By Khairie Hisyam
As conglomerate Sime Darby grapples with myriad issues, the most pressing being a ticking clock to pare down debts substantially, the case for a demerger grows stronger. KINIBIZ shines the spotlight on what the eventual structure may look like and why the current structure is in reality redundant.
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If Sime Darby pursues an immediate demerger of one or more of its core businesses to raise cash via spin-off, what might the eventual structure look like? There are several possibilities.
Mohd Bakke Salleh
One substantial hint on that question previously came from president and group chief executive Mohd Bakke Salleh, who stated that his desired endgame is to have a flagship entity with several listed subsidiaries.
This likely means a listed holding company with majority control over independently listed core businesses. One possibility along this line is that the holding company may retain one core business as its core operations with supplementary dividend income from its holdings.
A second possibility is to have a holding company without any core operations of its own other than holding interests in the listed subsidiaries. This would mean the current Sime Darby listed entity would evolve from a conglomerate to an investment holding company when the long-term demerger exercise is completed.
A third option is to list all of Sime Darby’s core businesses as independently listed entities and forgo having a listed holding entity altogether. This means having Sime Darby’s majority shareholder, Permodalan Nasional Bhd (PNB), as the common majority shareholder in the listed companies.
All things considered, the third option may prove the best route for Sime Darby in terms of shareholder interests, transparency and improving governance. KINIBIZ explains further below.
In interest of transparency
Transparency remains an important purpose in any break-up of Sime Darby, considering the relative opacity of the current conglomerate structure which may promote excessive risk-taking as seen in the 2010 financial year (FY10), which led to a massive RM2 billion loss for the Energy & Utilities division at the time.
This arises because divisional activities are shielded behind a collective public face that is the listed group entity. Not only does the shareholder run into problems when assessing individual performance of separate divisions, it is also problematic to assess whether energies, talent and resources are fairly spread across different divisions.
With this in mind, all three end-structure possibilities offer better transparency and presumably better governance as a result – important financial figures are not consolidated into one conglomerate account and shareholders also have direct access to various performance indicators as well as the management, not to mention a more accurate reflection of sector risks and valuation.
That said, for maximum value creation – considering a potential pursuit of demerger in less-than-ideal circumstances would already mean a lower value creation than possible in a perfect scenario – it seems more prudent to demerge all divisions and raise the proceeds from individual listing rather than keeping one core business away from the spin-off process.
This rules out the first possible structure. And the question then is whether there should be a listed investment holding entity binding together the spun-off businesses as sister companies under the Sime Darby umbrella – the second possibility.
It is not without merit. Having a listed investment holding entity would provide check-and-balance for shareholders of the listed core businesses.
In practice, without a core business of its own the investment holding company’s management would be monitoring the performance of these core businesses full-time – in essence a watchdog on behalf of fellow shareholders.
Without doubt such a scenario would promote further transparency and governance on the part of the listed core businesses. That said, however, that job in reality should fall to PNB as a government-linked investment fund, especially one tasked to promote bumiputera participation in the equity market.
A redundant structure
The existing relationship between PNB and Sime Darby as a conglomerate seems logical yet somewhat curious when pondered deeper.
At the heart of it, Sime Darby’s current conglomerate structure is aimed at having stability of earnings through a conglomerate form, which in turn provides PNB with some stability in dividend income.
However this has not materialised. Over the years since the Synergy Drive restructuring and Sime Darby’s return to the stock market, earnings have not seen a stable growth trajectory owing to the volatility and cyclical nature in Plantation and Industrial divisions, which traditionally makes up two-thirds earnings year after year.
This defeats the purpose of a conglomerate structure. Without providing the supposed primary benefit of a conglomerate form, the current structure has in reality depressed the value of PNB’s interests in the businesses due to the conglomerate discount.
Taking this further, retaining a listed investment holding entity post-demerger – the second possibility above – would also defeat the purpose of reducing the bureaucracy involved in the overall group governance monitoring.
Instead of simplifying the bureaucracy, what would likely happen is that there are two levels of monitoring which in reality would overlap with each other, creating unnecessary work and wastage of resources that could be put to better use.
Having a listed investment holding entity essentially means having an extra layer of governance and also an extra layer for earnings to filter through by way of dividends before PNB gets a taste of the cake.
Essentially the holding entity would need to retain some of the total dividends as its own earnings before passing on the rest to PNB. From PNB’s perspective it gains more by doing away with a listed intermediary and retaining a direct exposure to the listed businesses.
As for the watchdog role that the listed holding company may provide, PNB can create its own internal unit to undertake this role. One possibility is to absorb the existing group management team back into the fold and task them with monitoring the fund’s investments in these companies.
This of course necessitates that PNB up its own game in terms of corporate governance and management of its investments, especially when it comes to monitoring its listed subsidiaries. However this is a separate issue that merits further discussion beyond this series.
Tough decision for Bakke
In any case, the decision whether the group goes for a total demerger immediately falls on Mohd Bakke as the man in charge of Sime Darby to make. Only then can the plan be presented to shareholders for approval and pursued.
It would be a tough decision to make with various factors to consider, many already examined throughout this series. Among others he would have to decide whether the value that may be created through an immediate demerger would be sufficient despite less-than-ideal circumstances as well as the finer details on what to spin-off first and so on.
These aside, another consideration stands out: while the ideal post-demerger structure supports having listed companies without a listed holding company, there is a very real possibility that Mohd Bakke, his management team and other employees at the current group level would be working themselves out of a job.
However this is balanced by the consideration that pursuing a total demerger would be in the best interests of Sime Darby’s shareholders. Upholding such is the utmost duty of Mohd Bakke and company and it is logical to pursue the option despite the personal career consequences that may arise.
In addition PNB may yet choose to absorb the group-level employees made redundant into its own structure. One possibility would be to do so by creating a special unit to monitor its interests in the listed core businesses that used to form the conglomerate.
Breaking up is hard to do yet, it seems, the best way forward for Sime Darby overall.
Yesterday: Billions to unlock via demerger
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