This article first appeared in The Edge Financial Daily on March 27, 2019

Construction Sector
Maintain underweight: We believe the proposed takeover of four highways under Gamuda Bhd by the government will be on a willing buyer-willing seller basis and it is unlikely the government would exercise the expropriation clause in the concession agreements, thus executing a hostile takeover of the highways. If the offer is perceived to be detrimental to Gamuda and Lingkaran Trans Kota Holdings Bhd (Litrak) shareholders, they can vote against and reject the proposed offer in general meetings.

Earlier, the finance minister had said the proposed acquisition of the four highway concessions from Gamuda is expected to be concluded by August 2019. Recall in a press statement issued by the Prime Minister’s Office on Feb 23, 2019, the government announced it had commenced talks with Gamuda to negotiate the acquisition of highway concessions, in which Gamuda has a majority stake.

These highways are the LDP, via a 43.6% stake in Litrak, which in turn owns a 100% stake in LDP; Sprint (30% direct stake, and via a 43.6% stake in Litrak, which in turn owns 50% of Sprint); Lebuhraya Shah Alam (Kesas) (70% stake); and Stormwater Management and Road Tunnel (Smart Tunnel) (50% stake). The highway restructuring’s salient points are upon a successful takeover of the highways, the government intends to abolish the existing toll mechanism; a “congestion charge” will be introduced whereby commuters only pay a sum equivalent to the existing toll for six hours during the “peak” period a day; during the “off-peak” period between 11pm and 5am, commuters will travel on the highways for free; at other “normal” travelling hours, commuters will enjoy discounts of up to 30% compared with the existing toll rates; and the revenue collected from the “congestion charge” will go towards operating and maintaining the highways as well as to repay borrowings.

We believe the proposed takeover will be on a willing buyer-willing seller basis and it is unlikely the government would exercise the expropriation clause in the concession agreements to make a hostile takeover of the highways. Finance Minister Lim Guan Eng had said acquiring these highways will be done at a fair and reasonable price for the government. Gamuda has calmed its shareholders by clarifying the board of directors has a fiduciary duty to deliver a fair and reasonable value to its shareholders, and ensure the proposed transaction will be based on market valuation norms and practices.

If Gamuda and the government could reach an agreement on the proposed acquisition of highways by the government, we believe Gamuda’s disposal of highways would still be conditional on obtaining Litrak and Gamuda shareholders’ approvals, if the proposed disposal is carried out in a single exercise. This is given that shareholders’ approval is required for transactions exceeding a percentage ratio threshold of 25%.

Litrak requires at least 75% approval of those present and who vote in a general meeting as it is a major disposal. If the offer is perceived to be detrimental to Gamuda and Litrak shareholders, they can vote against and reject the proposed offer in the general meetings. This would act as a safety net if the offer is deemed unfavourable.

Subject to the offer price, we think the proposed acquisition is likely a positive to the government. This is given that Shah Alam Expressway (Kesas), LDP and Sprint generate a healthy cash flow; the concessions of Kesas, LDP and Sprint are relatively near the concession expiry dates, which generally require lower acquisition considerations and have lower outstanding debts, compared with other urban highways with longer remaining concession periods; the government’s cost of funds is generally lower than corporates’ funding costs; and the operation and financing costs of these highways are likely sufficiently covered by the proposed congestion charge, with a possibility of generating a surplus to the government, on our assumption that the congestion charge is imposed on a permanent basis.

We maintained our “sell” call on Gamuda with an unchanged TP of RM2.80 as we think the current share price has fully reflected its value. We reiterate our “buy” call on Litrak with an unchanged TP of RM5.11 as at the current share price, investors could potentially benefit from the proposed acquisition of the LDP and Sprint by the government, while having the downside risk capped.

We maintained our “underweight” call on the construction sector as we think the valuation has run ahead of its fundamentals. In addition, the property market, where most contractors have direct or indirect exposure, remains challenging. With the recent weakness in share price performance, we upgraded our calls on Gadang Holdings Bhd from “hold” to “buy” and Eversendai Corp Bhd from “sell” to “hold”. — TA Securities, March 26