Mergers and acquisitions (M&As) will remain the buzzword in the corporate scene in 2011. Among the sectors that are likely to see intensified M&A activities are in the electrical and electronic sub-sectors, agro-based companies, plantations, real estate, metal, chemicals, auto, carriers and the education industry.
The potential consolidation and the need for some government-linked companies to diversify their non-core assets and streamline their operations will be a key driver for the merger and acquisition scene in 2011.
The Palm Oil/Biodiesel Industry … Weak Dollar, Strong Demand From China And India Will Boost Oil And CPO Prices
The Oil & Gas Industry … More O&G Projects To Be Awarded
The Steel/Aluminium Industry … Spillover Effects From Entry Point Projects (10MP & New Economic Transformation Program)
The Construction Industry … Spillover Effects From Entry Point Projects (10MP & New Economic Transformation Program)
The Housing And Properties Industry … Bracing For More M&As & Economic Recovery
The Water Services Industry … Remains Uncertain
The Electronics Industry … Bracing For Recovery
The Rubber/Rubber Glove Industry … Bracing For M&As
The Automotive Industry … Bracing For M&As (Proton & Perodua)
The Education Industry … Bracing For M&As
The Palm Oil/Biodiesel Industry
The current (Dec 2010) rally in CPO prices is supported by the expected dwindling stock and weaker US dollar.
Despite the rally in CPO futures, there was little excitement shown by big cap plantation stocks … Sime Darby Bhd, Kuala Lumpur Kepong Bhd (KLK), IOI Corp Bhd, Genting Plantations Bhd and Kulim Malaysia Bhd, IJM Plantations Bhd, Batu Kawan Bhd.
Among the smaller plantation stocks were Glenealy Plantations ( Malaya ) Bhd, Sarawak Oil Palms Bhd and Kim Loong Resources Bhd.
The big cap plantation stocks were not sensitive to the movement of CPO futures as they were still considered pricier (mid Dec 2010) than their mid and small cap peers.
Industry observers warned that the risks to the upside of these planters include the cut-back in consumption as the economy slows.
Meanwhile, Malaysian big cap plantation stock valuations are fairly valued at this moment (Dec 2010), thus the limited upside. Small caps are playing catch-up.
Be that as it may, the rally in CPO prices will translate into better profit for planters this quarter (4Q2010).
In a recent technical note, both the near-term and mid-term technical outlook of the CPO market will remain bullish as long as prices stay above the RM2,700 to RM2,800 per tonne mark.
Nevertheless, the market will face a very tough challenge at the formidable RM3,750 per tonne level. Looking back, when CPO prices sharply tumbled in 1Q08, four major failed rebound attempts were seen at the RM3,750 per tonne level in the subsequent four months.
As a result, RM3,750 has become a very tough resistance and the market is now (mid Dec 2010) trading not too far away from this level. However, when the RM3,750 level is breached, RM4,000 per tonne as the next resistance.
Meanwhile Malaysian exports fell 24 per cent in the first 15 days of December 2010. Shipments slumped 29.5 per cent in the same period.
There is a lack of supportive fundamental news. Investors always tend to stay away from the market with the holidays ahead.
Palm oil has surged 37 per cent till Dec 2010, headed for a second annual advance, on speculation that rising demand from China and India may strain global supplies that have been curbed by rain and drought in producing nations.
Output in Malaysia fell to the lowest level in five months in November 2010, while stockpiles slid for the first time in four months. Heavy rainfall caused by a La Nina weather event has also reduced oil-palm yields in Indonesia , the biggest grower.
Malaysian production declined 11 percent to 1.46 million tons in Nov 2010 from 1.64 million tons in October 2010. Inventory dropped 8.7 percent to 1.64 million tons from 1.79 million tons.
India , the second-biggest cooking-oil consumer, imported 668,917 tons of vegetable oils last month, 11 percent less than a year earlier.
The Oil & Gas Industry
Petroliam Nasional Bhd (Petronas) will open marginal oilfields to niche players with strengths in development and production with hopes of recovering an estimated 1.7 billion barrels of oil equivalents over the next two decades.
The news came after Prime Minister Datuk Seri Najib Razak unveiled the tax incentives proposed by Petronas, which would potentially lead to additional petroleum-generated revenue of more than RM50 billion over the next 20 years.
