TEXCHEM Resources Bhd’s recent mandatory exit offer to the minority shareholders of its loss-making Singapore-listed unit, Texchem-Pack Holdings (S) Ltd (TPack), means there may be near-term pains as the group invests for future growth in the food and beverage scene.

Historically, TPack (fundamental: 0; valuation: 0.90), the polymer engineering division, has been the main drag on group earnings. Last year, when Texchem (fundamental: 0.75; valuation: 2.60) had a 70.48% stake in TPack, net losses attributable to Texchem shareholders were RM12.92 million while consolidated net assets were RM50.69 million.

A 100% ownership of TPack after the completion of the exit offer means Texchem will be booking up to 100% of the former’s profits or losses from now on. According to Texchem’s 2014 annual report, losses attributed to TPack minorities were RM5.02 million in FY2014 and RM5.93 million in FY2013.

In FY2014, the polymer engineering unit reported pre-tax losses of RM14.04 million, which largely negates the RM15.6 million in profits garnered by Texchem’s crown jewel, the restaurant division. Meanwhile, its industrial and food divisions made pre-tax profits of RM5.45 million and RM1.73 million respectively. As a whole, the group’s net profit for FY2014 came in at RM1.18 million, despite revenue growing 7.24% to RM1.02 billion.

In its Aug 6 announcement, Texchem said it expects the exit offer for TPack — which will be delisted from the Singapore Exchange (SGX) upon the completion of the exercise — “to have a positive contribution to the group in the long term”. It did not specify a period but a spokesman tells digitaledge Weekly that the unit could be in the black next year.

“We expect the division to be profitable in the financial year ending December 2016 (FY2016),” he says. “For FY2016, we can comfortably say that the polymer engineering division could make RM2 million to RM3 million in profit before tax.”

Texchem spent the last six years changing the division’s focus to catering for the medical and life sciences sectors from the electronics sector previously, after it slipped into the red post the 2008 financial crisis. The strategy seems to be working.

In a May interview with The Edge, group founder and executive chairman Tan Sri Fumihiko Konishi said the group expects the division to see a profit of RM8 million in FY2017, while its top line could grow 10% per annum over the next five years.

But pending a turnaround, whatever losses made by TPack would be fully consolidated into Texchem’s books.

TPack posted a net loss of RM12.9 million for FY2014, a 15% improvement from the RM15.2 million loss seen in FY2013. For the latest half-year ended June 30, net losses fell 53% year on year to RM3.7 million against a 10% increase in revenue to RM94.6 million.

In the current financial year, Texchem expects the division’s net losses to halve to RM6 million, says the Texchem spokesman. This would still be a 39% improvement from FY2014, once consolidated.

It is a shame that Texchem could not turn TPack around in time to retain its Singapore listing status. SGX, which placed TPack on its watch list in 2012, had ordered Texchem to make the exit offer to TPack’s minorities in March last year. It had previously given Texchem two years to turn the company around or achieve an average market capitalisation of S$40 million — TPack failed to do both and is thus being delisted. The trading of the stock has been suspended since April 7 last year.

The exit offer of 10.5 Singapore cents per share to shareholders, which together hold a 29.52% stake in TPack, is at a 5.7% discount to its latest net tangible assets of 11.14 cents per share. But based on its last traded price of 9 cents, the 10.5 cents offer price is at a 16.7% premium to the share price.

The exercise’s independent adviser, Asian Corporate Advisors Pte Ltd, is expected to provide its feedback on the exit offer by the end of next month.

As it is, the buyout cost is rising for Texchem.

The S$4.3 million or 10.5 cents per share exit offer works out to 29.5 sen or RM12.02 million at the Aug 5 exchange rate of 2.796. But the Singapore dollar was at 2.9619 as at Aug 21. This pushes the buyout cost to RM12.74 million.

If Texchem had made the offer back in April last year, the roughly 2.6 exchange rate would have meant a cheaper exit offer of RM11.2 million — some RM1.5 million cheaper than now.

That said, TPack is paid in US dollars and is poised to benefit from the ringgit’s depreciation against the greenback, the spokesman says.

