that an annual stepped-up PDR of 1.0% above the expected PDRs would be “excessive amid the current low-interest-rate environment and could be damaging to the group’s long-term growth and expansion objectives”.

However, not all view the proposal positively.

Kenanga Research analyst Lum Joe Shen raises concern over dilution, saying that the new RCPS-i C would result in a huge overhang for the stock at a lower conversion price level of RM1.39 tentatively, compared with the RCPS-i B’s conversion price of RM3.70, despite the group getting to save RM5 million in dividend distribution a year.

SP Setia has yet to fix the conversion price of the new RCPS. In order to raise RM1.035 billion, based on the assumption of (i) an entitlement ratio of three RCPS-i C for every 10 existing shares held, (ii) an issue price of RCPS-i C of 85 sen, and (iii) a conversion ratio of 18 RCPS-i C in exchange for 11 new shares, Lum notes that the conversion price will be at RM1.39 for every new share.

“Naturally, this would create an overhang for the counter with an invisible ceiling at the RM1.39 level. Thus, we are negative over the entire exercise,” Lum comments. SP Setia closed at RM1.17 last Friday.

Lum points out, however, that SP Setia’s balance sheet will be stretched further if it opts to take up a loan for redemption given that the group has a net gearing of 0.6 times.

In order to overcome such an overhang, Lum believes a strong and sustainable earnings trajectory coupled with an improving return on equity (ROE) are needed to rerate valuations.

“Looking at its past six-year historical record, SP Setia’s borrowing levels have grown from RM5.8 billion to RM12.6 billion excluding RCPSs, and ROE has declined from 8.2% in FY2016 (financial year ended Dec 31, 2016) to 1.1% as of FY2021,” says the analyst, who maintains an “underperform” call on the stock with a lower target price of 95 sen.

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