ON the face of it, it does seem that the market doesn't think much of the two-pronged corporate deal that TIME Dotcom Bhd (TdC) announced early this week. On Tuesday, the day after TdC's announcement, its share price took a beating, dropping by 14 sen to 63 sen by the end of that day although it has since recovered slightly, closing at 65.5 sen yesterday.
While the jury is still out on the merits of TdC's proposals, Afzal Abdul Rahim, the main character in the story, says the reaction is to be expected.
The sell-down is knee-jerk reaction by investors and is expected, given that it involves a capital reduction and consolidation of shares. Many of the analysts and fund managers we have spoken to in the last three to four months, have suggested that we clean up the balance sheet and rationalise our shares in circulation, considering TdC seems to be sustainably profitable now. There is also the intent on our side to institutionalise our shareholding. In July this year, when we first started actively engaging investment analysts and fund managers, we only had less than 1% of institutional shareholders. Today, institutional shareholders make up about 10% of our shareholder base, Afzal says.
But others remain unimpressed. Says one head of research, The proposals don't seem to be doing anything fundamentally different to TdC. It is proposing to buy a few companies that do not show much visibility in terms of how they will bring earnings enhancements for TdC, she says.
To recap, TdC is paying RM339mil, mostly in TdC shares, to buy three companies owned mainly by Afzal. TdC is also proposing a capital repayment of 2 sen per share, while rationalising its balance sheet by writing off part of its share capital that is not represented by available assets.
While the capital reduction exercise is welcomed by analysts, there are some concerns about valuations and the related party transaction (RPT) nature of the deal. There is also a worry that Afzal may be cashing out, considering that there is a RM90mil of cash being paid out by TdC for these companies.
On the onset though, a few facts need to be established. Firstly Afzal and parties associated with him as well as Khazanah Nasional Bhd aren't going to be voting on the proposals, leaving the matter entirely in the hands of minority shareholders to decide.
Secondly, while the proposals will give Afzal control over TdC, they were very much in the plans when Khazanah first picked Afzal in October 2008 to aid in the turnaround of the then-ailing TdC.
Thirdly, the acquisitions are being paid mostly in shares, indicating that Afzal is in for the long haul.
That leaves the issues of the valuations of the companies being bought.
In a note to clients this week, Maybank Investment states: The reason why the market may be viewing the deal unfavourably is due to the nature of it being a related-party transaction and the perception that its CEO Afzal is cashing out. Furthermore, there is very little information on the stock and the merits of the deal as it remains under-covered by the research community. We have been following the company closely and believe that the current share price weakness presents a great buying opportunity.
The note adds that Afzal will be getting paid mostly in shares rather than cash given that the RM339mil deal will be financed by 75% shares and 25% cash. This suggests that Afzal will be in this for the long haul.
Are the valuations justified?
One of the companies being bought is Global Transit Communications (GTC) that essentially sells international bandwidth and IP transit services to telcos, large and medium-sized-corporations (for their own private networks) and Internet service providers (ISPs) in the region.
According to the announcement by TdC, GTC made a net profit of RM5.1mil for the first nine months of 2010. If annualised, the profits should be around RM6.8mil. Thus, based on the purchase price of RM105mil, the asset is being bought at 15.5 times its earnings.
Low Yee Huap, head of research, HLG Research reckons the price is fair. GTC's growth will be driven by data growth numbers regionally. Based on its consistent growth trend both in terms of revenues and profits, GTC has strong earnings potential and is well positioned to leverage on the booming data and internet growth in the Asia-Pacific region. Valuation-wise the purchase price of GTC at 15 times FY2010 annualised earnings is at a discount to TdC's own price earnings multiple of about 25 times, Low says.
However, GTC reported losses in 2007 and 2008, its earlier years of operations, leading some to question if GTC's earnings are sustainable.
But GTC's profits ballooned after that, from only RM231,000 in FY2009 to RM5.1mil in the nine months of FY2010 while its revenues grew from RM10.9mil in FY2008 to RM20.7mil in FY2009 and to RM36mil in the nine months of FY2010.
