Unfair but reasonable is common

Overall, when one looks at a merger, acquisition, or sale of assets, while it may be fair on paper, it may not be fair when looking at market prices of the listed securities, or vice-versa.

AT the end of the last trading day last year, little-known Kuchai Development Bhd (KDB) agreed to dispose of its entire asset and liabilities to its sister company, Sungei Bagan Rubber Co (M) Bhd (SBR) for RM275.5mil via the issuance of 27.5 million new SBR shares priced at RM10.01 each.

However, as part of the deal, the assets under the proposed disposal exclude the RM83.8mil cash at KDB. Upon completion of the transaction, KDB will distribute the new SBR shares to its shareholders on the basis of 222 new SBR shares for every 1,000 KDB shares held.

According to the announcement made by KDB, the disposal value of RM275.5mil was derived based on a willing buyer-willing seller basis after taking into consideration the adjusted unaudited net asset of the company after taking into consideration revaluation surplus of a property located in Singapore of approximately RM4.5mil.

In essence, minus the cash, KDB assets to be sold to SBR are valued at RM2.23 per KDB share.

As for SBR, the company too undertook a revaluation of its properties, which raised the net asset value of the company from RM9.82 to RM10.01 per share.

As both the companies’ balance sheet was appraised by revaluing properties held by them to arrive at a fair value of the two companies, the disposal value and consideration can be said to be done at a fair price.

However, the market prices of KDB and SBR before the announcement were at only RM1.25 and RM3.25 respectively, a far cry from the last traded prices of the two companies.

In essence, KDB and SBR were seen last traded at about 0.43 times and 0.32 times of its net asset value but this was not the basis of the purchase consideration. Impact on SBR

For minority shareholders of SBR, the company will acquire the assets of KDB, which among others include the prized possession of some 3.032 million shares of Singapore-listed Great Eastern Holdings Ltd (GEH).

These shares alone are worth some S$55.1mil or RM192.4mil based on the latest share price of S$18.17 at the time of writing.

In fact, upon the completion of the deal, SBR will own a total of 4.765 milionl GEH shares, adding to its current 1.73 million shares in GEH.

SBR will emerge as the third-largest shareholder of GEH with a 1.01% stake, valued at RM302.3mil. Ironically, SBR’s current market capitalisation of RM292.5mil is less than the value of its stake in GEH, post-completion of this corporate exercise.

The other three main assets acquired are a two-storey corner refurbished pre-war shophouse bearing the address 9 Emerald Hill Road worth some S$16mil or RM55mil; two pieces of land located in Semenyih measuring some 8.225 acres valued at RM7.7mil; and investments in redeemable preference shares and bonds outside Malaysia worth RM24.3mil.

As mentioned, SBR will be issuing some 27.5 million new SBR shares at an issue price of RM10.01 per share, which seems fair to SBR shareholders.

After all, if the market price was chosen as the purchase consideration, SBR would have to issue some 84.8 million new SBR shares priced at RM3.25 each.

This would not only dilute SBR’s current net asset value per share from the proforma figure of RM9.79 to just RM6.09 but will also see KDB current shareholders receiving a higher number of shares for every 1,000 KDB shares held, estimated at 685 shares.

Impact on KDB

The plus point for SBR is the reverse for KDB shareholders as the new SBR shares are issued at SBR adjusted net asset value and not the market value of SBR shares.

This would also result in KDB recognising an impairment loss due to the price difference between the shares issued and the market price of SBR.

This loss is an accounting loss and does not impact the cashflow of the company.

Nevertheless, this can be justified as KDB is valued based on its adjusted net asset value and not market price either. Hence, the exchange mechanism of the new SBR shares is deemed fair.

There is another point to note in this transaction as the proposed disposal of KDB’s assets and liabilities to SBR will leave KDB with just some RM83.8mil in cash, triggering Practice Note 16 (PN16) of the Bursa Malaysia Listing Requirement.

It looks like the board of KDB intends to keep the listing status of KDB and hoping to have a new business injected into the listed entity.

Perhaps the board should have considered delisting KDB altogether and returning the cash to shareholders, which translates to about 67.7 sen per share.

After all, the nature of the business to be injected is unknown at this stage and there is no guarantee whether KDB will pay a fair price in acquiring a new business either.

KDB’s valuation tied to SBR

As KDB shareholders will receive 222 new SBR shares for every 1,000 KDB shares held, KDB’s fair share price is tied to SBR’s market value.

Based on SBR’s share price of RM4.41 per share at the time of writing, KDB’s theoretical ex-price upon distribution of the new SBR shares is estimated at 56.9 sen, which is some 16% lower than the cash value per share of 67.7 sen. Working backward, based on KDB’s cash value per share and SBR’s latest traded share price, KDB’s fair value works out to be at RM1.66 per share. Hence, based on KDB’s share price of RM1.55 at the time of writing, is trading at a 6.6% discount from its fair value. Based on sensitivity analysis, for every 10 sen movement in SBR’s share price, KDB’s fair value changes by 2.2 sen.

What next for Kluang?

Kluang Rubber Co (Malaya) Bhd (KRC), SBR, and KDB had for the longest time an inter-company shareholding but over the years, that link has been broken via various schemes. This includes the distribution of SBR shares held by KDB to its shareholders on the basis of 142 SBR shares for every 1,000 KDB shares. This distribution was carried out in August 2022 and removed KDB’s direct 26.5% shareholding in SBR.

In early 2019, KDB also distributed its shareholding in KRC to its shareholders on the basis of one KRC for every 62.5949 shares held. This dismantled KDB’s 3.1% stake held in KRC. SBR too distributed shares held in KRC to its shareholders on the basis of one KRC share for every 17.2827 SBR shares held in December 2018. This removed SBR’s direct 6.1% stake held in KRC.

With the proposed corporate exercise and after the distribution of the SBR shares, KRC remains the single largest shareholder of both KDB and SBR, having a 42.2% and 43.1% stake in the two companies. With KDB turning into a cash company and likely to distribute the remaining cash in the company to its shareholders, the next corporate exercise will likely involve KRC acquiring the assets and liabilities of SBR.

Based on the current book value, post-KDB acquisition, SBR would have some RM934.5mil in total net assets on a pro-forma basis. Hence, KRC could easily acquire the assets and liabilities held in SBR via a selective capital repayment (SCR) exercise. However, this has to be done at a fair price as SBR has a net asset value of RM10.01 per share, while its market price is just RM4.41 per share. Hence, KRC will become the sole listed company after years of reorganisation of the three companies, assuming KDB too is delisted upon distribution of its remaining cash to its shareholders.

Overall, when one looks at this exercise or any other exercise involving a merger, acquisition, or sale of assets, while it may be fair on paper, as seen in this KDB-SBR deal, it may not be fair when looking at market prices of the listed securities, or vice-versa. Hence, the terms “unfair/not fair but reasonable” are commonly used to describe a transaction.

This was exactly the term used in many other recent transactions which include Lembaga Tabung Angkatan Tentera’s offer to acquire Boustead Holdings Bhd as well as Boustead Plantations Bhd in two separate transactions, Chin Hin Group Bhd’s acquisition of shares in Ajiya Bhd, and Perrmodalan Nasional Bhd’s move to acquire UMW Holdings Bhd. In these transactions, the value of the assets was much higher than the transacted prices.