THE market’s reaction to Eastern and Oriental Bhd’s (E&O) cash call is to be expected. At a time of increasing uncertainty, and when the property market is seeing a slowdown, a cash call by a property developer can be unnerving for shareholders.
In E&O’s case, the massive RM550mil cash call through a private placement and rights issue is worrying because of the dilutive impact it will have on its shareholders.
MIDF Research says upon the completion of the fund-raising exercise, the share base of E&O is expected to increase by 51% to 1.98 billion shares.
In other words, if a shareholder does not participate in the cash call, the value of his holding is likely to halve post the exercise.
Meanwhile, Public Investment Bank Research, points out that the cash call is a “negative surprise”.
“We had believed earlier that E&O would raise funds by disposing of non-strategic assets or get more strategic partners for its Sri Tanjung Pinang Phase 2 (STP 2) development (pic),” it said in a report.
E&O says the reason for the cash call is finance its continued reclamation works for its STP2 project and to reduce bank borrowings.
Following the announcement, E&O issued a statement to say the firm is preparing the platform on which to embark on its next growth trajectory.
“Proceeds from the fundraising exercise will be utilised largely towards the implementation of projects, namely the infrastructure and development works at STP2, as well as working capital and loan repayments.
“With STP2A reclamation works of 253 acres nearing completion, resources are now focused towards creating a new prime seafront address, building further on the success achieved in STP Phase One,” it says.
E&O says the company’s fundamentals remain intact and it is committed and confident of its prospects going forward.
“We hope for participation and continued support in our push to create value for E&O and our shareholders,” it says.
Some do not rule out the possibility that the sudden cash call could be related to cash flow issues or problems with financing support to complete its reclamation works. It is puzzling that the company continues to conduct share buy backs despite proposing a cash call.
Who will subscribe the private placement and rights issue?
E&O said it is looking to secure undertakings from shareholders to take up the cash call. No shareholder has yet given any such undertaking.
AffinHwang Capital Research reckons that E&O’s substantial shareholders Datuk Seri Tham Ka Hon as well as the Tee brothers, who are the controlling shareholders of Kerjaya Prospek Group Bhd, will likely subscribe for the rights issue entitlement.
“This will show the entrepreneurs commitment and shore up support for the proposed equity issuances,” it said.
Tham, the company’s deputy executive chairman, holds a 20.39% stake, while the Tee brothers own 15.08%.
The other substantial shareholders of E&O are Sime Darby Bhd with 11.94% stake, newly-set-up Urusharta Jamaah Sdn Bhd, which has taken over some assets from Lembaga Tabung Haji (LTH), holding a 7.22% stake; and Kumpulan Wang Persaraan (diperbadankan) or KWAP holding 7.52%.
There are no assurances that the shareholders will participate in the rights issue. Sime Darby has been paring down its stake in E&O since 2014, when it sold 9.9% to Tham.
Subsequently, in 2016, Sime Darby sold 10% more to Tham. This whittled down Sime Darby’s holding in E&O to 12% from the 31.9% stake it held in 2013.
The position of Urusharta Jamaah is even more uncertain. It is worth noting that Urusharta Jamaah is the special purpose vehicle set up by the government to takeover some of LTH assets and securities worth RM19.9bil.
In return, Urusan Jamaah issued islamic notes to finance the purchase. Shares of E&O were part of the transaction.
For KWAP, which is a RM150bil pension fund, it had already pumped in more than RM880mil in E&O back in 2017 that helped the latter to finance part of its ambitious STP 2 project.
To put things in perspective, the STP 2 project, located along Penang’s northeast coast, between George Town and the Batu Ferringhi beaches, is divided into three parts – phases 2A, 2B and 2C – spanning over 760 acres.
The first phase, dubbed as STP 2A, involving 253 acres of reclamation works, is expected to be completed by late 2019. Phase 2A is expected to have a gross development value of over RM17bil, to be developed over 15 years.
In return for the capital pumped in by KWAP, the fund received 20% equity interest in STP 2A and a 5.52% stake in E&O.
The reclamation of the STP 2A is expected to complete late this year. E&O need to start the reclamation of the phases 2B and 2C soon to meet the 2022 deadline.
Recall that E&O had been issued by a concession by the Penang state authorities to conduct reclamation works for the project by December 2022.
This possibly explains why E&O is carrying out its cash call now, despite the difficult market conditions.
E&O says the initial reclamation works on phase 2B and 2C would cost RM250mil over the next two years.
“The total reclamation cost of Phase 2B and Phase 2C is envisaged to exceed RM1bil,” it said.
E&O had said part of the proceeds would be used to pare down some its debt. The group estimated that its gearing level to reduce to 0.24 times from 0.61 times, following the exercise. The group has debt of RM1.5bil and cash of RM715.02mil as at Sept 30, 2018.
“The equity issuances will support E&O’s plan to launch new projects this year while keeping its gearing at a manageable level,” says AffinHwang.
By the looks of it, E&O’s cash call is not a shoe in. Noticeably, E&O bought back one million of its stock three days after announcing its cash call, spending almost RM900,000 to do that. Since January, it has spent RM2.6mil to buy back shares.
That the massive capital requirement for the STP 2 project will continue to pressure E&O’s balance sheet in the coming years. But there may be investors who do not mind the high capital required and long gestation period involved in the company’s projects. They are likely to support the company’s cash call.
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