Getting related-party transactions right

IN today’s corporate setting and due to a higher level of scrutiny by not only shareholders but also other stakeholders, it is becoming increasingly challenging to make a business decision.

At times, although a transaction may be seen to be at a disadvantage to minority shareholders, it is, in all likelihood, the result of a vigorous internal process, especially when it involves a significant financial commitment and more so in a related party transaction (RPT).

Boards today are highly vigilant in safeguarding the interests of minority shareholders, ensuring that RPTs are conducted transparently and at arm’s length.

In this regard, a little over two weeks ago, DXN Holdings Bhd entered into an aircraft charter agreement with a charter carrier and a charter manager to lease a corporate jet for a period of one year.

The Gulfstream G550 corporate jet, complete with its two pilots, will be chartered for up to 300 hours.

According to its Bursa Malaysia announcement, this charter agreement will cost the company up to RM32mil a year or just over 10% of the company’s reported net profit for the financial year ended Feb 29, 2024.

While neither the charter carrier and charter manager are related parties to the company or its major shareholders, the aircraft in question is owned by LSJ Logistics Ltd (LSJL), which in turn is a wholly-owned subsidiary of DXN’s major shareholder, LSJ Global Sdn Bhd (LSJG).

The nine-year-old aircraft was purchased by LSJL for US$24.5mil in April this year.

The agreement was structured in such a way as to ensure compliance with regulatory requirements.

A licensed charter company with the necessary licences and capabilities was engaged, while the aircraft manager is responsible for maintaining airworthiness and operational standards.

As the owner of the aircraft is LSJL, it resulted in the transaction being categorised as an RPT.

In the filing with Bursa Malaysia, DXN explained that the charter agreement is expected to enhance the productivity of the group by providing more convenient and flexible connectivity when travelling between cities in key growth regions, reducing waiting times compared to commercial flights.

Additionally, the chartered jet will be used by DXN’s key management and high-performing team members for frequent travel across key cities in its international markets, enabling them to support the company’s global expansion.

DXN operates 13 factories across six countries, making cross-city travel between cities essential for business operations.

Justified reasons?

The directors and audit committee reviewed the RPT and opined that the transaction was in the best interest of the company, fair, reasonable, and conducted on normal commercial terms without harming the interests of minority shareholders.

While no revenue or incremental savings were disclosed in the announcement, the company’s assessment of the financial impact was deemed material.

Based on a scenario analysis using the maximum charter rate for the minimum flight hours, the cost involved will result in a straight reduction of the company’s profit after tax by more than 10% of its most recent full-year profit.

It must be said that the company took great strides in ensuring that it had the right tools to make a proper and fit judgement in the interest of non-interested shareholders due to the nature of the RPT.

DXN hired consultants and an independent third party to advise the board on the matter, especially the independent board members.

With the charter agreement in place and operative, DXN will generate cost savings compared to its previous reliance on commercial flights.

In addition, the charter agreement is structured as two separate transactions: one between DXN and the charter carrier, and the other between the charter carrier and LSJL.

This setup preserves the independent relationship between the entities, ensuring compliance with regulatory requirements while maintaining the structure’s integrity.

However, the market certainly did not take it well as the company’s share price fell by 8.8%, or five sen, to close at 51 sen the day after the announcement.

DXN’s share price has since fallen further, reaching 48 sen at Thursday’s close, 15% lower than before the announcement (56.5 sen), shedding almost RM423mil off its market capitalisation – more than 13 times the cost of the RPT!

A demanding market dynamics

This arrangement, akin to other marketing-based models, is designed to incentivise and motivate the company’s agency force, including Crown Ambassadors and Crown Diamonds.

By offering such benefits, DXN aims to strengthen its distribution network and drive business growth, an approach commonly used by marketing-based companies that depend on agency forces for sales and distribution.

Hence, the aircraft charter is seen as a significant marketing tool for its top leaders with a positive impact on performance.

The aircraft’s use can enhance and motivate the company’s members to deliver higher topline growth, which in turn will translate into greater profitability.

Additionally, by announcing the charter and seeking independent advice on the transaction, DXN demonstrates its commitment to meeting regulatory requirements and ensuring transparency in disclosing the RPT.

Strong fundamentals

DXN, which was re-listed on Bursa Malaysia with an initial public offering price of 70 sen, has mostly been trading below the offer price despite strong earnings momentum.

The company reported revenue growth of 12.6% in its financial year ended Feb 29, 2024 (FY24), while earnings rose to RM311mil from RM275.4mil, an increase of 12.9% year-on-year (y-o-y).

It also has a healthy balance sheet with net cash of RM476.7mil.

The company has also paid generous dividends, with a total payout of 3.6 sen per share or almost RM180mil in FY24, translating into a payout ratio of about 58%.

For FY25, the company reported a topline growth of 9.2% y-o-y, but net earnings were relatively flat, down by 1.4% y-o-y.

In the first half of FY25, DXN maintained a dividend payout of 1.7 sen per share, representing a payout ratio of almost 56%.

Its financial position remains strong, with a net cash position of RM544mil and a gearing ratio of less than 0.11 times as of August 2024.

Governance comes first

If one judges by the movement of the share price alone post the charter agreement announcement, it seems the market does not like this RPT as it is seen as hurting the company’s bottom line.

This is undeniably true, but at the same time, the RPT will increase the efficiency of DXN’s business operations across multiple countries and keep their top performing marketers on top of their game.

For a business to thrive in today’s environment, especially in growing the top line, there are short-term pains that need to be endured to achieve long-term success.

What better way to achieve this than by ensuring the RPT meets all governance standards and is transparent, as required by regulators?