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Saturday, November 13, 2010

UEM Land-Sunrise merger unravelled By ANITA GABRIEL

Saturday November 13, 2010
UEM Land-Sunrise merger unravelled

IT's a well-dressed deal, this planned takeover by government-linked UEM Land Holdings Bhd of builder Sunrise Bhd. Accompanied by a cavalcade of rosy numbers and promises that the merged entity will become one of the "leading real estate company by market value, land bank and total assets", not just in Malaysia but the region, the psychology behind the deal is hard to fault.

The truth, however, as analysts and thick-walleted bankers would tell you, rests in the numbers and, of course, execution. And as far as that's concerned, for now, the views appear as varied and divergent as the corporate cultures of UEM Land and Sunrise.

Since the veil was lifted off the quickly-conceived deal a week ago, for many, its obvious financial and strategic merits far outweigh its niggling points. But there are some who quibble over the "low valuation" accorded to Sunrise, while others deem the exercise as benefiting one more than the other.

This must be frustrating indeed for the deal's protagonists. Sunrise's chief steward Datuk Tong Kooi Ong, who is the single largest shareholder and executive chairman, says: "People are always hung up over who gets a better deal. I'm not. If we all try to get a better deal at the expense of the other, then surely we can't get a deal done.

"A deal materialises when both parties believe they are better off. And this one clearly is. The synergies are extremely clear," he says in an interview with StarBizWeek.

The deal in a nutshell

UEM Land has launched a RM1.4bil conditional takeover offer for Sunrise at RM2.80 a piece. Sunrise shareholders have two options – to accept 1.33 UEM Land shares at an issue price of RM2.10/share for every Sunrise share surrendered or to accept 2.8 unlisted redeemable convertible preference share (RCPS) in UEM Land at an issue price of RM1 for every Sunrise share.

Those who opt for the second route, can convert their RCPS any time within two years from the issue date at RM2.30 each.

Shareholders can also choose to redeem RCPS at RM1 upon maturity. Any outstanding RCPS not converted or redeemed will be converted into UEM Land shares automatically.

There's a third option for shareholders if you count dumping their shares and walking away from the deal. OSK Research throws in a fourth – to hold out and wait for a sweeter offer, which it readily admits is risky.

The voluntary general offer is conditional upon UEM Land receiving more than 50% acceptance, which is deemed almost a done deal as three key shareholders – Tong, Datuk Allan Lim and Tan Sri Danny Tan Chee Sing – who collectively own 40.3% interest in Sunrise (25% is held by Tong) have given an irrevocable undertaking to accept the offer.

Assuming a 100% acceptance for the share swap, UEM Group's current stake of 77.1% in UEM Land will be diluted to 65% while Tong and friends will collectively hold 6% in the merged entity and other shareholders of Sunrise will have a collective stake of 9% in UEM Land.

On the other hand, a 100% RCPS alternative with full conversion under the cash conversion method will see UEM Group's stake in UEM Land diluted to 56% while Tong and his friends will collectively hold 11% equity stake in the merged entity and other Sunrise shareholders will have a collective stake of 17%.

The quibble

Could the offer have been better? Maybe.

And more so, if you agree with OSK Research that the Malaysian property scene is "at the cusp of a strong positive re-rating". By most valuation benchmarks – be it price to earnings (P/E), price to net tangible asset (P/NTA) and price to real net asset value (P/RNAV) – it would appear as if the offer falls short.

At RM2.80 a piece and with the just-announced 20 sen net interim dividend tossed in, OSK Research says Sunrise is valued at 1.3 times FY11 price/NTA but at a mere 0.58 times price/RNAV (RNAV of RM5.15),

The offer, says ECM Libra Research, only values Sunrise at 7.3x P/E based on CY11 earnings, which is lower than its peers. "Its closest peer Mah Sing, which has similar market capitalisation and also a perceived lack of landbank, is currently trading at 10.4x P/E based on CY11 earnings," it says.

Sunrise's pre-announcement traded price of RM2.52 is some 23% off its 52-week high of RM3.26 while UEM's last traded price of RM2.26 is merely 10% off its 52-week high of RM2.52.

To put it simply, to accept the offer, Sunrise shareholders ought to be convinced that the merger would unlock more value in their holdings over and above what the company can achieve on a stand alone basis.

Ultimately, the best barometer on the market's take to the offer still rests in the price performance of both counters post-announcement. The deal has received a resounding nod; both counters have leaped since the announcement. Sunrise's shares have climbed 25% from its pre-suspension price of RM2.52 to RM3.16 on Thursday while those of UEM Land has risen by 9% from RM2.26 to RM2.47.

