Apollo Investment Management

FX headwinds & unheeded duties of care
Apollo Asia Fund: the manager's report for 3Q2014

The Apollo Asia Fund's NAV fell 2.9% in the third quarter, to US$2,037.55, giving up in September all the ground gained in July and August. Currency weakness accounted for part of the losses, and we had not hedged. The yen was the weakest of our currencies against the US$, tumbling by 8%, but prices of our Japanese holdings rose in 3Q by more than we lost on the currency. We incurred losses in all other markets, except on our small new position in India. 2Q results of our companies operating in Thailand and China were poor, as expected given the political unrest in the former and economic slowdown in the latter. We do not worry much about temporary setbacks when management responses are appropriate, but we watch our basket of holdings closely, and business conditions are clearly stressful for most: the resultant decisions are not always to our liking.

Geographical breakdown
by listing; 30 Sep14
% of assets
Hong Kong
20 
India
4 
Japan
18 
Malaysia
9 
Singapore
14 
Thailand
11 
Other
10 
Net cash & receivables
14 
 
100 

A particular irritation has been the collapse of corporate governance at Tomypak Holdings, a Malaysian manufacturer of flexible packaging. It has been one of the two national market leaders, with historical advantages in production and in access to subsidised piped gas, offset by relative weaknesses in sales, marketing, finance, and communications. The latter had caused it to be rated much more cheaply than its competitor, Daibochi Plastic and Packaging Industries, yet performance for several years was fairly similar. In 2013 Tomypak's managing director spent much of the year overseas for medical treatment, a fact not disclosed to the market: the business started to underperform, and repeatedly failed to follow through on overdue decisions for expansion. In 1Q, a major increase in electricity tariffs required hands-on management, and the disparity widened: 2Q results were shocking, and the board terminated the MD's contract, without as yet having identified a successor. Two new directors were hastily appointed on a stopgap basis. While hardly ideal, this much was arguably in the price: the lack of management depth had been of concern for some time, and members of the founding Chow family had said that they were working on a succession plan. Flexible packaging demand in the region continues to grow strongly, and there are many strong companies who would have been happy to buy Tomypak's business, acquiring either the controlling stake, or a significant interest in partnership with the family, to whom a resolution of the management challenges with ongoing participation and a steady dividend stream might logically have seemed attractive.

The ex-MD and his father then announced that they were seeking buyers for their 25.5% stake. Prospective buyers, including regional players with the ability to second the management resources now urgently required, tried all channels to express their interest, but were rebuffed - as were existing investors seeking information and offering assistance. Then the Chows announced a sale of the 25.5% stake to a newly formed company, whose beneficial shareholders have yet to declare themselves. This cannot be good for employee morale or the confidence of customers (let alone investors): any legitimate buyer would surely wish to show up at the factory at the earliest opportunity to provide reassurance as to stability and intentions. The reported price was inexplicably low: RM1.30 per share, compared to earlier indications 50% higher; strategic buyers would probably have expected to pay up to RM2.00, and might have gone further in competitive bidding. Since listing, the family has been allowed to exert control through its minority stake, and we believe that directors precluding alternative expressions of interest at a higher price by more suitable buyers should be deemed to be acting in concert. The combined holdings of directors, their family members, and the new buyer are together now over 50%. We therefore expect the Securities Commission to require a General Offer, albeit at the low price of RM1.30. We would hope that the independent directors will then rise to the occasion and use this opportunity to open up to competitive bidding, although we note that the board has not been very energetic to date, and that two of the three "independent" directors have served on the board for over 18 years. Apart from the duties of care owed by the executive directors to the business, we had expected the family to show more concern for the future of the business they founded, so their behaviour is very disappointing: any readers with an interest in this company are invited to contact us.

During 3Q the fund made its first investment in India: this did nothing to help the average multiples of the portfolio, but our investee company has the opportunity to realise various synergies allowing high returns on incrementally invested capital, so we hope it will grow into its valuation.

The fund is changing its administrator. Apex Fund Services will take over on 1 November; we and our investors will be dealing with the Singapore office. We have retained HSBC as custodian.

Claire Barnes, 19 Oct 2014

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