The right way for Sunway

BY now, most investors are familiar with the conditional voluntary take-over offer presented by Sunway Bhd on IJM Corp Bhd, valuing the latter at RM11.04bil or RM3.15 per share.

The proposed consideration will be satisfied via the issuance of 1.759 billion new Sunway shares valued at RM5.65 per share, worth some RM9.937bil, plus RM1.104bil in cash.

In summary, IJM shareholders will receive 501 new Sunway shares plus RM315 for every 1,000 IJM shares held. The deal remains conditional upon Sunway obtaining shareholders’ approval at an Extraordinary General Meeting (EGM), as well as Sunway crossing the 50% ownership threshold, which will allow the offer to turn unconditional.

Sunway must dispatch the offer document to IJM shareholders by Feb 2.

There are several issues with respect to Sunway’s offer and how the company could have provided a much better deal to IJM shareholders, as well as the timing of the offer itself.

Here are three factors as to how Sunway should have approached the IJM deal:

> An easier swap ratio

Instead of having a strict 90% share swap and 10% cash offer, Sunway should have made some adjustments to the offer with 500 new Sunway shares valued at RM5.65 each and adjusted the cash offer to RM0.325 instead.

A one-sen higher cash offer could have reduced the incidence of odd-lots for smaller retail investors.

Based on this scenario, Sunway would have to fork out an additional RM35mil in cash and reduce the number of new shares to be issued under the conditional offer to 1.753 billion new shares, a reduction of 6.2 million new Sunway shares.

> Timing of offer

One of the issues with the offer is that the new Sunway shares will not be entitled to the upcoming Sunway Healthcare Holdings Bhd (SHH) public issue.

Based on the dividend-in-specie that existing Sunway shareholders will receive on the basis of one SHH share for every 10 Sunway shares held, it can be estimated that the value per Sunway share is between 12 and 15 sen.

Assuming the higher end of 15 sen per share, Sunway should have adjusted the value of this dividend-in-specie, as IJM shareholders who accept the offer are not entitled to the new SHH shares.

Based on the calculated value of RM0.15 per Sunway share, it is equivalent to 7.5 sen per IJM share; Sunway should have adjusted the cash offer to IJM shareholders from 31.5 sen to 39 sen instead. In essence, the total value of the offer will increase to RM3.225 per IJM share from the current RM3.15 per share.

To avoid the complications arising from the SHH public issue, Sunway should have waited for the distribution of SHH shares to its shareholders to be completed before launching the conditional take-over offer. That would have removed doubts and valuation arising from the SHH shares to be distributed.

> Walk the talk

At the time of launching the offer, Sunway held zero shares in IJM. Since Jan 12 to the time of writing, Sunway has not picked up a single IJM share from the open market, although they are trading at a steep discount from Sunway’s offer price.

In merger and acquisition deals, it is vital for the offeror to show its seriousness by making open market purchases.

Buying IJM shares from the open market is not only cheaper, but Sunway will also reduce the number of new Sunway shares it will issue, as well as the cash portion under the deal.

Some 532 million IJM shares have changed hands in the market up to Jan 22, and Sunway could have purchased some and even have emerged as a substantial shareholder.

Instead, based on disclosures to Bursa Malaysia, the active market buyers/sellers were Sunway’s principal adviser, Maybank Investment Bank Bhd, and its appointed international financial adviser, UBS AG and other major institutional shareholders.

Having discussed three key points when it comes to this mega-deal, there are obviously other issues at play, and the potential arbitrage opportunities for both investors and Sunway shareholders.

Due diligence

It is not that Sunway woke up in the morning of Jan 12 and decided to launch the conditional offer. The conglomerate and IJM had previously denied that there was any merger talk in November last year.

Surely, even when Sunway decided to launch the offer, they must have done some form of legal due diligence to ensure they would not be subject to potential liabilities, especially with the current investigation by an enforcement agency.

While the timing of these investigations can be said to be coincidental to derail Sunway’s move, news about this issue first surfaced in October last year, and Sunway should have been better advised if there was an added risk to the conglomerate, should it proceed with this offer.

Arbitrage opportunities

For Sunway shareholders, as there is a given swap ratio for IJM shares, shareholders have an opportunity to arbitrage their Sunway shares with IJM shares, without assuming additional risk, other than losing their entitlement to SHH shares.

At Thursday’s closing price of RM5.57, a Sunway shareholder could sell 1,000 Sunway shares in the open market and use the proceeds to buy 2,000 IJM shares at RM2.64.

Excluding transaction costs, this will allow a Sunway shareholder to generate a net cash inflow of RM290 per 1,000 Sunway shares sold.

As Sunway has made it clear that it is not backing out of the IJM deal, accepting the offer would mean that a Sunway shareholder who has swapped his/her share for two IJM shares will receive 1,002 Sunway shares plus RM630 in cash based on the swap ratio of 501 Sunway shares for every 1,000 IJM shares plus RM315.

All in, a Sunway shareholder will generate a net cash inflow of RM920 per 1,000 Sunway shares that are sold in this arbitrage opportunity.

Minus the potential value of the SHH shares of approximately RM150 per 1,000 Sunway shares, the net gain is still a decent RM770 per 1,000 Sunway shares, translating to a risk-free gain of about 13.8%.

For investors, there is also an indirect opportunity to get Sunway shares at a lower price than the market.

An investor who buys 2,000 IJM shares at the last traded price of RM2.64 and accepts the conditional take-over offer will be issued 1,002 Sunway shares at a cheaper entry cost of RM4.64 per Sunway share ((RM2.64 x 2,000) – (RM0.315 X 2,000))/1,002.

Imputing a theoretical adjusted price of RM5.42 after the SHH distribution, investors stand to make a 16.8% return using this strategy. (Note: The above is a mere analysis of the differing scenarios and not advice or an invitation to trade Sunway or IJM shares.)

In conclusion, while Sunway’s move to pursue this voluntary general take-over offer on IJM seems attractive on the surface, it could have been done at a better swap ratio as well as after the distribution of SHH shares.

In addition, the ongoing investigation clouds investors’ perception of the value Sunway can generate, but the market prices of the two firms provide arbitrage opportunities for both Sunway shareholders and investors looking at the deal, especially if Sunway is able to turn the offer into an unconditional take-over offer.