What’s next after M&As?

The acquisition of companies like Ajiya by Chin Hin, while it is all above board, fair, and reasonable, must be responsible as well.

IN the world of finance, there are many ways an investor can make money, and among them are pure long-term investors who adopt a buy-and-hold strategy.

We also have short-term traders who are momentum players, driven mainly by technical analysis.

There are also short-sellers who are investors who believe the market price of a security is too high and ahead of fundamentals and sell the underlying security first in the hope of buying back the same security at a lower price.

Hedge funds are also investors deploying various strategies but with the help of leverage to enjoy superior returns while in some markets, we also have arbitrage traders, who take advantage of the market’s mispricing of securities mainly due to dual-listing.

Arbitrage strategy also works in a merger and acquisition (M&A) deal, involving mainly a share swap due to the mispricing in the market, or a price difference between an option security and the underlying company shares.

Asset strippers

Vulture investing is a term used to define funds that seek to invest in distressed companies with the hope of recouping huge profits by undertaking either a quick turnaround plan or selling some of the prized assets to make a sizeable profit.

Vulture funds are able to do this as the market may find the company is doomed and carries a huge bankruptcy risk and hence a low market price.

The term vulture funds came from vulture birds known to be scavengers that will scoop up dead animals.

Close to what a vulture fund is are funds that acquire undervalued companies with the same objective of stripping out either the assets on a piecemeal basis, restructuring the balance sheet, or taking the cash out via capital repayment exercises or dividends, or even as a loan if the company is cash-rich and trading well below its book value at the time of acquisition.

These investors are referred to as asset-strippers and are increasingly deployed by corporates as the strategy can enhance the value of their company, at the expense of the minority shareholders of the company where the assets or cash is being disposed of or used.

Acquiring a company and stripping out the assets or restructuring the balance sheet of the target company in an M&A deal, especially if the company is cash-rich, is nothing new for corporate Malaysia and we have seen this happen many times before.

Of course, some companies in an M&A deal are being acquired for strategic purposes too if the business of the target company is part of the supply chain, be it a horizontal acquisition or a vertical acquisition.

The target company is either taken private or left to remain as a listed entity with the acquirer holding a majority stake of more than 50%.

The Ajiya story

In September last year, Chin Hin Group Bhd acquired 6.22 million shares in Ajiya Bhd for RM9.51mil or RM1.53 per share.

At that time, as Chin Hin and parties acting in concert (PAC) also held a 32% stake in Ajiya, the additional shares acquired, representing a 2.1% stake, meant that Chin Hin was obliged to extend a conditional mandatory general offer (MGO) for all the remaining shares at the same price, that is, at RM1.53 per share.

Upon completion of the MGO, Chin Hin, together with the PAC, ended up with 164.7 million shares of Ajiya, representing a 55.85% equity interest costing some RM252mil.

Chin Hin funded this acquisition mainly via bank borrowings as stated in the circular to shareholders although it did clarify that the company had some RM128.2mil as at the latest quarterly financial report then.

Most of the additional shares that Chin Hin obtained from the MGO were from committed shareholders of Ajiya who had expressed their undertaking to accept the offer.

After all, even BDO Capital Consultants, the independent advisor to the MGO, reckoned that the MGO price of RM1.53 per share was not fair as it was 40 sen, or 20.9% discount, to Ajiya’s fair value.

Nevertheless, the MGO was reasonable and the independent adviser recommended that Ajiya shareholders accept the offer.

Chin Hin’s rationale of acquiring the majority stake in Ajiya made perfect sense as the group is involved in property development activities while Ajiya is a supplier of building materials. The synergistic benefit was obvious.

Ajiya recently reported its earnings, with a loss of RM12.7mil for the first quarter ended Feb 29, 2024 (1Q24), mainly due to a RM9.6mil realised loss and a fair value loss of almost RM6mil.

During the quarter, Ajiya also sold some RM21.8mil in other investments and carried out a revaluation of its land and building, boosting the value of its properties by some RM107.1mil.

As at the end of February 2024, Ajiya had a total equity of RM584mil while net asset per share stood at RM1.98 per share.

Ajiya’s cash and cash equivalents (mainly in the form of quoted equity investments, money market funds and bonds) stood at RM176.6mil, while investment properties jumped to RM71.2mil from RM25.8mil, largely due to a gain on revaluation.

Property, plant and equipment too were higher, rising by almost RM87mil for 1Q24.

