This article first appeared in The Edge Malaysia Weekly on May 29, 2017 - June 4, 2017

SOME may choose to see Proton as a waste of taxpayers’ money. Others may see it as a symbol of Malaysia’s ambitions as a once-young developing nation.

It is not surprising then that China’s Zhejiang Geely Holding Group Co Ltd’s acquisition of a 49% stake in Proton Holdings Bhd from DRB-Hicom Bhd has become a rather divisive issue.

But putting aside Proton’s emotional baggage and focusing on the nuts and bolts, is Proton’s disposal a good deal?

It really depends on which stakeholder you ask.

What it means for DRB-Hicom

On paper, the deal is unequivocally good for DRB-Hicom and its 55.9% controlling shareholder, Tan Sri Syed Mokhtar Al-bukhary.

For starters, it is understood that the proceeds from the disposal of Lotus will go straight to DRB-Hicom instead of Proton. Lotus is currently a wholly-owned subsidiary of Proton.

That is £100 million (RM556 million) into DRB-Hicom’s pocket. This is 6.8 times Lotus' net asset value of RM82.1 million, notes a report by CIMB Research.

“Although the offer price is lower than the RM1.96 billion that Proton invested in Lotus, the deal offers a good opportunity for DRB-Hicom to monetise its asset, given Lotus’ long history of losses. We estimate that Lotus recorded more than RM1.5 billion in losses in the last five years,” writes CIMB.

Hence, on paper, DRB-Hicom should book a sizeable extraordinary gain on Lotus’ disposal.

Besides the cash, DRB-Hicom is also going to extricate a sizeable amount of Proton’s assets for its own benefit, namely, land.

As part of the deal, DRB-Hicom will retain land bank with an estimated carrying book value of RM540 million. This includes the prized 250 acres occupied by the Shah Alam plant as well as land in Glenmarie and overseas.

The market value of the land banks, however, should be much higher.

“The Shah Alam land is in a good location, close to the Federal Highway. As industrial land, I estimate the market value to be about RM70 to RM80 psf,” says Anthony Chua, executive director of property consultancy KGV-Lambert Smith Hampton.

This values the Shah Alam land at about RM870 million in total. Past reports have put the estimated gross development value of the site at RM4 billion.

Note that Proton’s operations in Shah Alam will be shifted to the Tanjung Malim plant in about five years.  

Removing the land from Proton is to DRB-Hicom's advantage, since it will not be collateral for the government’s RM1.25 billion soft loan. If Proton flops again and the government converts the loan to shares, DRB-Hicom will retain 100% of the land.

Furthermore, DRB-Hicom will book a gain when the government injects RM1.1 billion into Proton as reimbursement for the latter’s R&D grant. With a 50.1% stake, DRB-Hicom effectively benefits from half that amount.

Also note that DRB-Hicom has advanced about RM1.2 billion to Proton. The government’s cash could be used to repay some of the money Proton owes to DRB-Hicom.

To be fair, DRB-Hicom incurred high costs to own Proton. To privatise Proton in 2012,  DRB-Hicom paid about RM3.02 billion. Since then, Proton has incurred about RM3.3 billion in losses as at March 31, 2016.

For FY2017, it is estimated Proton incurred slightly less than RM1 billion in losses — substantially lower than last year’s RM1.46 billion loss.

In total, Proton has cost DRB-Hicom an estimated RM7.3 billion.

What it means for the government

With Proton now partly foreign-owned, “there will be no more subsidies”, Second Finance Minister Datuk Seri Johari Abdul Ghani says.

That said, Proton will be running on government money nonetheless.

Some might disagree if these monies can be considered subsidies, but the government will pump RM1.35 billion into the company once the deal is concluded.

Firstly, the government will disburse the balance of the RM250 million soft loan. RM1.25 billion of the RM1.5 billion has been disbursed.

Secondly, the government will be reimbursing Proton RM1.1 billion for R&D that the latter has undertaken. Some might argue that this is a compromise. Proton was claiming RM3.5 billion from the government to begin with, adding to some RM15 billion that the government has spent supporting it.

