Beyond legacy investments

Azman: ‘Maybe Malaysia has done well but we need to diversify regionally for several reasons.’

Khazanah looks at higher returns from smallish companies that are game changers

BEFORE the initial public offering (IPO) of Alibaba Group Holding Ltd on the New York Stock Exchange years ago, veteran trader Tan Sri Chua Ma Yu was given the opportunity to subscribe a block of shares. He declined but the offices of Khazanah Nasional Bhd’s Beijing office, Ben Chan and his team put forward a proposal that Khazanah should take up the offer.

Khazanah’s board decided against taking up the entire allotment of shares that it was offered in Alibaba as investments in destructive technologies such as Alibaba – China’s premier e-commerce portal – was still a new phenomenon.

In hindsight, Chua regrets not taking up the opportunity and Khazanah’s board may rue the day it did not take up a higher stake in Alibaba.

But it was the purchase of Alibaba shares, which has netted Khazanah a huge profit after the China company was listed and its shares soared, that serves as one of its basis for the thinking behind the direction the sovereign fund is taking.

Khazanah trimmed its stake in Alibaba after it was listed, making a pile from its pre-IPO deal. It still holds a small stake in the China-based company.

When Khazanah managing director Tan Sri Azman Mokhtar first took charge of the sovereign fund, his first task was to whip into shape lacklustre government-linked companies (GLC). Over the 10 years of the GLC transformation programme, the performance of the companies in Khazanah and other government agencies showed marked improvements.

In general, the low hanging fruit of transformation has been plucked and what Khazanah wants more of in the future is productivity improvements. The performance of the Khazanah-linked companies since the GLC transformation has been better than the FTSE Bursa Malaysia KLCI since 2004, when the transformation programme started. But not by much.

Among its companies, Telekom Malaysia Bhd and Malaysia Airports Holdings Bhd (MAHB) have been the stellar performers, rising close to 600% and 450% respectively.

Others like Tenaga Nasional Bhd (TNB), CIMB Group Holdings Bhd and Axiata Group Bhd have improved in terms of share price performance but fell behind the average growth rate of the FBM KLCI since May 2004.

One thing has become clear is that the organisational improvements, processes and key performance indicators which Khazanah put into those companies have done their job but seen slowing returns in recent years. The focus now is on sweating those assets, incorporating innovation where possible but looking at boosting productivity.

The rate of growth of the realisable asset value and net worth adjusted (NWA) of Khazanah’s portfolio has been slowing in recent years, and in the case of NWA, dipped at the end of last year to RM109bil from RM110.7bil.

For 2015, Azman told the media during Khazanah’s annual review that its legacy assets returned a growth of 10.7%. In comparison, its international investments returned a gain of 18%.

“The legacy assets are difficult and drags the portfolio down while the newer discretionary investments are actually performing in the mid-teens.

“Maybe Malaysia has done well but we need to diversify regionally for several reasons,” Azman told the press briefing.

There is work still to be done in the brick and mortar companies that it owns but it is clear that Khazanah is looking to put more in companies that have and will disrupt the normal course of business.

Internet-based businesses will be where Khazanah will be looking at putting its money in this year. Deals for a stake in Skyscanner, a travel search engine, made this past week also fits into how such a business can possibly add value to Malaysia Airlines.

Disruptive technologies

Azman says that for this year, Khazanah will look to expand its international presence. The fund has set up offices in San Francisco, Beijing, Mumbai and London to scour for deals and the geographical location of those offices is said to be ideal for what Khazanah is looking for in terms of having a spread of opportunities.

While only one in 40 deals makes it through its initial screening, Khazanah has landed some gems. The windfall investment in Alibaba has given Khazanah the cash to source for more of such future deals.

It has missed out of some opportunities given the more cumbersome internal checks and processes it needs to go through compared with other more nimble private equity funds.

One example is MyTeksi. The home-grown Malaysian taxi app had courted Khazanah but the sovereign fund lost out when it could not agree to a financing deal. Temasek out of Singapore poured money into the taxi app company.

But what Khazanah has in its favour is its name. Khazanah’s brand has a lot of goodwill around the world and that opens doors to newer deals. What helps in China is its status as a qualified investor that allows it to makes investments directly into the world’s second largest economy that not many funds have.

A demonstration of its favourable position in China has been the latest deal by IHH Healthcare Bhd to set up a 350-bed hospital in China. It’s rare for a foreign company to be granted a licence to operate a hospital in China.

IHH, controlled by Khazanah, was the star performer among its portfolio. The healthcare segment in which IHH weighs heavily in, returned RM6.5bil to Khazanah in terms of NWA last year. All other major segments of its business such as banking, telecommunications and power registered a loss.

Deals in China makes sense for Khazanah. While its investments abroad returned 18% last year, China was a big outperformer.

Azman says Khazanah is now bracing for a new China thesis, and opportunities will grow as the market corrects. “When they have a big move, there will be a lot of opportunities,” says Azman.

“It’s about taking risk in the right way.”

Risks within its portfolio

While Khazanah can look forward to clinching more deals that will possibly be a home run in the future, there are risks emerging in its portfolio. Geographically, Turkey hosts a big chunk of its portfolio with IHH, MAHB and TNB investing big money in the country. Operationally, investments by IHH and MAHB are good but with the geography so close to conflict and with the Turkish lira taking a hit, those investments will pose a risk to Khazanah.

Another risk on the horizon for Khazanah is its investments in Iskandar Malaysia. This year will mark the 10th anniversary of Iskandar Malaysia and Khazanah has done a lot to develop that area.

Khazanah is aware that the lack of critical mass of people is the major sore point for the development as most people have seen that development area as an investment opportunity rather than a place to live.

It is overcoming those constrains by putting into place various soft infrastructure such as theme parks and education businesses such as schools and universities. A growing healthcare segment in the area will also help to populate Iskandar Malaysia.

But Khazanah is painfully aware of the slump in the property market especially in Iskandar Malaysia. The difference between it and property companies is that it can ride out the sluggishness as much of the land it owns there is still at cost.