The making of a RM150bil GDV company

We can make a general summary that indeed UEMS is larger than ECW on all counts

Late last week, there was again renewed market rumour of yet another attempt to merge UEM Sunrise (UEMS) and Eco World Development Group (ECW).

The news item that originated from down south suggested that ECW owners are insisting on management control should the planned merger go through. It was also suggested that the planned merger would be on a share-swap basis.

In a share swap, there could potentially be two scenarios. One would be whereby a Special Purpose Vehicle (SPV) is formed which would act as the merged entity of the two companies and the SPV will issue shares to the current shareholders on a certain fixed ratio basis.

The second scenario would be that one of the companies would act as an anchor whereby the anchor company would than issue shares of the company to acquire the target company, also on a certain swap ratio basis. Of course, the second scenario sounds more like an acquisition rather than a merger.

Bottomline to any merger or acquisition is the valuation. For property companies, the benchmark used for valuation is normally what is referred to as revalued (or revised) net asset value (RNAV) basis.

In this method, profits derived from the company’s current projects are discounted at an appropriate discount rate and market values of undeveloped landbank are applied to arrive at the total amount.

The RNAV figure is than derived by subtracting the company’s net debt. The RNAV figure gives investors what is the appropriate value of the company and of course the current market price of the company not only reflects the amount of discount that the market perceives but also due to the weak market sentiment towards property based companies.

From the first table, we can make a general summary that indeed UEMS is larger than ECW on all counts and critically, UEMS’ RNAV (which is derived from analysts’ average estimates) is about 1.77x the size of ECW.

Granted the higher acreage of landbank that UEMS has (mainly in Nusajaya), its landbank is less valuable than that of ECW in terms of future development value.

Is this merger in the best interest of both companies’ shareholders?

While at the moment, the news flow seems to suggests that the major shareholders of the companies may be on some talking terms and exploring the idea of the merger and its merits.

The question is would the merger create synergistic benefits where one plus one is greater than two or would it result in diminishing returns to shareholders? While on paper it does suggest that the SPV would be a significant market player within the property sector with total GDV of about RM150bil and total undeveloped land of more than 10,000 acres, the issue is all about chemistry between the two companies.

ECW is known to be a strong township developer as well as an integrated commercial development and high-rise condominiums while UEMS’ specialty is also similar to that of ECW.

However, other than what is left at Mont Kiara as well as its new RM15bil Kiara Bay development, UEMS is primarily focused in Nusajaya, where 75% of its future GDV is located. Hence, both developers basically have a similar forte and hence they could perhaps be in-tune when it comes to understanding the ropes of the business in a merged entity.

Financially, due to the ECW’s larger net gearing level, the SPV would see its net gearing level to be lower but still significant at 55% of shareholders’ funds while in terms of revenue and profits, the merger between ECW and UEMS will see potential revenue of about RM4.5bil and net profit of about RM360mil.

This is based on the annualised figures using the nine months cumulative normalised earnings of UEMS and ECW respectively year-to-date.

The plus point for ECW is the market’s perceived higher brand value for ECW rather than UEMS as ECW is seen to have a superior marketing and branding strategy while UEMS lacks the push for its brand.

As we know, UEMS’ brand value was derived when UEM bought over Sunrise, which helped it to reposition itself in the market, especially on projects located in Mont Kiara. ECW on the other hand built its brand from scratch.

The negative point in any merger is the time it takes and the merger integration process, which typically leads to some form of right sizing the entire organisation in terms of human capital. But, in the longer term, if done right, a merger does provide synergistic benefits in terms of overhead costs and economies of scale.

Based on the current market capitalisation of the two companies, the combined value of the SPV is approximately RM5.39bil. As explained earlier, the right formula to value property companies is the RNAV method and that method values the SPV at a huge valuation of RM17.83bil. Of course, the market is not pricing this and at the moment, the two companies are trading at a price to RNAV ratio of 0.3x and 0.29x for ECW and UEMS respectively.

Assuming the fair P/RNAV ratio is at 0.5x for both, which is the current appropriate value of listed property companies in the market, the SPV should have a value of RM8.914bil as highlighted in the second table.

With the higher weighting on UEMS and with UEMS’ largest shareholder being UEM Group, which is an indirect wholly owned subsidiary of Khazanah Nasional, it is likely that UEM Group will end-up as the largest shareholder of the SPV. Table 3 provides the impact of a share-swap between shareholders of ECW and UEMS into the new merged SPV.

UEM Group presently has 66.1% stake in UEMS and based on the 64% weighting of UEMS on SPV, UEM Group’s shareholding in the SPV would be about 42.2%. Meanwhile, ECW’s largest shareholder is Sinarmas Harta SB, which has a 32.9% stake in ECW, will emerged as the second largest shareholder in the merged entity with 11.9% shareholding as ECW’s weighting in the SPV is 36%. On an indirect basis, Dato’ Leong Kok Wah, who has some 40.1% stake in ECW, will emerged as the 2nd largest shareholder in the SPV with a combined holding off 14.5% as he is a deemed shareholder of both Sinarmas Harta SB and EcoWorld Development SB.

From the above analysis, it is clear that because UEMS is a larger company in terms of market capitalisation, shareholders’ funds and RNAV, shareholders of UEMS will be bigger shareholders in the merged entity and not shareholders of ECW. With that, it would be interesting to see how ECW would enable to gain management control as suggested by last week’s news report. Watch this space!

With the higher weighting on UEMS and with UEMS’ largest shareholder being UEM Group, which is an indirect wholly owned subsidiary of Khazanah Nasional, it is likely that UEM Group will end up as the largest shareholder of the SPV. The table provides the impact of a share-swap between shareholders of ECW and UEMS into the new merged SPV.

UEM Group presently has 66.1% stake in UEMS and based on the 64% weighting of UEMS on SPV, UEM Group’s shareholding in the SPV would be about 42.2%. Meanwhile, ECW’s largest shareholder is Sinarmas Harta SB, which has a 32.9% stake in ECW, will emerged as the second largest shareholder in the merged entity with 11.9% shareholding as ECW’s weighting in the SPV is 36%. On an indirect basis, Dato’ Leong Kok Wah, who has some 40.1% stake in ECW, will emerged as the second largest shareholder in the SPV with a combined holding off 14.5% as he is a deemed shareholder of both Sinarmas Harta SB and EcoWorld Development SB.

From the above analysis, it is clear that because UEMS is a larger company in terms of market capitalisation, shareholders’ funds and RNAV, shareholders of UEMS will be bigger shareholders in the merged entity and not shareholders of ECW.

With that, it would be interesting to see how ECW would enable to gain management control as suggested by last week’s news report. Watch this space!

The views expressed here are the writer’s own.