Denko deal raises questions

Corporate exercise: A production line at Denko’s factory. Denko said this week that it had entered into an agreement to buy a larger plastic moulding company from the company’s major owner and chairman, Datuk Seri Foo Chee Juan.

It will dilute minority shareholders’ share of the company to only 5%

THE announcement by manufacturer of plastic injection moulds Denko Industrial Corp Bhd this week does raise some questions.

Denko said this week that it had entered into an agreement to buy a larger plastic moulding company from the company’s major owner and chairman, Datuk Seri Foo Chee Juan.

But here’s the issue: Denko plans to pay for that acquisition with 1.03 billion new shares.

That is 10 times the number of its existing shares, which means that once done, the deal will result in all minorities being squeezed out into holding a mere 5% of the company.

Such transactions are not unheard of. The deal sounds like a classic reverse takeover but the fact that it is the major owner injecting his own asset into Denko is possibly why it is not one.

However, two key points are to be noted. One is that the deal will result in Foo having to make a mandatory general offer (MGO) as his stake will rise significantly to around 95% in Denko, and secondly, the deal is a related party transaction or RPT.

Due to it being a RPT, this means that Foo who currently owns 52.2% of Denko, will not be able to vote on the deal.

In other words, the choice of whether Denko goes ahead with buying Foo’s assets lies entirely in the hands of the minority shareholders of Denko who now collectively own 48% of Denko.

However it is unclear how many percent of these minorities are aligned to Foo.

It should be noted that Denko’s board had entered into the heads of agreement with Foo, indicating that other board members are in support of this deal.

Under the deal, Denko is looking to buy Foo’s Integrated Manufacturing Solutions Sdn Bhd (IMS), which is involved in the manufacturing and sales of precision plastic injection moulded parts.

This is similar to Denko’s current business.

IMS is also in the business of manufacturing and trading of air filters and sterilisers, assembly of electrical and electronic components and products, as well as design and fabrication of tools and moulds, serving the electrical and electronic industry.

In a filing on Monday, Denko said the proposed acquisition would create enhanced scale and synergies for the enlarged Denko group through increased production capacity as well as economies of scale.

“The enlarged Denko group is able to increase the range of value-added services for its existing and future customers with better customisation of its plastic moulds to meet the requirements of the electrical and electronic industry,” Denko said.

Earnings wise, IMS is a profitable company with profit after tax of RM79.2mil for financial ended March 31, 2017, on the back of RM1.8bil revenue.

However this indicates a low profit margin but this could be representative of the business the company is in, points out a dealer.

The proposed deal values the company at 15 times FY17 earnings.

Minority shareholders will have to consider if this is a fair value for the asset their company is buying.

As for Denko’s earnings, its profitability has been erratic.

Denko reported a loss of RM11.3mil for the financial ended March 31, 2017 (FY17), compared with a net profit of RM2.9mil a year earlier.

It was also in the red in 2014.

Nonetheless, it’s revenue has been growing steadily.

In FY17 it grew by 10% to RM101.6mil from RM92.7mil previously.

Denko had net debts of RM23.2mil as at June 30, 2017.

Back to Denko’s proposed acquisition, it is likely that Foo intends to maintain Denko’s listing status following the acquisition, to allow the the company access to the capital market for future fund-raising needs.

Going by this, and considering that Foo will end up with around 95% of the equity of Denko post the acquisition, the company will have to conduct a massive placement exercise to meet it’s public spread requirement of 25%.

This is turn will dilute further the stakes of existing minority shareholders although it would bring in fresh capital into the company.

Foo’s emergence in Denko

Foo first emerged in Denko when he launched an unexpected takeover offer for Denko in February at a price of 55 sen a share.

The offer was at a 21% premium over Denko’s market price of 45 sen. His offer was conditional upon him reaching at least 50% of the company’s ownership and he had intended to maintain the listing status of Denko. Foo ended up with just over 50% and his move stirred

excitement in the otherwise dull stock.

Prior to the offer Foo did not own any shares in Denko.

Following his buy in, he became chairman of Denko.

Foo’s move is seen as one aimed at strengthening his business footprint in the Malaysian plastic injection moulding sector. But he will only get this deal done with Denko’s minority shareholders’ support.

He could face resistance from these minority shareholders, considering the dilution of their equity following from the deal.

But it is worth noting that the shareholders of Denko, who did not sell their shares back in February are sitting on a handsome return.

Shares of Denko have doubled since Foo emerged in the company.

It was last traded at RM1.47 a share, which is a significant premium to Denko’s net asset per share of 41.4 sen.

For a loss making company, Denko has received a lot of headlines this year.

But the question is could this deal mark the turnaround of this company which was listed on the Main Market back in 1991?


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