But one market wag says the trend is "rather atypical". "Normally, the buyer's counter will fall while the seller's will go up. But in this instance, both have gone up. Because it's a share swap, if the buyer goes up, the target's price will also rise," he says.

That's a good start, if any and one that UEM Group Bhd group managing director/CEO Datuk Izzaddin Idris can't help but point out: "For a start, the fact that the market has spoken with the appreciation in the respective share prices, is a good sign."

Naturally, Tong can't resist either: "The value proposition for UEM Land is the strength of the people and the brand in Sunrise. It only makes sense if UEM Land can retain and harness this value for the new enlarged UEM Land ... the financial market agrees given the way both companies' shares have appreciated since the deal was announced."

Merger of unequals?

One's a large scale developer with massive tracts of land with an "I got your back" stamp from the Government, given its ultimate controlling shareholder is state investment arm Khazanah Nasional Bhd, while the other, an entrepreneur-driven nimble outfit with a penchant for high-end high rise buildings. Yet, small, Sunrise is anything but.

"Let me correct a general misperception. Sunrise was, but is hardly, a boutique developer today. It is one of Malaysia's largest property developers with sales of RM800mil and pre-tax profit of over RM150mil a year. There are only a handful of other developers in Malaysia with better financials," says Tong.

Melding two diverse corporate cultures could prove to be a tough act.

The different cultures are perhaps best embodied by the top executive cadre of the two entities; Tong is the casually-clad innovative-oriented and creative risk-seeker who used to be a banker and also owns media company The Edge Communications Sdn Bhd apart from having businesses abroad. UEM Land CEO Wan Abdullah Wan Ibrahim is an industry lifer who has spent over a decade of his career in several GLCs while Izzaddin, boss of UEM Group, which controls UEM Land, is a "GLC-lifer" who has spent his career in a smorgasbord of businesses from banking, utility, construction to property. One's a true-blue entrepreneur, while the other two, true blue professional managers.

It's easy to forget but UEM Group is actually more of a "reverse GLC" as it was privately-owned long before it was brought to the fold of state-owned Khazanah.

"UEM has a private sector DNA but it has government backing. In that sense, you can say that both organisations are not as vastly different as perceived. Still there is a state-owned mentality that's quite prevalent in the organisation," says an observer.

But some contend that it is this unique difference which could make the teaming up work.

"The unique thing about property companies is that the cultures may not even have to merge. By nature, a property company is focused on a project by project basis. For example, in UEM Land, the Putera Harbour team (a high end luxury waterfront project) is different from the team that is undertaking the rest of Nusajaya. On the development side, there are always separate teams handling the various projects. That means, one can leverage off the central expertise but each development can run separately," says an industry observer.

Still, quite visibly it's an issue foremost in everyone's mind.

"The major challenge will be people. We will need to address their concerns, to encourage and motivate them," says Tong.

Izzaddin alludes to that when he says: "Ultimately with any business or operational combination, the challenge is to successfully implement the plan to immediately extract the synergies. Call it execution risk. In this case, with the common ground and universal values that both organisations profess coupled with the professionalism and mutual respect we have for each other, I am fairly confident that it will be the case of 1+1 is more than 2. The issue for my team and I is how much more than 2!"

Tension among partners?

Could there be another reason, though not over-riding, for the recent deal? According to industry insiders, there is some long-standing friction between two other major shareholders of Sunrise – Danny Tan and Allan Lim, who respectively own 8.5% and 7.2%. Tan and Lim are brothers-in-law, having married two sisters.

Lim, the executive deputy chairman of Sunrise, according to insiders has keen interest in property development and has contributed substantially to the group's achievements. On the other hand, Tan is regarded as a passive investor in Sunrise as he is the controlling shareholder of another property company Dijaya Corp Bhd.

Still, an industry source says "the issues" between the two parties do not at all affect Sunrise.

For UEM Land, it hooked up with Sunrise after trawling for potential suitors for some time.

"We explored a host of potential candidates. After a careful study ... where we mapped the various candidates' profiles against a selection criteria based on our own strategic requirements, we felt that Sunrise was the most suitable candidate.

We were fortunate that Sunrise shares the same view and more importantly it was a willing seller," says Wan Abdullah.

Paving the way for an exit?

There is a strong sense of foreboding in the marketplace, that Tong, through this deal, is paving the way for his exit from the property developer. That may be a possible risk which, at this juncture, none of the deal's proponents would care to admit as he has been instrumental in the company's commendable growth in recent years.