Using pro-forma numbers provided on Aug 6, Texchem expects the TPack buyout to raise its 2014 net asset value per share to RM1.54 to RM1.60.

However, gearing is expected to rise from 0.74 times to 0.85 times as the company will fund the exit offer with 90% borrowings and 10% cash, its statement read.

Using end-June 2015 unaudited numbers, Texchem had RM97.5 million cash and cash equivalents but is in a RM89.95 million net debt position after accounting for RM187.45 million loans and borrowings.

If the exit offer cost RM12.74 million, net debt would go up to RM102.7 million, translating into about 0.35 times gearing, which is below Texchem’s targeted 0.5 times gearing ratio.

It remains to be seen if that ceiling would change as Texchem is still looking to grow its F&B business, including through mergers and acquisitions (M&A).

When Texchem sold a 28% stake in Sushi King to Asia Yoshinoya International Sdn Bhd at end-February for RM102.2 million, it had put aside RM10 million from the proceeds for this exit offer.

“However we’ve decided not to use most of that RM10 million we had put aside,” says the Texchem official.

“We are taking the loan so that we will have the freedom to tap what cash we have for our business plans and potential M&A. The restaurant business is going to be our core business going forward, so we are channelling our money there.”

The restaurant division makes up the bulk of its profit and the highest margin for the group at 9% to 10% each year. Texchem is looking to consolidate and spin off its restaurant assets in a few years’ time to unlock its value.

Market observers and analysts appreciate this move given that Texchem’s business units — restaurant, polymer engineering, industrial manufacturing, and surimi and seafood farming — are not obviously synergistic.

The restaurant division is led by the Sushi King brand, but also carries other Japanese brands such as Goku Raku Ramen, Miraku, Waku Waku, Yoshinoya, Hanamaru and, most recently, Tim Ho Wan — a Hong Kong-based Michelin-starred restaurant.

By year-end, it is targeting 92 Sushi King outlets, 100 each for Yoshinoya and Hanamaru, and three Tim Ho Wan.

“We have started consolidating our restaurant business under Texchem Restaurant Systems Sdn Bhd and by year-end, it will all be in place. In three to five years, we will look at a potential listing of this unit,” says the official.

“We will bring in new shareholders to inject some cash into the company so that we have room for more M&A,” he says, adding that Texchem will still maintain the majority shareholding at some 70%.

It expects the unit to be valued at about RM400 million.

Texchem’s remaining 70.35% stake in Sushi King is worth RM257 million on its own, exceeding its present market capitalisation of RM172.5 million — possibly due to losses from its other businesses.

“The restaurant business is going to be [Texchem’s] main source of growth in the future and a lot of hope is pinned on the potential IPO (initial public offering). I think it has a good business plan in place. Its current divisions are not particularly synergistic and the IPO would unlock a lot of value,” RHB Research analyst Ahmad Shahir tells digitaledge Weekly.

But he points out that new restaurants need at least a one-year gestation period and will take time to grow. RHB Research expects the division’s top line to grow between 13% and 21% from FY15 to FY17. At the net profit level, it is forecasting RM12.5 million in FY2015, RM19.6 million in FY2016 and RM24.8 million in FY2017 compared with just RM1.2 million last year.

Texchem’s shares have gained some 70% since January, but tumbled about 15% in the last few weeks to a six-month low of RM1.31 on Aug 17 as the broader market took a similar dive.

RHB Research’s Shahir, for one, says the stock looks attractive now based on valuations of 8.5 times forward price-earnings ratio. RHB Research has a RM1.90 fair value for Texchem, indicating a 36.7% upside from last Friday’s close of RM1.39.

Given the prevailing market uncertainties, the speed at which the market will reward Texchem could well be tied to how successful it will be in stemming the losses at TPack while reinventing itself into a sought-after F&B play.

Note: The Edge Research’s fundamental score reflects a company’s profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations. Visit www.theedgemarkets.com for more details on a company’s financial dashboard.

This article first appeared in digitaledgeWeekly, on August 24 - 30, 2015.