Najib said the tax incentives proproposed by Petronas would be incorporated into the Petroleum Income Tax Act (PITA), stressing that five new incentives were proposed to promote the development of new oil resources, facilitate exploitation of harder-to-reach oil fields and stimulate domestic exploration.
Petronas would encourage both new local and international players to become service contractors to develop these fields.
It entails an investment of between RM70 billion and RM75 billion.
The perks were to make the fields economical, as most of Malaysia ’s oil basins were mature. According to Petronas’ 2010 annual report, production fell to the equivalent of 1.63 million barrels of oil a day in the financial year ended March 31, from 1.66 million barrels a year earlier.
Malaysia has more than 25 marginal fields. If the government does not provide incentives, they will remain undeveloped. The government has come up with a set of incentives worth about RM8 billion, but over 15 years, they will be able to see a tax revenue of RM58 billion.
At present, the average recovery factor for Malaysian oilfields is about 26%. Through the incentives which would in turn boost enhanced oil recovery (EOR), Petronas hopes to increase the recovery rate of oil exploration activity to above 30%.
This new incentive will provide a change in terms of the production and tax regime in the country to promote the development of complex and challenging oilfields.
The new incentives include an investment tax allowance of up to 60% to100% of capital expenditure to be deducted against statutory income to encourage the development of capital-intensive projects, reduction of the tax rate to 25% from the current 38% for marginal oilfield developments and an Accelerated Capital Allowance of up to five years from 10 years where the full utilisation of capital costs deducted could improve project viability.
The other incentives are a Qualifying Exploration Expenditure Transfer between non-contiguous petroleum agreements with the same partnership or sole proprietor to enhance contractor’s risk-taking attitude, and the waiver of export duties on oil produced and exported from marginal field developments to improve project viability.
In line with the nation’s efforts to transform Malaysia into a regional oil and gas hub, Najib also announced that Tanjong Agas Supply Base & Marine Services Sdn Bhd would develop the Tanjong Agas Oil & Gas and Logistics Industrial Park as a one-stop centre to serve and support the region’s rapidly growing upstream and downstream activities. This includes oil and gas exploration, exploitation and production activities. The industrial park project situated on 4,260 acres of land in Pekan, Pahang.
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Minister in the Prime Minister’s Department Senator Datuk Seri Idris Jala says Petroliam Nasional Bhd (Petronas) will be announcing more incentives for the oil & gas industries soon as the government sets the stage for the country to be a regional hub for oilfield service.
There are a lot of opportunities for local players to participate in this – be it in the form of construction work, or providing related oil and gas services. All of this will come into play. The incentives companies could expect were the renegotiation of certain contracts for renewal like for those production sharing contractors such as Shell and Exxonmobil.
Meanwhile deluge of contracts has led to speculation that the oil and gas sector is poised for a good run. What is creating a stir in the market is the redevelopment of old oilfields. T
There are some 600 rigs sitting on old oilfields that Petronas is looking to upgrade and improve on to enhance the oil extraction rate. There platforms are 20 years old and on average and there is a lot of work to be done.
While new technology allows the implementation of what the industry calls enhanced oil recovery (EOR), the platforms and the equipment on them, such as pipes, valves and pumps, have to be changed and upgraded to cater for it. Hence oil and gas players are expecting increased spending by Petronas.
In fact Petronas’ capex has been on the rise in the past few years (Before 2010), except in the just concluded FY2010 ended March 31.
Previously E&P spending was mainly on developing new oilfields to increase reserve, especially deep waters. Moving forward, industry players are expecting more money to go towards EOR projects as cheaper way of increasing reserves.
Petronas commitment to redirect capex to the home market spells spin off benefits and positive prospects for local oil and gas players. Deepwater, shallow, marginal and brownfield as well as gas related and floater construction work contracts are set to dominate the local scene over the next few months (Oct 2010 & Beyond). The following players are the eight contenders for the jobs …
Naim, Dayang, TGOFFs, Kencana, Petra Energy, MMHE, Dialog, Wah Seong, SapCrest
The Steel/Aluminium Industry
After an uneventful year (2010), industry players say local steel players can look forward to a better 2011, thanks to the rolling out of 10th Malaysia Plan (10MP) projects.
