SHARES of loss-making Emas Kiara Industries Bhd are on a tear, up nearly two-thirds in the past two months as trading interest rose in the normally sleepy counter. Most of the gains have remained intact despite the company proposing a related-party deal, which generally raises eyebrows at the potential benefit the major shareholder will enjoy over minorities.

In Emas Kiara’s case, the related-party transaction (RPT) will essentially result in the company selling its land and assets in Selangor and Sabah for a total of RM48.52 million and using most of the proceeds to buy development rights to a project in Johor Baru that comes with a profit guarantee.

At a glance, the profit guarantee of at least RM51 million over three years and at least RM15 million for the first year seems a steal for the company, which has been loss-making for 14 consecutive quarters and incurred a net loss of RM8.9 million for FY2013.

Losses for the nine months ended Sept 30, 2014, stood at RM4.28 million for the geosynthetics engineering and lighting solutions provider that is diversifying into property development. In the company’s own words, geosynthetics engineering expertise essentially allows the conversion of non-usable land, such as swampy soft ground, hilly terrains and disused mining pools, into commercially viable parcels.

Still, have investors been overly exuberant about the prospective turnaround?

This is given that the short-term profits promised by the vendors of the Johor Baru development rights, dubbed the MB Max project, for the first three years come at the expense of the company selling its core assets (landbank and factory) to a firm that is 81% owned by Emas Kiara deputy executive chairman, co-founder and key strategist Wong Kong Foo, 14% by executive director and substantial shareholder Lim Yew Hoe and 5% by Wong Kong Meng.

To recap, Emas Kiara has proposed to acquire MB Max Sdn Bhd for RM45 million from Wong Weng Ho, Heng Aik Hwee, Pee Phek Yen and Oh Sze Peng. MB Max has development rights to a commercial project with serviced apartments in Johor Baru (Pinnacle Tower) with a gross development value (GDV) of RM264.63 million. The cost of construction is estimated at RM164.64 million.

Emas Kiara would have to take on borrowings of at least RM40 million to fund the development, which is 20% done and expected to be completed in June 2017. The vendors also promised that MB Max will generate at least RM51 million in the first three years, of which a minimum of RM15 million will be in the first year (FY2015) and at least RM16 million in the second year (FY2016).

The MB Max acquisition will be paid using proceeds from Emas Kiara’s proposed sale of Noblecorp Lands Sdn Bhd and Emas Kiara Sdn Bhd (EKSB) for RM48.52 million in a combination of cash and settlement of cash advances.

Specifically, Noblecorp Lands, which has 74.12 acres of leasehold land for residential use in Kota Kinabalu, Sabah, will be sold for RM38.66 million; and EKSB, which owns 1.69 acres of freehold land in Rawang, Selangor, on which Emas Kiara’s factory-cum-warehouse and three-storey office building is located, for RM9.86 million.

Emas Kiara currently occupies 22,500 sq ft of the space, and 5,000 sq ft is rented out at RM4,000 a month to Innovative Ecological System Sdn Bhd (IES), a company controlled by three Emas Kiara directors (chairman Tan Sri Kamaruzzaman Shariff, Lim and Kong Foo). After the proposed EKSB disposal, Emas Kiara will continue to occupy the space by paying a rent of RM19,000 per month. The assets, valued at RM7 million as at Aug 27 this year, were carried in its books at RM5.02 million as at end-2013.

According to the company’s announcement, EKSB is suing Michael Joseph Monteiro and Heng Ji Keng for the right to buy 1,433 acres of land in Lembah Beringin at RM83.8 million, which works out to only RM2.68 psf if one assumes 50% of the land is useable. A price of RM2.50 psf is closer to estate land in the area, while residential land should be double that, one property analyst estimates. If the suit goes in its favour, Emas Kiara agrees to pay RM22 million to take up a 25% stake in the special vehicle that would buy the Lembah Beringin land.

The possible upside there has not taken into account the potential development value of that tract, as well as that of Noblecorp Lands’ Sabah land — located within the Kota Kinabalu Industrial Park and in the vicinity of Institut Kemahiran Mara — which was carried in its books at RM30.05 million as at end-September 2014 and was valued at RM34.2 million on Nov 3 this year.

To be sure, any development value will take time and additional investments to realise. And that is the same case for the MB Max development, which has greater visibility, thanks to the profit guarantee by the vendors. One question that Emas Kiara minority shareholders might want to ask their directors is, why the vendors agree to give up nearly RM100 million worth of gross development profit for only RM45 million cash upfront.

In its announcement, Emas Kiara says it is selling Noblecorp Lands to unlock the capital appreciation of the Sabah land, which “is not expected to generate revenue for the group in the near to medium term as the proposed development is only expected to start two years after the completion of its acquisition”.

Still, it is worth noting that Emas Kiara had only sought shareholders’ approval to venture into property development in September 2013. The move into real estate resulted in the acquisition of the Sabah land that is now being sold to some of its main shareholders -- some of whom offered to buy out the company just six months earlier.

In March 2013, Kong Foo and parties aligned to him (including Lim) offered to buy 40.27% interest held by minority shareholders at 45 sen a share. At the time, the independent adviser had told shareholders to reject the offer, which was 21% below the company’s 57 sen net cash per share. As at end-September 2014, however, Emas Kiara’s net cash only stood at RM9.6 million or 10.7 sen per share, excluding a RM34.8 million deposit for a land acquisition.

Closing at 73 sen last Thursday, the stock is trading at 0.91 times its net asset value of 80 sen per share. It was also captured by theedgemarkets.com as a stock with momentum, but is deemed highly volatile, scoring 4 out of 5 for volatility and only 1.2 out of 3 points on strength in fundamentals and valuation.

According to its latest annual report, Kong Foo owned 23.92% of Emas Kiara and is deemed interested in another 19.38% stake as at April 30, 2014. Kamaruzzaman, who was mayor of Kuala Lumpur from 1995 to 2001, has 7.41% direct interest, while Lim has a 6.63% direct stake and is deemed interested in another 5.75%.

The proposed RPT announced on Nov 13 still needs approval from non-interested shareholders. When contacted, a member of Emas Kiara’s senior management team said the extraordinary general meeting to discuss the proposed RPT is expected to be held in the first half of 2015. The EGM date had not been fixed at the time of writing.

If approved, the company spokesman confirmed that the MB Max project will be Emas Kiara’s “main project”, and property development will become one of its core businesses, in line with the “diversification plan, which was approved by shareholders in 2013”.

Asked if Emas Kiara has any other landbank or property development projects, the spokesman said “assuming the proposals do not materialise, the Sabah land will remain with the group”. If the deal does go through, the spokesman says the MB Max acquisition will be “value enhancing” for the company’s shareholders.

If nothing else, Emas Kiara’s minority shareholders should ask if the RM51 million profit promised by the MB Max acquisition over three years is enough to ensure the company has enough resources to generate continued profits after the project is completed.

This article first appeared in The Edge Malaysia Weekly, on December 15 - 21, 2014.

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