Construction cheer?

Malaysian Business, Nov 16, 2006 by James S

COULD THE sentiment for construction stocks be changing among investors? Out of favour for the last two years at least, the recent voluntary general offer (VGO) by IJM Corporation Bhd for Road Builder (M) Holdings Bhd (RBH) has spurred market talk of more mergers and acquisitions (M&As) among construction players, apparently, to enhance their chances of securing some of the large projects post- Ninth Malaysia Plan (9MP). According to analysts, it is no secret that the Malaysian construction industry pie is getting smaller, and hence, M&As are seen as one of the ways to eliminate competition and maintain market share.

Even IJM's Managing Director, Datuk Krishnan Tan, mentioned on Oct 18, 2006 that the acquisition of RBH would spearhead the anticipated consolidation of the construction industry in the country. Foreign research broker, Citigroup Investment Research, meanwhile, believes that construction companies may also see M&As as an option to diversify into other areas of expertise, as under the 9MP, construction companies that have experience in various sub-sectors would stand a better chance of securing the cream of the large jobs available.

Benchmark deal

To recap, in early October, RBH's Executive Vice-Chairman and major shareholder, Tan Sri Chua Hock Chin, exited the group after selling off his 68.04 million or 13.12% of RBH shares for RM3.00/ share. Speculation back then was that it was IJM, although the company denied it. Still, speculation of an impending entry by IJM continued after it hinted that it was open to exploring good investment opportunities, which might include buying into RBH.

True enough, on Oct 18, IJM announced its share-swap proposal for the privatisation of RBH. The transaction involves IJM acquiring all assets and liabilities of RBH for a total consideration of RM1.56 billion (implying a price of RM3.00 per share) to be satisfied by the issuance of 1.56 billion worth of Redeemable Unsecured Loan Stocks (RULS) of RM1.00. Simultaneously, RBH would also implement a Voluntary General Offer (VGO) to acquire all RBH shares on the basis of one new IJM share (to be issued at RM6.00 per share) for every two existing RBH shares held.

Should IJM obtain the necessary shareholder approval, complete its due diligence exercise and achieve the level of acceptance required under a Mandatory General Offer (MGO), it intends to eventually de- list and liquidate RBH. At the time of writing, IJM was seeking RBH board approval for the offer, after which it would commence its due diligence process. According to a report by JP Morgan Equity Research (JP Morgan), any de- listing, if successful, would be targeted for completion by June 2007.

On the other hand, if IJM can't trigger a compulsory acquisition under a MGO, it would then procure RBH to undertake a capital repayment exercise by distributing the RULS to the dissenting RBH shareholders. IJM would then continue to service the coupon payment of 3% attributable to the dissenting shareholders and redeem the RULS by the end of the five-year tenure.

Why RBH?

According to JP Morgan, IJM's management recently shed more light on its rationale and intentions to acquire RBH in an analyst briefing. In its report, JP Morgan says that the acquisition should enlarge IJM's order book, human capital pool and strengthen the balance sheet of the group. The enlarged order book resulting from the acquisition will be approximately RM5 billion (up from RM4 billion).

The research house also believes that IJM will target more projects once it beefs up its human capital strength through the acquisition. According to the report, recent indications have shown that IJM is experiencing a skill and headcount shortage. During the briefing, IJM's management also stated that growth through organic means is a prolonged and difficult process, and it currently also requires more headcount to fill its project capacity.

For instance, the management quoted its recent RM1.34 billion project win in Abu Dhabi as an example of the shortage issue, where it had to sub- contract the project to other parties due to the lack of manpower within the group. With the acquisition, it is apparent that the group will be in a stronger position to compete both domestically and internationally.

Note that prior to the merger, IJM's market capitalisation was at par with its peer, Gamuda Bhd, at around the RM3 billion level. With the acquisition, IJM will now have a market cap of over RM4.8 billion, hence making it the largest listed construction company in Malaysia. As such, one can expect IJM to be more aggressive in its bids, as it will now have a much stronger balance sheet as well as a more diverse repertoire of projects.

Apart from the above reasons, the management in the briefing also cited its lack of recurrent income in Malaysia as one of the key reasons that motivated it to initiate the acquisition. Post-merger, it said that the contribution of cash-generating assets would increase and strengthen IJM's credit profile. Pre-acquisition, `infrastructure-related' income only accounted for 5% of IJM's operating income. However, post-acquisition, the management expects this to grow to over 20%.