This year (2010) has been characterised by a lacklustre demand and low capacity utilisation on the lack of large infrastructure projects and competition from Chinese imports, as well as squeezed margins due to high feedstock prices.
However, industry players might still face headwinds in the near term given the prevailing high and volatile prices of raw materials. This includes scrap and iron ore pellets.
Much of 2010 was challenging for steel players, as they had to contend with both weaker demand and higher raw material prices. The third quarter ended Sept 30, turned out to be the worst in the year for most players, with several such as Kinsteel Bhd and Lion Industries Bhd posting losses. Local steel millers have probably seen the worst in the third quarter of 2010. They are confident the steel players can look forward to a much better 4Q, and a better 2011.
4Q2010 – 1Q2011 …
Expect to see an improvement in the coming quarter (4Q2010 – 1Q2011) especially with selling prices showing signs of recovery. The price of scrap is back to the US$400 (RM1,250) per tonne level, and steel players are also witnessing more enquiries from traders since early November 2010. However, the improvement is nothing to shout about, especially with the unappealing spread between iron ore pellets and hot briquetted iron (HBI) prices, which is expected to persist. It is worth noting that over the past year (2009 – 2010) spot prices of iron ore have more than doubled.
Moving forward, the price of iron ore fines will still strengthen and trade in the band of US$150 to US$170 per tonne until 2012. Any potential dip below US$120 per tonne and China ’s present short iron ore position would trigger re-stocking and thereby lend support to global prices.
Nonetheless, significant steel orders for Budget 2011 projects as well as the longer-term 10MP would start emerging in 2H2011 at the earliest, allowing selling prices to better match current (Dec 2010) high iron ore markets.
Another relief is the strength of the ringgit, which helps cushion the higher prices of iron ore traded in US dollars.
Additionally, the expected appreciation of the yuan, albeit a gradual pace, should see local steel players, whether domestically focused or otherwise, facing less competition from Chinese steel dumping.
Only players with sufficient cash and efficient inventory management will be strong and quick enough to endure and take advantage of feedstock price fluctuations in the spot market.
While steel demand will be boosted by the government’s expansion plans, investors are better exposed to companies with cleaner balance sheets.
It also said upstream players stand to benefit more in the current (Dec 2010) environment of high commodity prices, but any significant re-rating catalyst for the sector will be driven by an increase in demand.
The flexibility to cope with raw material costs is also an area that investors may want to watch out for when investing in a steel player.
Ann Joo Resources as it is one company that can manage better in the face of volatility in raw material prices. Additionally, Ann Joo’s higher export ratio of its production will help to cushion sales when the domestic market is lacklustre, as was the case in 2009 and potentially during the early part of 2011 as well. Furthermore, with the abolishment of the annual iron ore pricing system in April 2010 and a move towards quarterly price contracts, it expects greater volatility in iron ore prices globally.
Ann Joo is therefore able to manage input costs better compared with companies such as Southern Steel, which has similar plant operations, production capacity and market capitalisation.
With the expected commissioning of its mini blast furnace plant in Dec 2010, Ann Joo will now have the flexibility in the usage of feedstock (iron ore and scrap) versus relying mainly on steel scrap for Southern Steel.
Apart from Ann Joo, other steel millers are also upping their capacity in anticipation of rising demand. Kinsteel, for one, will be constructing a steel pelletising plant that is expected to cost some RM200 million.
The Construction Industry
The Construction Industry Development Board (CIDB) expects the construction sector to be buoyant next year (2011) as projects under the 10th Malaysia Plan (10MP) start to roll out from January 2010.
The European debt crises and the slow US economic recovery was worrying and many countries are taking steps to reduce their expenditure in order to improve their budget deficit. Malaysia is taking similar steps in view of the expected crises. The impact will be felt in 2011 as what was experienced in 2009.
However, impact will not be as great as 2009 due to continuation of projects from the Ninth Malaysia Plan (9MP), new jobs under the 10MP and more public-private partnership (PPP) projects coming up.
Under the 10MP, an amount of RM230 billion has been allocated for development, whereby 60 per cent, or RM138 billion, is for infrastructure.
Projects like Matrade Centre, Warisan Merdeka, mass rapid transit and the Malaysian Rubber Board's land development in Sungai Buloh, worth RM70 billion, will contribute to growth in 2011.
