IPO ... MMHE

MISC Bhd could use the proceeds from the IPO of its engineering unit, Malaysia Marine and Heavy Engineering Holdings Bhd (MMHE), for further expansion such as acquiring more very large crude carriers (VLCC) for its petroleum business.

MISC could leverage on its synergies with VTTI  BV (provider of storage space for fossil fuels), in which it recently acquired a 50% stake, and fund MMHE’s expansion plans, including increased activities in Turkmenistan .

The dilution to MISC’s income from MMHE will be minimal.

The RM300 million cash dividend from MMHE and the potential RM1.6 billion raised from the IPO would reduce MISC’s gearing level from 0.37 times to 0.29 times.

MISC proposed to offer 25.5% of MMHE pursuant to the IPO by the fourth quarter of 2010. Under the IPO, MISC would sell 9.1%, or 146 million shares, to institutional investors, and MMHE will propose a public issue of 16.4%, or 262 million shares.

MMHE was among MISC’s key earnings contributors and the company had grown to become a significant contributor in recent years by helping to cushion the impact of decelerating earnings from other divisions, especially losses at MISC’s liner division.

In the preceding year (FY10), MMHE was one of the leading revenue contributors of MISC group, accounting for revenue of RM6.1 billion and PAT (profit after tax) of RM284.1 million.  The thin margins in FY3/10 were mainly due to a large recognition of procurement activities that fetched thin margins during the financial year.

It is believed that margins were likely to be higher going forward as the unit benefited from the potential upturn in the oil and gas cycle on the back of sizeable orderbook replenishment.

MISC’s cost of investment in MMHE from Oct 11, 1991 to Jan 14, 2008 stood at RM303.8 million, representing an investment cost of about 22.7 sen per MMHE share.

The listing exercise might involve the revaluation of some key assets owned by MMHE, which would translate into a one-off exceptional gain for MISC.

The offer for sale of 146 million shares by MISC would also give rise to a disposal gain which could amount to RM655 million (a gain of RM4.48 per share based on the IPO price of RM4.71).

While this type of profit is usually categorised as an exceptional gain by the investment community, this would eventually unlock MISC’s long term investment and bump up its group shareholders’ funds and NTA per share.

 

Valuations …

 

In most cases, holding companies with various businesses float some of their units to unlock value in the parent company. This is especially when a holding company believes that the value of its subsidiaries is not reflected in the holding company.

 

However, in MISC Bhd’s case, its proposed listing of MMHE, which is currently a wholly owned unit. The exercise was announced by Najib as part of the government’s efforts to drive liquidity in the capital markets.

 

With the listing of MMHE, MISC will be able to unlock the value of MMHE for shareholders. Not only will MISC shareholders get RM300 million in dividends before the listing, MISC will gain from the disposal of a stake in MMHE via the IPO. There is also an asset revaluation exercise that will benefit MISC.

 

Although MISC will get some cash from the listing, it will not make an impact on the shipping giant considering it already has RM7.8 billion in its coffers.

 

From the PER and earnings per share enhancement point of view, MISC is not getting a good deal from the proposed listing of MMHE. At closing price of RM8.80, MISC is already trading at a PER of more than 49 times. Even if MISC hits RM10, based on forecast FY2011 earnings, MISC will still be trading 22 times PER.

 

MISC has not announced MMHE’s IPO price and PER. However, estimates shows that upon listing, MMHE is likely to be valued lower than MISC. This is based on industry trends that value oil and gas stocks at about 16 times PER.

 

Research houses is valuing MMHE in its entirely at rm4.8 billion based on MMHE’s net profit forecast of rm300 million with a one year forward target PER of 16 times. The valuation is already at the upper end of its benchmark one year forward target PER band for the oil and gas sector to reflect MMHE’s strong fundamentals and ultimate controlling shareholder, which is Petronas, the national oil company.

 

Technically, if MMHE is indeed floated to enhance its value, it ought to be trading at similar or higher PER. However, from the PER perspective, MMHE is more likely to face value erosion than enhancement from its listing exercise.

 

The listing does not look good for MISC either. MISC’s high valuations show that the market has already priced in MMHE. This means there is not much value to be added into the stock following the listing.

 

Also, MISC’s EPS is likely fall following the listing of MMHW. This is because MISC will no longer own 100% of MMHE and will not be able to equity account MMHE’s businesses into is consolidated group earnings.

 

MMHE’s oil and gas and heavy engineering businesses are the jewel in MISC’s crown. Its financial summary shows that MMHE contributes over 40% to MISC’s net profit in FY2010. MMHE also has an order of more than RM6 billion as at Dec 31, 2009.

 

MMHE’s earnings contribution to MISC has become even more important at a time when MISC is still weighed down by weaker earnings in its other divisions, shipping and containers.

 

However, these gains are one-off in nature and MISC shareholders effectively get less indirect exposure in MMHE – 74.5% stake, instead of 100% previously.