China Merchant Pacific, a Singapore listed toll road company recently purchase another toll road. I have not have the time to write about it. As the EGM took place this morning, I would like to summarize my thoughts here.
Previous written articles on this company are listed here.
- Investing in the economic moat of toll roads: CMHP
- CMHP: Dividend Yield on Track
- Purchase of Beilun
- Purchase of Jiu Rui
- Q1 2013 report and some AGM updates and analysis
- The dividend growth thesis
- Relocation and Removal of toll gates
- Full year results and dividend hike
- Restructuring of Management
- 2014 AGM Updates
Second Chance with Jiurui
On 21st July 2014, CMHP announced that they will be acquiring Jiurui Expressway again. You can view the announcement here.
On 12th Dec 2012, CMHP previously announced the acquisition of Jiurui Expressway. The deal involves funding the purchase of Jiurui expressway by way of a cash + placement + sale of the New Zealand property business to the seller. You can view the announcement here and the circular here.
The first deal didn’t went through not because of the expressway but due to a problem selling the New Zealand property business to the sellers. Deal was aborted. The above information was from the 2012 announcement on how the acquisition would be funded.
This current acquisition will cost RMB 697 mil (HK$ 879 mil) and will be paid by way of issuing 119 mil new shares at SG$0.985 and cash consideration of RMB 116 mil.
Consider the situation during the first deal
- Jiurui was open for traffic on 1st Jan 2011.For the first year loss was near HK$ 161 mil
- The purchase concession runs from 1 Jan 2011 to Nov 2033 (21 years concession left then)
- Total sale price RMB 675 mil
- Placement shares issued at SG$0.84, a total of 72 mil (RMB 310 mil)
- To lengthen the concession, it will cost CMHP RMB 50 mil per year of extension up to a maximum of RMB 250 mil (Note that the profits from these lengthening of concession will be shared between CMHP and the seller). In this case, where the concession is lengthen to 2038, the placement would be SG$0.84, a total of 131 mil shares for RMB 563 mil)
- Debt Equivalent amount to HK$ 1.95 bil
The details of the current deal is not know yet, but this is what I can gather
- The purchase concession runs from 1 Jan 2011 to 31 Dec 2040 (28 years concession left since the first deal, and 26.5 years left for this current deal)
- The toll rate for small vehicles have increased 12.5% from 0.4 RMB/km to 0.45 RMB/km
- Total sale price RMB 697 mil
- Placement shares issued at SG$0.985, a total of 119 mil (RMB 581 mil)
- GCAL appraised 100% equity + loan (EV) to be RMB 702 mil (HK$ 885 mil) as of 31 Mar 2014
- NAV appraised to be HK$ 372 mil
- Net loss before tax, MI and exceptional FY 2013 is HK$ –27 mil, Q1 FY2014 is HK$ –13 mil
- Toll increment between now to 2024 shall be equally shared by seller and CMHP, there after toll increment will be CMHP
- Debt Equivalent amount to HK$ 1.6 bil
So they basically going to pay RMB 697 mil for what 1.5 years ago cost RMB 925 mil as the previous deal comes with 5.5 years concession. The deal also comes with HK$ 325 mil (RMB 258 mil) more debt. This means that they are essentially paying RMB 486 mil less for the same asset.
The way its been portrayed the original deal involves paying off debts and refinancing them as the loan covenant was breached. When the CMHP sale didn’t went through, there must be even more distress.
At the EGM, the management updated that the debt interest currently is close to 6.4%. Looking at the current debt financing of CMHP, it is likely they can refinance under 3%, thus saving 3.4% or HK$54 mil.
As more business in China gets into bad debts, when they have less and less means to turn to, this presents more opportunities for firms like CMHP with the ability to restructure them. This deal validates CMHP ability to keep tabs on distress deals when the situation becomes worse.
What we gather about Jiurui
Based on the first deal, the planned bridges and expressways, the key being the 2017 one:
Some details garnered from here on traffic figures. On the second year there was a near 100% growth. How much it has moderate down we will have to see the updated circular figures.
From the estimation of the current deal, for the past 2 years the revenue growth could possibly be 30% per annum. But also, you realize how optimistic projections can be when you compare the 2012 and 2014.
Big Changes in Share holdings
CMHP due to convertible bonds, convertible preference shares, placements can be a huge mess. But things are going to get simpler.
The acquisition of Jiurui will be finance majority by issuing 119.37 mil shares at SG$0.985. This is diluting to existing shareholders.
If you look at the cash holding of HK$ 2.1 bil, CMHP do not need to issue shares for this.
This situation looks the sort of excuse the management needed to increase the liquidity. They been trying hard to place out shares or attract major investors to purchase their stake but with lukewarm results.
As of 9th of September, upon approval of the purchase by share holders, this 119 mil shares will be added to the outstanding share pool.
Convertible Bonds slowly being Converted
CMHP successfully issued HK$1163 mil convertible bonds due 2017. The interest cost on this debt is 1.25% and conversion price is SG$0.84. If CMP raised the dividends above SG$0.055 the conversion price would be lowered accordingly.
We do not know how holds these convertible bonds and they have not been converted for the longest time. It make no sense to stick with 1.25% pay off when they can convert and get 6 to 7.5% pay off.