In 2010, the government has announced projects to the tune of RM72 billion such as the LRT extension, the New LCCT terminal, power plants and luxury housing projects in Iskandar Malaysia.
These are high-impact projects which will improve the business environment and private investment.
The Housing And Properties Industry
On November 4 2010, UEM Land Holdings Bhd offered RM1.4 billion to buy rival Sunrise Bhd, followed by news of a merger between Malaysian Resources Corp Bhd (MRCB) and IJM Land Bhd to create a group with a market value of RM7 billion. Then, Tan Sri Jeffrey Cheah proposed to combine his companies Sunway Holdings Bhd and Sunway City Bhd (SunCity) in a RM4.5 billion deal.
The first two deals reflect the government's intent to create bigger companies to lure more foreign investors to Malaysia 's stock market.
UEM Land is ultimately controlled by state investment arm Khazanah Nasional Bhd, while both MRCB and IJM Land have the Employees Provident Fund (EPF) as major shareholders. It is quite clear that the EPF is driving the merger as it seeks to develop the strategic and massive Rubber Research Institute land next to Kota Damansara, Selangor.
Both deals are also about securing expertise as the buyer is in a hurry to grow. UEM Land needs Sunrise for high-end property development and marketing, while EPF wants a developer that could build townships ( IJM Land ) as well as commercial projects (MRCB).
But the Sunway deal is more about the ability to fight for bigger jobs and address the liquidity issue. A major problem for Malaysian property companies is there are not enough shares readily available for trading, something that foreign investors love. This means the stock price will have a tough time catching up to its fair value.
But some property executives contend there are downsides to becoming a bigger group. You could end up being a lumbering giant. Example was how Mah Sing Group Bhd was able to buy some 25 hectares of land in Batu Ferringhi, Penang, for RM157 million. Bigger rivals had also bid for the land but Mah Sing was able to win as it moved faster than the competition.
Why the deluge of M&A activities in the sector? It is attributed it to a combination of reasons …
In the cases of Sunrise-UEM Land and MRCB-IJM Land , it is hoped that through these mergers, the government-linked companies (GLCs) can move forward to stamp their mark as regional champions.
Another reason for the current (N0v 2010) consolidation could be players trying to get a bigger slice of land redevelopment projects created by the proposed mass rapid transit (MRT) system.
The mergers between the GLCs and private companies show that there is a significant push for execution and performance. There is now (Nov 2010) a greater urgency for M&As. The formation of two large companies from the mergers of UEM Land-Sunrise and IJM Land-MRCB would pose a threat to other smaller companies in that the former will have more resources and liquidity.
Another disadvantage for these entities which on a stand-alone basis were not too appealing to foreign investors given their size (or lack of it), would post-merger have the economies of scale to draw these investors' attention.
The bigger size of these companies will make them more investable to foreign investors. These companies will now (Nov 2010) be able to compete with their regional counterparts.
Indeed Malaysian corporates are entering an interesting phase in the market. For the first time, GLCs are actively looking for expertise from the private sector to ready themselves for the next phase of development.
In Malaysia , all major land banks are government-owned. The reason why private sector companies such as Sunrise and IJM Land are roped in, is because they have the branding and expertise. Hence, what you're seeing now (Nov 2010) is not just the making of bigger companies, but stronger ones.
If a property company has a good track record but is a small player, it may not be good enough as the company does not have the balance sheet to acquire landbank. On the other hand, what the GLCs may lack in expertise or branding, they make up in landbank and government funds. So the public-private partnership is a formula that should work.
It also makes sense for GLCs to buy over property companies rather than land as valuations of these companies are still relatively attractive, whereas land prices have appreciated significantly. Driving home this point is the fact that property counters are trading at an average of 35% discount to their net asset value (NAV). In fact, most of them are also trading (Nov 2010) at a discount to their net tangible asset. Almost all property companies that merge can break up their assets and unlock more value out of their existing land bank.
There is expectation that the spate of recent (Nov 2010) proposed mergers will unleash another slew of merger activities among other industry players to avoid being left behind in the race to be bigger and better.
The Water Services Industry
Malaysia ’s government is considering bondholder proposals to avoid defaults by water companies operating in Selangor state, including possibly taking over the notes or offering loans.
