BASED on how Iskandar Waterfront City Bhd’s (IWC) share price hit limit-up last Friday to close at a record high of RM2.28 apiece, investors have certainly taken to the proposed merger and acquisition by Tan Sri Lim Kang Hoo.
On this basis, IWC’s minorities should be more than thrilled.
In brief, the proposed deal will see Lim’s Iskandar Waterfront Holdings Sdn Bhd (IWH) assume the listing status of its 38.34%-controlled subsidiary, IWC. More land assets will also be injected into the company, followed by a private placement to raise funds.
Based on the one-for-one share swap offered to IWC’s minorities at RM1.50 apiece, their 61.7% stake in IWC will become an estimated 12% stake in the merged entity, IWH Group.
The enlarged group will boast a 7,367-acre land bank in Johor with a gross estimated open market value of RM32 billion or a revised net asset value (RNAV) of RM4.50 a share (fully diluted). On top of that, IWH Group will have a 36% effective stake in the 486-acre Bandar Malaysia development.
At first glance, it would appear to be a dream deal for IWC’s minorities, who have been waiting a long time to see the value in IWC unlocked.
It is estimated that IWC is sitting on a land bank with an open market value of more than RM5 billion. On paper, that works out to RM6 per share. Unfortunately, IWC has been a bit of a value trap for investors. The group’s share price has been lacklustre since late 2015, hovering between 80 sen and 90 sen before the deal was announced.
From this perspective, the proposed exercises will certainly unlock IWC’s value. But could the minorities have got a better deal?
It is important to note that IWC is waiting on a RM2.4 billion disposal of 128 acres of land to China’s Greenland Group. Based on its 2015 annual report, IWC expected to book a gain on disposal worth RM1.89 per share or approximately RM1.39 billion.
For perspective, at RM1.50 a share, IWC is valued at only RM1.24 billion.
Accounting for a recent dilution of the company’s share base to 823.7 million shares (due to a land acquisition), the same gain today would be worth RM1.69 per share.
Had the disposal been completed first, some might argue that IWC would have commanded a higher value in this merger, translating into a higher share-swap ratio.
For example, valuing IWC at a RM2 per share for the purpose of the swap would translate into a swap ratio of 1-for-1.3 instead. That would translate into minorities taking up a 14.5% stake in IWH, instead of only 12%.
Alternatively, if the disposal to Greenland goes through after the M&A is concluded, the share of profit from the disposal for IWC’s minorities will be diluted by about 82% to only 22.3 sen per share.
Although much delayed, Greenland is unlikely to abandon the deal altogether. After all, the property giant is in the process of negotiating for another parcel of land in Bandar Malaysia.
“Currently, there is no certainty that the land disposal to Greenland will be concluded in view of the numerous extensions of the cut-off date in respect of the SPA (sales and purchase agreement). However, for the purpose of the merger, we have assumed the deal will be concluded and fully priced it in the proposed one-for-one share swap,” says Astramina Advisory Sdn Bhd managing director Wong Muh Rong, who is advising on the deal.
“We have assumed the acquisition will go through and have included it in the RM4.50 RNAV per share of the merged entity,” she explains.
Wong points out that if the Greenland acquisition had not been priced in, the share swap would not have been proposed on a one-for-one basis. Instead, the share swap would have been done at a lower ratio, around 0.7-for-1, she says.
Wong stresses that the minorities should not focus on the dilutive effect the merger will have on the RM2.4 billion land disposal but instead “assess the one-for-one share swap offer versus the enlarged value base of IWH versus IWC, and if the discount to RNAV for IWH versus the existing RNAV value of IWC is fair and reasonable.”
The devil is in the details
IWH Group’s RNAV of RM4.50 per share is one of the key headline figures that is being bandied about, along with the RM32 billion open market value for the 7,400 acres in IWH Group.
At face value, these figures certainly build a compelling case for IWC’s share price rally. More importantly, it is the key selling point for shareholders to stay invested.
At last Friday’s close of RM2.28, IWC’s shares are essentially valued at a 49% discount to IWH Group’s RNAV.
Note that property companies are typically valued at a steep discount to their RNAV anyway. But to IWH Group’s credit, its RNAV figure is based on the open market value of IWH Group’s total land bank. In contrast, many property development companies typically use the gross development value of their land bank to calculate RNAV.
UEM Sunrise Bhd, possibly the largest landowner in Johor Baru and Iskandar Malaysia, has been valued at an RNAV discount of as much as 70%. Another smaller Johor-based property developer, KSL Holdings Bhd, was recently valued at an 86% discount to RNAV by Kenanga Research.