- They are bond funds. Google “China Merchant Pacific 1.25%” and you will hit much results. If you are bond fund you are likely to have a mandate not to hold a large proportion of equities
- The holders view the convertible bonds for its appreciative nature. When the bonds approach convertible price and above, price appreciate. It might be a business decision to forgo dividends but stick with an instrument of this nature
- Not converting withhold the identity of the debt owner. And as shady as it sounds, it might indicate much mainland holders of this debt. Why would they not want their identity to be publicised? A lot of reasons, we could guess all day but I would not go into it
- DBS the bond issuer provides a guarantee till the end of 2015. A strong incentive if the holders value safety over returns
Since 6 months ago, we are starting to see some conversion here and there. They amount to 1 mil or so at a time.
At 9th Sep, 976mil worth of convertible bonds still left out of 1163 mil original, most converting at $0.826. There are still a long way to go. Outstanding Shares Undiluted should be around 757 mil up from 718 mil.
Judging by the interest rates, for share holders it is better the bond holders DO NOT convert.
The conversion seem to hold down the share price, since the holders are likely to attempt to convert and sell off to the public. CMHP is not a very well known stock, so it will take some time for the market to digest it.
RCPS being converted on 9th Sep
The parent still owns approximately 135 mil RCPS shares at 1.25% dividend rate, that can be converted to shares. The management have indicated numerous times that they do not have the intention to convert.
The interest rate versus the prevailing equity interest is a joke. And the only reason that they are not converting is that they have a higher priority not to own more of CMHP and bumping up liquidity, reducing their share holdings than to earn a higher return.
We might have spoken too soon, because shortly on the evening of the EGM, Easton Overseas Limited fully converted the RCPS to ordinary shares, thus able to enjoy the 3.5 cents dividends.
Eventual Shareholding Mix and Impact
Out of a total diluted number of shares of 1196 mil, the management and parent would likely own 724 mil shares. This is based on 82% shareholding of 718 mil existing undiluted shares.
Management and parent would hold 60% shareholdings.
These conversions and the upcoming placement have resulted in more shares in the hands of non-China Merchant Group.
With the placement of 119 mil shares and conversion of 135 mil RCPS, there left the outstanding 180 mil convertible bonds that are not converted yet.
In a short span of 1 year, there is a 40% dilution. Why the conversion now? It is likely Easton would like to convert much earlier but they do not want to hold more than their 82% of CMHP. With the placement, it gives them the opportunity to convert.
This is somewhat of a double edge sword for the shareholders. At one point much of the thesis hinges on strong linkage to the state own enterprise, knowing that they are unlikely to do anything funny when majority are so called “public funds”.
Lowering the ownership, makes it likely that other agendas or late stage strategic moves starts coming into play. I have not thought far enough as to why a SOE would build something up with much public assets and give it away, divesting totally.
The huge conspiracy is that these assets IRR or ROA is fabricated to such an extend that the cash flow is not as high as what they touted to be, and that all these years there is a mega operation by the parent and the management to make it seem like all is ok.
The positive aspect I felt is that it might invite bigger funds, strategic holders to scoop up a large portion of shares, not to mentioned once CMHP achieves a certain size, to be included in major index. The potential activist nature might steer CMHP in an interesting direction.
The worry is that with a non-performing, young road, and full dilution the dividends would be impacted. A knowledgeable gentleman asked during the EGM would they maintained the dividends with this full dilution. Mr Jiang indicated that the company policy is to pay at least 50% of net profits as dividends.
In their plan, they would rather pay out as much as dividend as possible. This is because to purchase a sizable road, they would need to conserve three years of cash flow at least. Thus to speed up expansion (they must be rushing to build up mass, as Mr Luo indicated), they would rather adopt paying a good dividend, keep the share price high, so that they can carry out placement.
The gentlemen asked if parent ownership drops to 51% would rights issue be on the cards, Mr Jiang indicated they prefer not to as this would be similar to taking back cash from share holders.
The model seem to be keep share price high, buy toll road, place out shares and use debt. This sounds like what Second Chance and Silverlake would do.
We covered in the past that fully diluted, CMHP can pay dividend but the pay out is near 90%. This is paid out of net profit. If you would like to compare to the REITs, the REITs practically paid out all their cash flows, and this includes the depreciation portion. By conserving the depreciation, it means CMHP preserve their capital base to renew expiring concession by buying replacement roads. It is a more sound structure.
Had this been a business trust like K-Green, CMHP would be paying out 14% dividend yield. It doesn’t appeal to investors because of the reputation as a China company.
There wasn’t much share price movement despite this acquisition, nor the dividend raise. Currently, the overhang is the digestion of these converted issues. I felt that management seem to be silently confident they can maintained this 7 cents dividend. Lets hope they do.
Wednesday 10th of September 2014
Thanks a lot for your analysis. I wanted to join the EGM but did not find the time to do so. I am happy with their strategy. Paying with new stocks may have an immediate dilution effect but there is a real tangible asset in front of it. It also preserves their ability to fund future acquisitions should there be opportunities in the future with real money.
As you mention we shall not expect to see the price increasing a lot. There will be too many new stocks for sale acting as a cap on the share price. But I see it more like an opportunity to stack up some more, should a shareholder be in a hurry to sell a bunch of them. Keep an alert on the stock price :)
Friday 12th of September 2014
Ah I missed a good opportunity to chat haha! Well what they are doing is a bit of what we do with properties using the cash flow of a few build up to get another one. I feel they will shift their strategy if they realize their cash flow in 1 year can acquire one road. The key thing as investors is to make sure they show good governance and that purchases are accretive. This deal might be. but if they load the parents roads on them with poor ROA, then it might be a problem