Cover Story: A merger of opposites

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Opposites attract, so the saying goes. And the UEM Land-Sunrise merger announced last Thursday is a case of two very different companies coming together.

Since its listing in 2008, UEM Land Holdings Bhd has been one of the two largest listed property players in terms of market capitalisation, the other being SP Setia. It is also one of the largest landowners in the country, having amassed 11,400 acres of land over the years, predominantly in Iskandar Malaysia, the development region in the state of Johor.

However, industry observers have often said its lacklustre financial performance and share price do not fully reflect the company’s substantial assets. Much of that has to do with the lack of short-term earnings, as Iskandar Malaysia is a longer term development. Indeed, the bulk of UEM Land’s profits are generated from land sales, rather than property development.

Even its management acknowledged that UEM Land is not performing as expected. “Our PE multiple is so high, compared with Sunrise’s single-digit PE, that it’s embarrassing,” Datuk Wan Abdullah Wan Ibrahim, managing director and CEO of UEM Land, told the press last week.

On the other hand, Sunrise Bhd has a relatively smaller development landbank of 164 acres, of which about half is in Mont’Kiara.

While its land bank is limited, Sunrise has one of the most valuable and recognisable brands in the property industry. Its unbilled sales are a high RM1.2 billion and the company has a steady pipeline of new projects to sustain near-term earnings. Even then, its fundamentals are also not reflected in its lacklustre stock price, with the stock trading in single- digit multiples.

Hence, the strategic merger that has been proposed which would create Malaysia’s largest property company,  a far more attractive entity than either company standing on its own.

The deal was a well-kept secret that took the market and employees of both companies by surprise.  Word has it that even the most senior management staff and board members of UEM Land and Sunrise were notified only days before the merger was announced.

The courtship period was also a short one, with the deal put on the table and agreed upon within a month.

Under the exercise, UEM Land has proposed a conditional takeover of Sunrise at RM2.80 per Sunrise share, valuing the deal at RM1.39 billion.

Just a day before the general offer from UEM Land and following the release of its first quarter results, Sunrise had also declared an interim gross dividend of 26.67 sen, or 20 sen net.  This implies Sunrise shareholders will be receiving a total of RM3 per share  —  RM2.80 from UEM Land’s offer and 20 sen in net dividends from Sunrise. 

The offer price of RM2.80 represents a premium of 30.4% to the one-month volume-weighted average price of Sunrise shares to Nov 2.

Sunrise investors will have two options — either take up UEM Land shares or its unlisted redeemable convertible preference shares (RCPS). 

Those taking up the share swap option will exchange one Sunrise share for 1.33 UEM Land shares, with the latter issued at RM2.10 per share, 7% below its last traded pre-suspension price of RM2.26.

For those opting for the RCPS, the exchange will be 2.8 UEM Land RCPS issued at RM1 each, for one Sunrise share.

Shareholders may convert the RCPS any time until maturity at RM2.30 per RCPS, or redeem the amount in full after two years.

The RCPS also have a warrant-like gearing feature as they can be converted into one ordinary UEM Land share via two options — by tendering 2.3 RCPS or 1 RCPS plus RM1.30 cash.

Post-merger, should all Sunrise shareholders take the share alternative, UEM Group will pare down its stake in UEM Land to 65% from 77%, while the major shareholders in Sunrise — Tong, Tan Sri Datuk Danny Tan Chee Sing and Datuk Allan Lim — will collectively own a 6% stake in the enlarged UEM Land.

However, if shareholders take the RCPS alternative with full conversion, UEM Group will end up with 56% stake in UEM Land, while Sunrise’s major shareholders will hold an 11% stake in the property player.

UEM Land has already received irrevocable acceptance from Tong, Lim and Tan, who collectively own 40.3% of Sunrise currently. Upon getting more than 75% acceptance from Sunrise shareholders, its listing will be withdrawn.

Of all property players, why Sunrise?

“It’s the fit. We look at the numbers, earnings and asset base of Sunrise and we feel it is a good fit for UEM Land. Then, we looked at the valuations and we think it is a fair price to pay,” Datuk Izzaddin Idris, group managing director and chief executive officer of UEM Group, tells The Edge in an interview last week.

Izzadin explains that UEM Land has the landbank, but it needs to have the expertise and brand name to create more value from its development projects.

“You need to have the track record, that’s the difference. Granted you can pinch a team of 20 people and it’s cheaper to do that than buy over the entire outfit, but you do not have the track record to develop projects in Singapore, for instance, if I want to undertake high-rise projects.

“On the other hand, Sunrise is established and very recognised. It has the customer base from Singapore and other regional customers and it is nicely packaged within the company,” he says.

Synergistic benefits are the key drivers behind this merger.

For Sunrise shareholders, the merger provides a shorter period to realise the value of the company, says Datuk Tong Kooi Ong, executive chairman of Sunrise.

“From the perspective of Sunrise, the staff will have more growth opportunities. Because of UEM Land’s huge landbank, we will have a lot of land to work on.

“Under the enlarged company, we will also have a lot more financial flexibility, as our major shareholder is Khazanah Nasional. This is also a deal about capital structure, and hence, it is an opportune time to do it now,” he says.

Tong says the merged company is expected to have a market capitalisation of RM10 billion, with various segments from construction to property development to hospitality.