TdC's announcement points out that the rise in GTC's earnings were due to the company reaching more efficiencies in its operations and to higher bandwidth utilisation by customers coupled with the introduction of new services.
GTC is on a fast growth trajectory. In fact if TdC were to acquire GTC in the future, it will likely cost (TdC) more, says Afzal.
Then there's AIMS Group, another company to be bought by TdC.
TdC will be paying RM128mil for this company, RM25mil in shares and RM38.4mil in cash.
AIMS, which is a data centre operator, is Afzal's first business, having joined the company, then owned by Formis Resources Bhd, in 2000. He then led a management buyout of AIMS in 2006, implementing a business-driven culture within the group, something which he is said to have also inculcated in TdC.
It should be noted though that the AIMS Group is made up of three companies, AIMS Asia Group, AIMS Data Centre 2 and AIMS Cyberjaya.
Consolidating these three companies profit before tax figures for the nine months in FY2010 these companies are deemed tax exempt due to their Multimedia Super Corridor (MSC)-status the profit figure comes up to RM5mil. Annualised, this amounts to close to RM7mil, indicating that that TdC is paying 18 times earnings for these companies.
Two of the three companies in the AIMS group however also suffered losses in FY2007 and FY2008. Afzal explains that the AIMS companies have been profitable since 2000 and the losses in 2007 and 2008 were due to investment losses for pulling out of the Singapore market, where they had ventured to build a data centre but were hit by the global financial crisis.
Hong Leong's Low, one of the few research analysts who has written extensively about TdC in recent times, is also positive on the AIMS acquisitions.
The Asia Pacific data centre business, according to industry reports, is growing at a 15%-18% CAGR in the coming years. AIMS in particular, having achieved a critical mass of 188 carriers as its client-base, is uniquely positioned to benefit from this growth, he says.
Getting a slice of a submarine cable
Perhaps the most interesting proposed purchase in the exercise is that of Global Transit Ltd (GTL). In a sense, GTL is one of Afzal's biggest coup, considering its rarity. Afzal, via GTL, managed to work his way in a deal with the big boys of the Internet and telecommunications space. GTL today owns 10% of the recently-commissioned Unity Cable System, a 9,620km submarine cable system from Asia to the United States, which is banking on a growth of Asia to US data connectivity. The other shareholders of the cable system are Google (20%), who were part of the front runners of the project, India's Bharti Airtel Ltd (10%), Korea's KDDI Corp (10%), SingTel (10%) and Pacnet Ltd, the Singapore-based and listed operator of undersea phone and Internet cables in Asia (40%).
According to insiders, Afzal had been contacted by one Erikas Napjus, Google Inc's global infrastructure manager, a couple of years ago, when the Internet giant had first wanted to take up some data centre space in Malaysia. Napjus is said to have turned down AIMS then due to the latter not meeting the standards required by Google. Following that, Afzal had remained in contact with Napjus and received advice on how to raise the quality of his data centers. That in turn led to a friendship as how technology entrepreneurs are apt to connect. Some time later, Napjus offered Afzal a chance to participate in the submarine cable, an opportunity that Afzal naturally jumped at.
Wan Azmi an early investor
Huge capital was required to be part of consortium and through some contacts, Afzal raised venture capital funding from certain parties. It is these parties who are part of the owners of GTL and who are receiving the cash and shares from TdC. The venture capitalists or angel investors as they are sometimes called, include Halfmoon Bay, owned by tycoon Tan Sri Wan Azmi Wan Hamzah, an active investor in private companies and founder of Land & General Bhd, and Accurate Gain Profits, owned by Tan Sri Mohd Razali Abdul Rahman, the chairman of Peremba. Another investor is Continuum Capital, a venture capital firm owned by Khazanah.
All these investors, according to the announcement by TdC, had pumped in US$12mil (RM37mil) since 2008 to fund their entry into the submarine cable project.
In exchange for the company now, they are receiving RM52.5mil in cash and another RM52.5mil in TdC shares.