It is interesting that the government chose not to contra the R&D reimbursement with the soft loan owed to it.

Instead, Proton will owe the government RM1.5 billion. Of course, the hope is that the company will start to turn around and eventually pay back the soft loan.

But what if it cannot?

The soft loan, in the form of redeemable convertible cumulative preference shares (RCCPS) issued by the government, could be converted into ordinary Proton shares in the event it defaults. It could be converted into 2.1 billion new Proton shares, giving the government a 79.28% stake in the car maker.

With new shares issued to Geely for its 49% interest in Proton, it is not clear how the convertibility of the RCCPS will be affected. However, 2.1 billion new shares should still get the government at least 65% in Proton post-disposal.

The trouble, however, is that many assets have been removed from Proton. Lotus will be sold off and the proceeds paid to DRB-Hicom. In addition, the prime Shah Alam land bank, together with other plots, will be transferred to DRB-Hicom.

What it means for Proton

Proton is about to receive lots of cash — RM1.52 billion in total.

Besides the RM1.35 billion from the government, the car maker will also be getting RM170.3 million from Geely for the 49% stake.

On top of that, Geely will also be giving Proton the platform for its best-selling vehicle, the Boyue SUV. This will allow Proton to assemble and sell a new line of SUVs without having to incur any R&D costs. Only the capital expenditure for setting up the assembly line is needed.

This platform has an indicative valuation of between RM500 million and RM1 billion.

However, there is a catch. Proton will have about five years to recover value from owning this platform because the rights from Geely are not given in perpetuity.

In other words, the value of the platform for Proton is equivalent to how many units it can sell. While the SUV should command a modest positive margin, the mid-range SUV market is not very big. For example,  a top-selling SUV like Honda’s HRV only turns over about 1,600 units a month.

Assuming Proton can move a similar volume, how much money can the group make from selling about 20,000 units a year?

Of course, partnering Geely opens up many avenues for Proton, for example, selling its cars in China. But that is an intensely competitive market.

Furthermore, an official familiar with the deal notes that Proton will have to set up its own plant if it hopes to venture into China. Hence, such a move is both expensive and unlikely.

Geely will not compete with Proton in Malaysia, but that is not much of a consolation. Proton is still struggling with the current competition.

However, it does open up the possibility of Proton assembling Volvos in the Tanjung Malim plant.

Realistically, however, the car maker will simply leverage Geely’s engineering and technological capability to develop new models. It will take about two years, at least, before Proton is able to roll out new models.

In the meantime, it will be a mix of the same old loss-making line-up boosted with the new SUV.

What it means for Geely

It looks like Geely got what it wanted all along — Lotus. It needs only pay RM170 million for an equity interest in Proton.

After all, sharing the SUV platform will not cost Geely anything.

Meanwhile,Geely is willing to pay substantially more for a controlling stake in Lotus — £50 million.

In fact, sources say Geely plans to invest huge amounts of capital in Lotus to turn the loss-making luxury British sports car maker around.

This is one reason DRB-Hicom chose not to retain the 49% stake in Lotus, explains a source. The constant capital injections would require DRB-Hicom to do the same or risk dilution. Instead, Syed Mokhtar’s private unit will take on that risk.

It is not clear if Geely will take a similar interest in Proton. It is certainly fortunate for Geely that the government chooses to pump RM1.1 billion into Proton prior to its acquisition.

By simply paying RM170 million, Geely will enjoy the RM550 million cash injected by the government (half of RM1.1 billion).

And if all else fails, and Proton runs into trouble again, Geely can always opt to back out.  After all, the Malaysian government still has the RM1.5 billion RCCPS in Proton, making it roughly nine times more invested in Proton than Geely.

In turn, this could make overhauling the car company very challenging for Geely. Political interests have always taken precedence over commercial considerations when it comes to Proton. This is especially problematic for the 49.99% shareholder.

That said, it is also unfair to assume the Geely-Proton union is doomed to fail. In the event Proton finally comes of age, Geely  will not have many complaints either. The Chinese automaker's entry cost into Proton is very low.

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