AFTER three failed attempts in the past three years, SILK Holdings Bhd may finally succeed in disposing of its 37km Kajang Traffic Dispersal Ring Road (SILK Highway). Last week, it was announced that Permodalan Nasional Bhd (PNB) would acquire the highway for RM380 million cash.
But shareholders do not appear overly enthusiastic. After rallying to an intraday high of 49 sen on the news break, SILK’s shares closed at only 42.5 sen last Friday, giving the company a market capitalisation of RM298.2 million. This is a 22% discount to the RM380 million that the company may soon get.
It is either the market is sceptical about the deal or investors are pessimistic about how the management will utilise the proceeds.
Recall that RM70.15 million, or 18.5% of the proceeds, will be distributed as dividends. This translates into 10 sen per share. The balance (less costs) of RM301.85 million will be used as working capital and for future investments, including offshore marine support services for oil and gas.
Furthermore, the disposal will reduce SILK’s borrowings by RM1.02 billion and consequently, lower its gearing from 91.57% to 53.29%.
In stark contrast, SILK’s share price almost doubled to 80 sen back in 2014 when news first broke that IJM Corp would acquire the highway at a marginally higher price of RM398 million. In fact, the share price would rally to a record high of RM1.20 over the following few months in anticipation of the deal closing.
Even when Taliworks Corp Bhd was said to be interested in taking over the SILK Highway, SILK’s share price hit 48 sen early last year. But no formal deal materialised and the share price came back down.
Last September, when WZ Satu Bhd made a bid for the highway, SILK’s share price rose again, to as high as 47.5 sen a share. But when the deal was called off, the share price once again dropped.
Before looking into PNB’s advantages, it is important to understand some of the major hurdles faced by previous would-be buyers.
For starters, SILK is carrying a relatively heavy debt of around RM1.02 billion, based on a circular to its shareholders. The debt is mostly from a sukuk mudharabah that was issued in 2007.
This sukuk has been particularly problematic because it has a high profit rate (a term for coupon rate for Islamic instruments) of 8%.
To understand the sukuk, the history of the debt and the highway must be revisited.
Recall that SILK Highway used to be held under Sunway Infrastructure Bhd. Back then, the highway was secured to a RM2.01 billion 20-year Al-Bai Bithaman Ajiil Islamic Debt Security (BaIDS). But in 2006, after suffering from underperforming traffic volumes on the highway, the BaIDS was reduced to junk bond status and the debt was restructured. Eventually, the highway was injected into SILK while the debt was refinanced to the sukuk mudharabah with an 8% profit rate.
But to ensure that the sukuk did not default again, SILK was allowed to pay a minimum 3.5% profit rate while the rest of the interest was deferred. Furthermore, sukuk holders were given an additional sweetener in the form of profit sharing, whereby they were entitled to a share of profits if the highway performed exceptionally well.
Currently, the deferred interest payments have ballooned to RM400.79 million, bringing the total carrying amount of the sukuk to RM1.02 billion.
On top of that, the profit payments (coupon payments) could not be deferred indefinitely. Last year, the profit rate for the sukuk resumed at 8%.
In summary, the sukuk mudharabah’s structure heavily favours the sukuk holders. In turn, this means that equity holders of the highway will see minimal returns for most of the life of the highway.
This is not to say that the highway is not performing well. Operationally, it generated RM87.99 million in gross profit for the nine months ended Sept 30, 2016. Earnings before interest, taxes, depreciation and amortisation (Ebitda) was RM80.07 million in the same period. Annualised, last year’s Ebitda is estimated at RM106 million.
The trouble is that finance cost stood at RM77.56 million, sapping 96% of Ebitda. After taxes and depreciation, SILK actually posted a net loss of RM6.55 million for the nine-month period. Annualised, that works out to a net loss of RM8.73 million.
Hence, the only way to make financial sense of the SILK Highway is to refinance the sukuk. Unfortunately, that proved to be a stumbling block for the past three would-be acquirers.