The government has to look at the viability of these bonds.
Some bondholders asked the government to take control of the bonds, or extend “soft loans” to the Selangor state government’s water distribution company.
Malaysian Rating Corp downgraded about RM7 billion (US$2.2 billion) of bonds issued by seven water- related companies in September, citing regulatory and operational uncertainties.
Selangor hasn’t been able to reach an agreement with the central government and private companies over reorganization of the water industry.
The federal government doesn’t object to Selangor’s plan to buy water assets if it has the financial means to execute it. Implementation “should be done on a willing buyer, willing seller basis whilst honoring the sanctity of existing concession agreements.
Previous bids by Selangor to acquire water assets were rejected by local water distributors as too low. Though a revised proposal was accepted by Syarikat Pengeluar Air Sungai Selangor Sdn. and Konsortium Abass Sdn., the transaction failed when Syarikat Bekalan Air Selangor Sdn. and Puncak Niaga (M) Sdn Bhd continued to hold out for more.
The Malaysian central bank and the Finance Ministry is in talks with bondholders to “allay their anxiousness”. Malaysia ’s commitment to ensure the water will keep flowing, that is something that we will honor.”
The Electronics Industry
Despite the weak 3Q10 results, the technology sector is due to the potential re-rating catalysts. The catalysts were a strong growth in the key end-user segment of handphones and the advent of the corporate replacement cycle, which is admittedly a more gradual one.
The earnings profile for the tech stocks is not expected to improve in the near term as they battle inventory correction, seasonality, slower demand growth and the strong though reversing RM and high raw material costs. But this should start to reverse itself in 2H11 as the industry returns to more typical seasonal patterns. Certain product segments are also still exhibiting fairly robust growth.
Moreover, the long-term secular picture looks favourable given the growing use of electronic devices which require the input of chips and the continued trend of outsourcing. In addition, valuations (Dec 2010) for the semicon stocks are fairly attractive.
Meanwhile the North America-based manufacturers of semiconductor equipment posted US$1.51 billion in orders in November 2010 (three-month average basis) and a book-to-bill ratio of 0.96.
The book-to-bill ratio of 0.96, means that US$96 worth of orders were received for every US$100 of product billed for the month, was the lowest since June 2009’s ratio of 0.80.
The three-month average of worldwide bookings in November 2010 was US$1.51 billion. The bookings figure is 5.3% lower than the final October 2010 level of US$1.59 billion, and is 90.6% above the US$791.8 million in orders posted in November 2009.
The three-month average of worldwide billings in November 2010 was US$1.57 billion. The billings figure is down 3.4% from the final October 2010 level of US$1.62 billion, and is 110.7% above the November 2009 billings level of US$744.2 million.
Following a historic growth period and 18 months of sequential growth, and in accordance with seasonal trends, sales of semiconductor equipment eased in November 2010 This tracks the bookings trend which peaked in July 2010.
The SEMI book-to-bill is a ratio of three-month moving averages of worldwide bookings and billings for North American-based semiconductor equipment manufacturers.
The Rubber/Rubber Glove Industry
The 44.7% decline in the earnings of Malaysia ’s largest glove producer, Top Glove Corp Bhd, is not a sign of things to come for the other glove manufacturers.
According to analysts and industry players, the existing headwinds may indicate tougher times for Malaysian glove manufacturers, but not all earnings profiles are the same.
The financial performance of manufacturers will hinge on their respective product mix and raw material cost structures.
Top Glove was the most affected among the six listed glove manufacturers in Malaysia due to its portfolio of mainly natural rubber or latex gloves. The others are less affected due to their different product mix comprising latex and nitrile gloves.
Other listed glove manufacturers in the country include Supermax Corp Bhd, Kossan Rubber Industries Bhd, Hartalega Holdings Bhd, Latexx Partners Bhd and Adventa Bhd.
Top Glove’s results were not necessarily an indication of how other players will fare in the current environment (Dec 2010) of costlier latex and a weakening US dollar.
Glove players will have less bargaining power [to dictate prices] as there is no shortage of supply. Demand for gloves will, however, still be there but not the “extra demand” seen during recent outbreaks of disease.