Loan to Chin Hin

Last Friday, Ajiya announced that it is providing financial assistance to Chin Hin in the form of a RM250mil loan within a period of two years at an interest rate of 7.5% per annum for Chin Hin’s funding requirement and its subsidiaries.

Of this amount, some RM110mil will be utilised to fund the acquisition of Chin Hing Construction Engineering Sdn Bhd and Kayangan Kemas Sdn Bhd for RM16.5mil and RM93.5mil by Chin Hin from Chin Hin Property Group Bhd (CHPG) respectively, which in turn, is a 55.4% subsidiary of Chin Hin.

The balance of RM140mil will be utilised by Chin Hin for the expansion of the group’s building material and construction division (RM90mil) and other investment purposes (RM50mil).

The repayment of the RM250mil will be up to five years from the date of each disbursement.

Of course, due to the nature of the loan itself and being a related party transaction, shareholder approvals are required, while Chin Hin’s major shareholder too is expected to provide a personal guarantee for the facility granted to Chin Hin.

Fair and reasonable?

The Audit Committee (AC) as well as other directors of Ajiya opined that this facility is in the best interest of the company, fair, reasonable, on normal commercial terms, and not detrimental to minority shareholders.

However, based on Ajiya’s latest balance sheet, the company does not have RM250mil ready cash to deploy to Chin Hin. Even if all its cash and investments were liquidated, the company would only be able to raise RM176.6mil.

Early this week, Ajiya entered into an agreement to dispose of a piece of land in Thailand for RM26.7mil, but the proceeds of this will be utilised for its glass manufacturing facilities and not earmarked for the deployment as a loan to Chin Hin.

Ajiya will still be short of RM73.4mil to provide Chin Hin with its funding requirement.

Will Ajiya be forced to sell its investment properties which have some RM71mil in value to extend this RM250mil facility to Chin Hin, or will Ajiya go into debt to raise enough funds for Chin Hin’s funding purposes?

Chin Hin has every right to use the balance sheet of Ajiya to its advantage but not strip out its cash, investments, or properties the way it is proposing now and minority shareholders should reject such corporate behaviour.

After all, this is a tripartite related-party transaction that has raised eyebrows and the regulators too should keep a close watch on the proposed funding for Chin Hin.

A look at Chin Hin’s balance sheet also suggests that the company is rather stretched with total borrowings of RM1.11bil and cash and cash equivalents of RM452.8mil.

With a net debt level of RM660mil and shareholders’ equity of RM762.3mil, Chin Hin has a net gearing level of 0.87 times as at end-December 2023.

Post 2023 and up to now, following the additional acquisition of shares in Signature International Bhd and the subsequent MGO to acquire the remaining shares not already owned, Chin Hin would have easily spent another RM231.7mil to raise its stake in Signature to 72.2%, making the company a new subsidiary.

At the same time, in subsequent event post-balance sheet, as shown in its 2023 Annual Report, Chin Hin bought 40.6mil shares in CHPG for RM48.9mil and raised RM20mil in new perpetual medium-term notes at a fixed rate of 7.5%.

CHPG also raised some RM41.2mil from the placement of new shares. On a net basis and at the group level, leaving everything else unchanged, Chin Hin’s net debt would have increased by another RM220mil at least.

Of course, the incorporation of Signature would also mean that Chin Hin would treat Signature as a subsidiary, thus causing further deterioration in the company’s balance sheet as Signature is a net debt company too.

Over to minority shareholders

The acquisition of companies like Ajiya or even Signature by Chin Hin, while it is all above board, fair, and reasonable, must be responsible as well. Granted that Chin Hin is expanding and acquiring these businesses which are strategic and positive, what it does with Ajiya and Signature post-acquisition without undermining minority shareholders is crucial.

The RM250mil facility to be extended to Chin Hin at a 7.5% interest rate surely looks good on paper for Ajiya’s shareholders but it comes at a price.

In addition, Chin Hin should leverage its balance sheet, after all, it is also paying a 7.5% coupon for its medium-term note programme while its other borrowings had even lower rates of less than 5% on a blended basis for all its borrowings based on the total finance cost in 2023 against its average total debt of close to RM1bil.

While the board of directors and the AC recommend that shareholders accept this proposal, shareholders must weigh the pros and cons of this proposal.

For Ajiya’s minority shareholders, if the deal is approved, the repayment of the RM250mil facility at the end of the five-year tenure too must be guaranteed.

Having said that, would it be more appropriate for Chin Hin to source its own RM250mil funding that it needs rather than digging into Ajia’s deep pockets?

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writer’s own.