“This deal gives great value to IWC’s shareholders. Instead of holding shares in IWC, they now have exposure to a much larger land bank. This includes prime land in Johor and Bandar Malaysia,” says Lim, advising shareholders to look at the long-term value of the land.
“The average cost of our land is only RM93 psf. Think of buying IWH shares as buying land. It has a tangible value and by accounting treatment, land cannot be depreciated. It is good investment for the future,” he explains.
Looking beyond the massive headline figures, however, where is the land?
Many investors may already be familiar with the bulk of IWH’s prime land bank in Johor, particularly the parcels in Danga Bay and on the Tebrau coast, which lie to the west and east of the Causeway respectively.
Danga Bay, in particular, is well known for seeding some of the largest property projects in the state via foreign developers like Country Garden Holdings Co Ltd, Guangzhou R&F Properties Co Ltd and Greenland Group. It has also attracted the likes of Singapore’s CapitaLand Ltd and Temasek Holdings (Pvt) Ltd, which have entered into joint ventures with IWH to develop the land.
But it is also important to note that there will be about 3,600 acres of new land injected into IWH Group as part of the acquisition exercise.
As part of the merger, Lim will inject about 450 acres while Kumpulan Prasarana Rakyat Johor will inject 1,901 acres. Additionally, Sultan of Johor Sultan Ibrahim Iskandar will be injecting 1,240 acres into IWH Group.
Thus far, IWC has not announced any details about the location and value of these tracts. Full details are expected to be released along with a circular to shareholders by April 29.
Nonetheless, it is understood that some of this land is less central than IWH’s prime land. Among the tracts are land around Tebrau, in Plentong, Kota Puteri, Kampung Teluk Jawa and Pasir Gudang. They also include more waterfront land along the mouth of the Johor River — around Kampung Kong Kong and on Juling Island. Land as far west as Pulai will also be acquired.
In total, the new land bank will be acquired for RM3.87 billion — 15% via 646.9 million new shares and 85% via 3.7 billion redeemable convertible preference shares (RCPS).
Note that the RCPS have a two-for-one conversion ratio and are conditional upon IWH Group achieving a cumulative after-tax profit of RM1 billion. Along with the 646.9 million shares, the fully converted RCPS would add up to 2.48 billion shares or a 39.8% stake in IWH Group.
Clearly, the RM3.8 billion worth of land acquired is a heavy investment for the group and is something investors will want to pay close attention to. However, they will have to wait for more details to be revealed before deciding if this additional 3,593 acres is a welcome addition to IWH’s existing land bank.
After all, the Johor property market is facing a glut, which makes subprime land even more difficult to monetise.
Even Lim acknowledges that there is an oversupply of high-rise residential properties in and around Johor Baru.
However, he says, “There is no right or wrong timing. There will always be a property cycle. I began investing in Johor back in 1998. Back then, people told me I was crazy. But look at Johor today. It has grown from a population of one million to two million.”
Instead, he points to Shenzen, which has grown from a tiny fishing village to a city with over 12 million people due to its close proximity to Guangzhou. Johor Baru should see a similar boost from Singapore.
A different business model
Overall, many would agree that IWH’s land assets are of value. But at the end of the day, investors want to see either one of two things from a company — earnings or dividends.
For dividends at least, Lim is not willing to commit to a dividend policy as it is something that is “still being discussed”.
Meanwhile, IWC is loss-making and IWH is understood to be in a similar position as well. Neither company has substantial recurring income.
Given the sluggish pace in the property market, will IWH Group be able to churn out strong profits from its sizeable asset base?
“We are not a property developer. Instead, our clients are property developers. Either we will sell land to them or we will form a joint venture to develop the land. This is the same model that we are using for Bandar Malaysia,” explains Lim.
With this in mind, he is confident that IWH Group will be able to hit the cumulative after-tax profit target of RM1 billion (for the RCPS) within 18 to 24 months. However, details are scant on how this target will be achieved.
Note that deals that have already been signed, like the disposal to Greenland by IWC, will not count towards to the RM1 billion profit target.
The good news is that IWH Group will be able to take its time to unlock the value of its land bank. The group plans to pay off most of its RM2 billion in existing borrowings via the primary placement of 400 million shares.
Unlike most property developers that rely on debt, IWH Group will have near-zero gearing. This will make the group highly resilient to down-cycles in the property market.
All things considered, the M&A should create value for all stakeholders.
But beyond the immediate gap-up in IWC’s share price, IWH Group may not be as exciting a stock in the near term. Given the group’s sizeable land bank, however, IWH Group still presents a long-term value proposition for patient investors. Major catalysts in the medium to long-term include the possible spin-off of Bandar Malaysia and the eventual listing of a real estate investment trust for IWH Group’s mature property investments with recurring income.
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