By Khairie Hisyam
Recent months have seen valuations fall as global uncertainty and turbulence spur a selldown in the stock market. That said, Sime Darby still retains substantial value to be unlocked via corporate spin-offs – indications are there is still value to be unlocked even in this less-than-ideal circumstances by a break-up.
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Despite global and domestic headwinds depressing valuation in the stock market, various analyst estimates indicate that Sime Darby is worth at least RM3 billion more after a total break-up than it is now.
Five research houses in separate reports dated Aug 27 estimate the conglomerate to be worth between RM49.24 billion and RM63.26 billion compared to its RM46.6 billion in market value on Sept 2.
While there is variation due to differing approaches used to derive a valuation, it is indicative that there is substantial value to be unlocked through a demerger of its various core businesses. This of course presumes an immediate break-up of all divisions to remove the prevailing conglomerate discount.
That said, it should also be recognised that a demerger process, even if immediately undertaken, takes some time to complete and the eventual valuation would depend heavily on prevailing market conditions and investor sentiment.
Going forward, however, the disparity in valuation may even grow bigger as two of Sime Darby’s biggest earning drivers – Plantation and Industrial – are facing prolonged downturn in their sectors (see Part 1).
It remains unclear when things may look up for these two businesses and this in turn suggests that Sime Darby’s market valuation in the current conglomerate form may even drop further in the near future. That scenario would add further weight to the case for a break-up despite less-than-ideal circumstances for corporate spin-offs.
Is Sime Darby worth breaking up now?
With these in mind, how much cash can Sime Darby raise by undertaking corporate spin-offs immediately? This would very much depend on which division is listed first.
For simplicity’s sake, KINIBIZ takes an estimated valuation of the divisions by Public Investment Bank dated Aug 27, which estimates current-year 2016 earnings against forecasted price-earnings (PE) ratio for 2016 in a sum-of-parts (SOP) valuation method.
A PE ratio is essentially the ratio of a company’s earnings to its market value and reflects how much the market thinks it is worth. Among the component core businesses, property seems a good candidate for the first spin-off.
While the Malaysian property market has been softening amid various cooling measures imposed by Bank Negara in recent years, Sime Darby Property remains among the top property brands in the country with a strong land bank owing to its ties to Sime Darby Plantation.
For the purpose of this very simple analysis, KINIBIZ presumes Sime Darby divests 30% of its shares in a core business for the initial public offering (IPO). Applying that percentage to a hypothetical IPO of the property business – based on Public Investment Bank’s valuation estimate – would mean proceeds of RM3.5 billion without factoring fees and other expenses.
This is a substantial amount from the listing of one division alone considering that the magic figure for Sime Darby, based on the amount of borrowings it needs to reduce, is RM7 billion (see Part 1).
If, instead, Sime Darby goes with Plantation first, offering 30% of shares based on Public Investment Bank’s valuation amounts to gross proceeds of RM6.1 billion before costs and fees, which goes a long way towards the debt-reduction goal.
If this 30% divestment by way of IPO is done for all divisions simultaneously, the gross proceeds would come to a staggering RM15.1 billion before costs, fees and other uses of the proceeds.
This more than covers the debt-reducing requirement and would even spare shareholders any potential rights issue exercises, which would dilute earnings per share and hurt shareholders’ bank accounts – arguably unnecessarily so considering how much value can be tapped into via a demerger.
Is a rights issue needed?
Though obviously any amount raised through IPO under prevailing circumstances would be far below the maximum possible valuation under more ideal conditions, potential proceeds are not inconsiderable and run into billions of ringgit, as seen in the rough calculations in this article.
An additional consideration is that the shares divested at IPO need not be the final divestment percentage as the group may opt to hold a bigger majority and undertake further placement of shares down the road.
Returning to the 30% divestment scenario above, the group would retain 70% and can offer up to a further 19% in an extreme scenario post-IPO for major investors to come in without losing majority control. This would presumably be considered when conditions improve substantially to boost valuations up again.
To some extent this means there may yet be opportunities to capitalise on a market upturn though to a lesser degree.
In any case, this is significant as it provides an alternative avenue to raise funds as opposed to a rights issue, which had been mentioned as one among various options being considered in respect of paring down debt.
Going further, a break-up to resolve the borrowings conundrum may prove the better option in terms of shareholder interests.
On one hand, a rights issue would mean some RM6 billion or more coming out of their own wallets whereas the alternative would be to accept a lower cash-in on Sime Darby’s businesses but without coughing up any further cash. It would be an easy decision.
Of course, a more realistic scenario, should Sime Darby pursue the demerger route to raise cash, would probably see the listing or several divisions at most instead of an immediate and full break-up – for instance listing Plantation or Property only to start with.
Even then, however, the gains are substantial for the shareholder – the billions raised are billions less to raise through rights issuances or any other fund-raising exercise.
In other words, at worst the proceeds from spin-off listings would reduce the quantum needed through other avenues.
For the shareholders, this would reduce the dilutive impact of a potential rights issue on earnings per share as well as dividend per share while also reducing – if not sparing outright – the damage on shareholders’ bank accounts by way of rights subscription.
And one possibility is that while Sime Darby may not need to undertake an IPO for all divisions in order to resolve its borrowings conundrum, it can list enough divisions to raise what cash it needs and still list the rest by way of share distribution to existing shareholders.
Tuesday: The case for a break-up
Tomorrow: A redundant conglomerate
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