Sukuk holders have demanded high premiums in the past for a buyback of the sukuk. On top of that, any acquisition of the SILK Highway requires a two-thirds approval by the sukuk holders.
Why PNB’s acquisition should succeed
PNB, however, has three distinct advantages. For starters, it has much deeper pockets.
The total enterprise value of the SILK Highway is estimated at around RM1.4 billion. This includes RM380 million in equity and RM1.02 billion in debt. At the very least, PNB can afford to buy back the sukuk at face value.
It could be argued that the sukuk holders need to be paid a premium to part with the sukuk and forgo the potential upside in the profit-sharing mechanism. But the deal is still bankable.
Assuming a 10% premium for sukuk holders, PNB’s acquisition cost would increase to RM1.5 billion. But this would allow PNB to redeem the sukuk, effectively reducing the highway’s interest cost to zero.
Based on SILK’s FY2016’s estimated Ebitda of RM106 million, PNB would hypothetically generate a yield of 7%. Keep in mind that this does not take into account the potential for future earnings growth as traffic volumes and toll rates increase over the years.
SILK Highway’s traffic volume is estimated to grow between 7% and 8% annually.
In fact, it is interesting to note that PNB and SILK have made it a joint condition precedent of the acquisition that PNB also acquires more than 50% of all outstanding sukuk.
This is only possible due to a recent change in rules by the Securities Commission Malaysia that allows for unrated bonds and sukuk to be transferred.
This means that PNB has committed to spend at least RM510 million to acquire 50% of the outstanding sukuk mudharabah.
However, channel checks show that SILK has yet to issue a circular to bondholders detailing the sukuk buyout.
“PNB is probably going to have preliminary discussions with sukuk holders to see what they want in terms of pricing before putting out a circular. They won’t risk this deal not going through,” explains one fund manager who holds the sukuk.
That said, PNB is not expected to have any trouble securing 50% of the sukuk. After all, one of the larger sukuk holders is Etiqa Insurance and Takaful Bhd, which happens to be an indirect subsidiary of PNB via Malayan Banking Bhd. Another substantial sukuk holder is Affin Hwang Asset Capital. Coincidentally, Affin Hwang Investment Bank Bhd is one of the advisers to the SILK Highway’s acquisition.
PNB’s third advantage is that it has a potential pathway to monetise the highway acquisition. PNB’s wholly owned Projek Lintasan Kota Holdings Sdn Bhd (Prolintas) owns 44.55km of highways, with another 51.9km under construction. The inclusion of the SILK Highway in its portfolio could pave the way for a yield-driven infrastructure initial public offering.
Recall that Prolintas has the 7.9km Ampang-Kuala Lumpur Elevated Highway, the 14km Lebuhraya Kemuning-Shah Alam and the 22km Guthrie Corridor Expressway. It is also constructing the 20.1km Damansara-Shah Alam Highway and the 31.8km Sungai Besi-Ulu Kelang Elevated Expressway.
It is understood that Prolintas’ highway operations currently serve about 72 million vehicles a year. For scale, SILK Highway serves about 70 million vehicles a day.
On top of that, there is the Wahid factor. Tan Sri Abdul Wahid Omar, as the chairman of PNB, is said to be the driving force behind a series of corporate deals last week, including the SILK deal.
Put it all together and the chance of the acquisition exercise falling apart is rather slim this time round.
In turn, that means there is a good chance that SILK should soon be flush with cash. At face value, the company should at least be trading at RM380 million, or 54 sen a share.
Unfortunately, SILK’s venture into the oil and gas sector and marine logistics has not paid off. For the nine-month period ended Sept 30, 2016, the company suffered a loss before tax of RM61.3 million on revenue of RM124 million.
Despite the recovery in crude oil prices, the company blamed sluggish O&G activity for the continued poor performance of the division.
Looking ahead, however, it remains to be seen if a cash injection of about RM300 million will be able to turn SILK’s fortunes around.
Or perhaps the company will be part of the consolidation in the O&G industry.
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