Top Glove is most exposed to the rising price of latex as some 90% of its revenue is from gloves made from latex. The other producers tend to have a larger proportion of nitrile gloves, which use synthetic rubber as their core raw material. Nitrile gloves make up about 7% of Top Glove’s revenue. In contrast, nitrile glove sales make up 83% and 38% of the revenue of Hartalega and Kossan, respectively.
Looking ahead, industry observers foresee normalisation of glove demand in the short term, but expects business to pick up in the long term. This will be helped by demand from emerging markets and the global healthcare industry.
Apart from demand normalisation the manufacturer, capable of producing some 34 billion gloves annually, the industry also had to contend with excess capacity. Another crucial concern is that buyers are opting to delay purchases and keep inventory at a minimum as they wait for glove prices to decline.
Nevertheless, this adverse situation will possibly lead to further consolidation among the industry players and Top Glove is in a good position to further enlarge its business when the opportunities arise.
Top Glove plans to dedicate more production lines to manufacture synthetic rubber or nitrile gloves, which fetch higher margins and are not subject to the volatility in natural rubber prices. Synthetic rubber is made from butadiene, a by-product of crude oil. Meanwhile, critics said “a massive and sustained switch to nitrile may not be sustainable” for Top Glove because the cost of nitrile gloves is linked to crude oil prices, which are also rising.
Escalating latex prices will prompt consolidation in the rubber glove industry … a synergistic M&As.
Customer buying trends have shifted to maintaining lowest inventory levels as latex prices remain high. The first half of the year is seasonally a low-production period for latex and, thus, an indication of high prices, glove inventory levels may be kept low in the next few months. However, inventory is expected to rise as the market adjusts to the expectations of higher latex prices.
The Automotive Industry
The Malaysian Automotive Institute (MAI) is understood to have submitted its proposals and recommendations pertaining to the consolidation of the automotive
sector to the government for a final decision on the merger between the players.
Industry sources said MAI had interviewed several of them and submitted the proposal to the government, with a decision likely to be made soon.
MAI was incorporated on April 16 2010 to function as an independent non-profit organisation under the auspices of the Ministry of International Trade and Industry (Miti).
According to its website, MAI serves as a focal point and coordination centre for the development of the local automotive industry in all related matters, including formulating the national automotive policy and coordinating automotive-related research and development, among others.
The consolidation of the auto sector, if it happens, is widely expected to entail a merger between two national automakers, Proton Holdings Bhd and Perusahaan Otomobil
Kedua Sdn Bhd (Perodua), and could possibly include some other players as well.
Meanwhile the government will decide on Nov 2010 whether to allow five foreign carmakers to set up assembly plants in Malaysia .
International Trade and Industry Minister Datuk Seri Mustapa Mohamed said it is still looking through the applications and expected to make an announcement soon.
In September 2010, Malaysian Investment Development Authority was evaluating five foreign carmakers interested in setting up assembly and manufacturing facilities in the country.
Among companies interested included those from Europe, India , China , Japan and South Korea . Mustapa did not dismiss the possibility of the companies using existing facilities for their production.
With the recent review of the National Automotive Policy, foreign carmakers can wholly own facilities that produce luxury vehicles with engine capacity of more than 1,800cc and costing more than RM150,000 per unit.
The Education Industry
While the property sector now (Nov 2010) is in a flurry of consolidation through mergers and acquisitions, the education sector still remains “under the radar”. However, the fast growing private education business in Malaysia, which is valued to be worth some RM7.2 billion, seems to be stirring of late.
Ekuiti Nasional Bhd’s (EKUINAS) recent 51 per cent acquisition of APIIT/UCTI Education Group from Sapura Resources Bhd is seen as trailblazer for consolidation in the private education sector.
This is because of more outright acquisitions, mergers and the entry of fresh foreign players in time to come.
There will be more mergers in the works as education entities that don't merge may risk being left behind. There is urgency for smaller players to bulk up for scale and build up quality as the more renowned and established international players which have made their presence in Malaysia pose healthy competition to the growing market.
This is more so as education has been identified as one of 12 National Key Economic Areas (NKEAs), with private education leading the charge in catapulting Malaysia into the fastest growing education hub in South East Asia .
Among the listed educational entities are Sapura Resources, SEG International Bhd, Help International Corp Bhd and Masterskill (M) Education Group Bhd.