The cable was completed and operational in April this year and GTL only received the necessary licence from the relevant authorities to start charging for its services last month. According to TdC's announcement, GTL will achieve a revenue of US$30,000 (RM94,000) in November 2010 alone.
To be noted is that GTL's portion of the 4.8 Tbps (tera bits per second) submarine cable is an entitlement of 480 Gbps (giga bits per second), which can scale up to 1 Tbps.
But while all this sounds interesting, the question is, can the asset make money?
Afzal says that GTL has already sold 10% capacity of the initial 480Gbps that GTL is entitled to from the cable, but he declined to reveal prices.
According to industry reports though, the current retail price of trans-Pacific bandwidth is US$700,000 to US$1mil per year per 10 GBps.
Assuming a price of say US$800,000 per 10Gbps, then GTL's 1 Tbps can theoretically fetch somewhere close to US$76.8mil (RM230mil). While bandwidth prices do erode at 18% to 20% every year, with an asset life of more than 10 years, the math works out very much in Time DotCom's favour, points out Hong Leong's Low.
Back to Afzal. While he is receiving some cash from the sale of his assets into TdC, he is likely to be using a big portion of that money to pay for exercising his options to raise his stake in PKV, the special purpose vehicle owning 30% of TdC.
According to TdC's announcement, Afzal is exercising options to increase his stake in PKV to 51%.
When Afzal first came into PKV in 2008, it was via injecting GTL into PKV. At that time, Khazanah is said to have picked Afzal via a selection committee comprising independent professionals from the telecommunications and corporate sectors. Khazanah's managing director Tan Sri Azman Mokhtar had then said that the move was made to ensure the long-term operational and financial stability of TdC.
Azman had then said that the committee believed that Afzal and GTL were the best candidates for the task to turn around TdC as they have the entrepreneurial skills and telecommunications experience as well as sound management.
GTC was then injected at a price of RM48.2mil, which gave GTI 38.8% in PKV. Thus, this valued PKV at about RM124.2mil. Khazanah on the other hand had injected its direct holding of TdC of 30.04% into PKV, to own 61.2% of the latter.
Hence for Afzal to exercise options to bring his stake in PKV to 51%, he is likely to be spending more than RM15mil.
Also to be noted is that the announcement reveals that there is a portion of deferred consideration of up to RM128mil to be paid by PKV to Afzal's vehicle, upon the Afzal meeting certain conditions. These conditions are believed to relate to certain profit milestones and could take place in a year's time and are part of the earn out clause that was in the original shareholder agreement between Khazanah and Afzal. That consideration is to be paid in PKV shares, meaning that going forward, Afzal will likely emerge as owning much more 51% of PKV and by that, a higher degree of control over the 30.04% block of shares in TdC.
We have exceeded all our milestones thus far, says Afzal.
In the end though, Afzal will have to convince the minority shareholders of TdC that the deals being proposed are for the long-term good of the comanpy and not aimed solely at benefiting him or other individuals personally. No wonder Afzal has been busy trying to explain this deal to analysts and fund managers over the last few days.
The proposals in a nutshell
TIME dotCom Bhd (TdC) announced on Monday that it proposed to buy three companies for RM339mil. The three companies were AIMS Group, which would be acquired for RM128mil, of which RM38.4mil would be in cash, Global Transit Communications Sdn Bhd (GTC) for RM106mil in stock and Global Transit Ltd (GTL) for RM105mil, of which RM52.5mil would be in cash and the balance in shares. It also proposed to make a capital repayment to existing shareholders totalling RM50.6mil, equal to 2 sen a share, as well as a 90% capital reduction and share consolidation exercise.
TdC, which has a paid-up capital of RM2.53bil, comprising 2.53 billion shares of RM1 each, is proposing to cancel 90 sen of the par value of its shares. It is proposing to then consolidate its 2.53 billion 10 sen par value shares into 506.15 million 50 sen par value shares, on the basis of five shares of 10 sen par value into one share of 50 sen par value in TdC.
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