“UEM Land will have a large land bank spread over Iskandar, Cyberjaya, Mont’Kiara, downtown Kuala Lumpur, Kajang and Canada, giving investors less concentrated geographical risks and exposure to different growth areas.

“Sunrise’s sizeable near-term earnings will complement the much stronger longer-term potential of Iskandar, and will reduce UEM Land’s price-to-earnings multiples by half.

“Going forward, I would think it is also very hard for big institutional funds not to own the enlarged UEM Land, given its sheer size, earnings potential, land bank and branding,” he adds.

The earnings enhancement from this merger is significant. According to estimates, net profit for CY2011 for the enlarged entity will rise to RM266 million, compared with RM107 million and RM158 million for UEM Land and Sunrise, respectively.

Equity value of the company will increase to RM9.8 billion, compared with RM8.4 billion on UEM Land’s standalone basis. Post-merger, UEM Land’s CY2011 PE will fall to 37 times from 78.7 times.

UEM Land is not known as a darling among foreign fund managers, although more investors have warmed up to the stock this year as they started appreciating the Iskandar story.

One reason for the shortage of interest is the lack of near-term earnings, which is reflected in its high PE ratios. The impression of UEM Group is also coloured by a history of over-leveraging and its acquisition of Renong Group during the 1997-98 Asian Financial Crisis.

But, all that is set to change.

Izzadin says the corporate exercise also effectively sees the reduction of UEM Group’s stake in the property player.  “There is not crowding out effect of UEM Group’s shareholding in UEM Land. With the additional shareholders coming in from Sunrise, it will add to the diversity in UEM Land’s shareholding,” he says.

Bringing down UEM Group’s stake is just a near-term objective for this merger. What UEM Land wants is to streamline its operations, using the expertise of Sunrise.

To do that, UEM Land is getting Tong — who will remain executive chairman of Sunrise — to sit on the board of UEM Land, as well as chair a development committee that will oversee the execution of UEM Land’s projects.

Development committee to drive Iskandar regionIzzadin says the committee, which will include Wan Abdullah and himself, will be the driving force for UEM Land’s operational strategies.

“How the development committee works is that, the committee will look at the design, choose architects, do the numbers and present to the board. Once the board approves the project, the development committee will also take charge of the operations and execute the project, and this includes appointing contractors and monitoring progress.

“It’s the whole value chain to make sure the project is delivered on time and within budget, up to the mark and has quality,” says Izzaddin.

The bulk of the work lies in the Nusajaya development projects in Iskandar Malaysia, where UEM Land is a major landowner.

“Sunrise is a catalyst to jumpstart the development of Iskandar because we now have the track record immediately in high-rise and lifestyle development.

“We want Datuk Tong to provide the experience, the network he has developed over the years and bring in new investors and developers beyond Singapore. I call him a platform for us to take Nusajaya a step further,” explains Izzadin.

That is why Tong is being made the chairman of the development committee, he says.

Izzadin adds that the underlying message that he is sending to UEM Group and its units is a change in the culture of doing things.

Both Sunrise and UEM Land admit that the different cultures in the two companies were among the major issues contemplated by both sides before they decided on the merger deal.

Izzadin says the cultural differences between the two companies — Sunrise being run by entrepreneurs and predominantly Chinese, while UEM Land, a government-linked company, is mainly run by Malay management and staff — has been acknowledged. However, according to some industry observers, that is merely scratching the surface of the different management styles in the two companies.

At the press conference on Thursday to announce the deal, Wan Abdullah said the two companies are planning to set up an integration committee to address the issues, but it is still at a preliminary stage.

For a start, UEM Land and Sunrise will run parallel to each other and integration will be done over time, says Tong. However, he believes there is a universal value in the workforce of the two companies, and personality differences will be secondary when it comes to creating value for the merged company for the next stage of growth.

Aspiring to become the next CapitaLand Izzaddin says what the UEM Group can give Sunrise shareholders is the exposure to bigger development projects, apart from Nusajaya.

“There are other major development projects coming up, and we think we have a strong proposition to EPF (Employees Provident Fund) to develop RRI (Rubber Research Institute) land, for example. I am sure there are components of development where EPF will tender out to other developers,” he says.

Another development project that UEM Land is said to be eyeing is a 271ha piece of land owned by KTM Bhd in Singapore that will be jointly developed by Khazanah Nasional and Temasek Holdings.

In the long term, the enlarged entity wants to become a regional property player, modelled after Singapore’s CapitaLand Ltd.

“CapitaLand is also a result of a merger between Pidemco Land and DBS Land. They are now all over the world, and that is our vision,” says UEM Land’s Wan Abdullah.

Tong says the first step in that direction will be the merger, as it will create the size that will enable it to keep capital costs low. “The success of CapitaLand lies in its low borrowing costs, and this is why the company can keep on building and selling its properties to investors. So, CapitaLand is a financing vehicle as much as it is a property vehicle,” he says.

Against the backdrop of a recovering property market, UEM Land wants to put in place the right stepping stones that will lead it towards becoming a formidable player.

“We are already in a state of readiness,” declares Wan Abdullah. But for now, the merger of opposites will be an interesting one to watch.

This article appeared in Cover Story page, The Edge Malaysia, Issue 831, Nov 8-14, 2010