In fact, Credit Suisse in a recent report pointedly refers to it: "The risks to potential benefits lies in the retention of Sunrise's key staff and the role Sunrise chairman Datuk Tong will play in UEM Land following the acquisition."

OSK Research echoes this sentiment: "Should he (Tong) no longer play a proactive role in driving Sunrise post-merger, there is little doubt that the company's current shareholders may get jittery."

But Tong is quick to brush off such nagging suspicions. "I am a shareholder of Sunrise like other shareholders. This deal creates value for all of us. I am not sure what you mean by "exit". I am not selling out. I am accepting the offer," he says just as pointedly.

"It is not possible to know how long I will stay invested, whether in Sunrise or in the new enlarged UEM Land. Many things can happen to my life. But my intention is to continue (being) invested, to help grow the business and the people and create value for shareholders and customers," he elaborates.

In line with this, Tong will be made chairman of both the development committees of UEM Land and Sunrise, and is expected to be the "platform" to take Nusajaya (UEM Land's flagship project) to the next level. "This appointment is a strong signal from UEM Land (that they want my experience, knowledge and assistance)," says Tong.

Tong's RCPS option

Tong plans to convert his shares in Sunrise to the RCPS of UEM Land. "Taking the RCPS shows my longer term commitment to the enlarged entity. The market would be worried if I take shares on the basis that I will sell out," he says, adding that this acquisition was clearly not just for the physical assets of Sunrise but also "the intangibles, the brand, the people".

"The structure of the RCPS has a good gearing effect on the performance of UEM Land. Although the conversion is at a premium (RM2.30 versus RM2.10), the RCPS holders can opt for cash option redemption as well ... In other words, if UEM Land does well (which I am confident it will), then the RCPS has a very good "option value".

"What options you choose depends on your assessment of the future success of the enlarged entity. The more positive you are of the future UEM Land, the higher is the value of the RCPS. As someone who will be partly responsible for the future UEM Land, I should show by example and commitment and my confidence. Therefore, I must accept the RCPS. It would be wrong otherwise," he adds.

But as far as minority shareholders are concerned, there may be little reason to opt for the RCPS – it is not tradeable, offers zero yield and is convertible at a higher price. "The shares are more liquid. There's no motivation to take up the RCPS. The only one who may be incentivised to do it is someone like Tong as it allows him to buy more shares in future and tap the upside potential of the group, which he will be helping to contribute to anyway over the next two years (tenure of the RCPS)," says an observer.

The pull factor

UEM Land's most prized asset is in Nusajaya, located west of Johor Baru and part of Iskandar Malaysia, a masive southern development corridor project. UEM Land has some 8,300 acres left in Nusajaya, of which about 2,700 acres are currently being developed.

To date, the company has introduced various projects in Nusajaya with a combined gross development value (GDV) of RM13bil. "UEM Land has brought in various development partners to accelerate the development namely Gamuda Bhd, United Malayan Land Bhd, Malaysian Biotechnology Corp Sdn Bhd (BiotechCorp), Encorp Bhd and most recently Bandar Raya Developments Bhd with a total committed land investments of RM744mil.

Sunrise, and more specifically, Tong's role in this precious piece is hard to miss.

"This deal will allow UEM Land to leverage on Sunrise's strong brand equity, pioneering knowledge in developing "lifestyle experience", capable management team and proven track-record in managing development of quality, high-rise residential, serviced residences and commercial properties.

"Sunrise will be able to immediately fill one of the numerous key components of the entire Nusajaya development," says Izzaddin, In short "to pull in the crowd and buyers".

The BIG picture

The deal's merits are hard to knock. UEM Land will be able to feel the sugar rush in its earnings as soon as it consolidates the financial results of the Sunrise group, which has RM3.2bil in GDV for new projects till the end of next year with RM1.2bil in unbilled sales, boasting an admirably high gross margins of 30%.

For Sunrise, it is just as compelling; it can finally diversify from flagship Mont'Kiara, where some say competition is heating up and gain an entry into Iskandar Malaysia, which is in sync with its growth strategy to have "multiple products in multiple locations." It also helps solve its "small landbank" disadvantage (Sunrise has 164 acres versus UEM Land's 11,400 acres).

But be warned – big may be vogue for booming sectors hungry for consolidation but it doesn't always end up better. The corporate landscape around the globe is proof of that.

Closer to home, the mega plantation merger that resulted in the rebirth of a larger Sime Darby Group three years ago is far from flaw-free. If anything, it has taught us that the sweetness in the combined numbers and commercial rhetoric at the inception of such mergers can very soon turn sour if executed poorly.

For we all know, UEM Group, which has to a great extent managed to shed its past stigma, can ill afford another big blunder.

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