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Saturday, September 3, 2011

Is Sime’s E&O buy strategic and fair?

Two questions need to be answered to assess Sime Darby's purchase of a 30% interest in property developer Eastern & Oriental (E&O). Is the purchase really strategic? Is the price fair? For both questions, the answers may well be no.

Let's look at the first question. It's paying RM766mil in cash for a fully diluted 30% stake (after conversion of irredeemable convertible secured loan stocks or ICSLS).

That makes it the single largest shareholder in the company but the existing management continues to be in place.

Introduced into the deal is a collaboration agreement between the two companies for sharing of knowledge and expertise, leveraging on each other's core competencies and exploitation of mutually identified economic opportunities for three years.

Here's what Sime Darby's president and CEO Datuk Mohd Bakke Salleh had to say about the deal: “The proposed acquisition will provide a springboard for us to expand our property business and the type of products we can offer. E&O is a distinctive brand in the industry and is synonymous with quality. We strongly believe that through collaboration and cross fertilisation of ideas and expertise, there are significant opportunities for synergies for both parties, thus creating value for our stakeholders.”

Perhaps. But is the chosen approach the best way to deal with this? Sime Darby has one of the largest land banks in the country. There is no lack of land to develop. Plus it has considerable property development expertise spanning 40 years having developed townships, bungalows, houses, condominiums, and commercial projects.

Is acquiring a 30% stake in what is at best a niche developer of high-end properties the way to acquire expertise? Or would it be better for Sime Darby to acquire the necessary expertise by developing its own capabilities in-house and hiring selectively appropriate people and consultants to fill in the gaps in its own management?

It would seem under the circumstances that Sime Darby has more experience and expertise than E&O and even if it lacked some of these in some areas it would have been perfectly capable to hire the necessary expertise instead of an expensive acquisition which gives it no control of the company even.

Sime Darby would have done something more strategic if it put in place and executed a plan to develop its own in-house capabilities so that it can better exploit its own considerable land reserves of thousands of hectares efficiently and without having to make expensive minority investments to get expertise.

Recall that early last year Sime Darby went into an equal joint venture to develop a RM1bil commercial project in its established Bukit Jelutong housing area in Shah Alam, Selangor with another property developer, Sunrise.

Again why did Sime Darby, a developer with a long and varied track record, need Sunrise, an established condominium developer with limited experience in commercial development, to put up a commercial centre? Has not Sime Darby more expertise than Sunrise in this area?

Sime Darby and Sunrise will have equal stakes in a joint venture to develop 20.95 acres in the 180-acre Bukit Jelutong township. The land comes from Sime Daby's huge land bank, probably the largest in the country.

The price of the three pieces of freehold commercial land land was RM114mil, or RM125 a sq ft. That is a rather good price for a buyer considering that the gross development area is 2.7 million sq ft and it is a RM1bil project.

In fact, one may be hard put to buy residential land in Bukit Jelutong at that price now!

Sime Darby really needs to get its strategy right here and now.

Next, is the price fair? The acquisition was made at RM2.30 per E&O share and per ICSLS. That's a premium of a huge 60% over E&O's closing price of RM1.45 Thursday before it was suspended on Friday pending the announcement.

In fact E&O's price was climbing steadily from around RM1.20 end-March for a 21% gain despite the broad property index dropping nearly 140 points to about 960 or a decline of 13%.

Sime Darby said that the acquisition was at a 20% discount to E&O's estimated realisable net asset value of RM3.2bil. However it is not clear how this was estimated and over what period of time these assets would be realised.

Basically it means that the three sellers of the E&O stake benefited enormously by getting a 60% premium over the market price for their stake. Their gains over the market price alone would have amounted to a massive RM283mil.

Perhaps Sime Darby, even if it thought that this was the best route for its property sector strategically, could have made a partial offer directly to all E&O shareholders for a 30% stake at a more palatable premium to market and then accepted all offers proportionately.

That would have meant that all minority shareholders of E&O would have had an opportunity to partake in Sime Darby's very generous offer instead of just the select three. The select three are Datuk Tham Ka Hon also known as Terry Tham managing director of E&O; Tan Sri Wan Azmi Wan Hamzah of Land and General fame; and GK Goh Holdings Ltd of Singapore which sold their stockbroking operations to CIMB group some years back.

Yes, Sime Darby is big and yes it has a lot of cash and yes it generates a lot of cash too. Which is why its strategic moves must commensurate with its overall size. Making a joint venture here and an acquisition there is not going to do much for its property division but will instead spread its resources thin.

Revamping it to reflect the size, scale and complexity of its property operations and to enable it to acquire a capacity to undertake all manner of property ventures with the help of appropriate consultants such as architects, designers and planners and keeping all the profits for itself will help it much more. That's what other property companies do.

Managing editor P Gunasegaram thinks that many bad corporate decisions are made in the name of this nebulous thing called strategy.

By The Star

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