Apollo Asia Fund

Here we go again
Preying on Fear - Pirates of the Dai-bo-chi

On this Malaysia Day, it is dispiriting to be writing about yet another attempt at a squeeze-out privatisation. 'Pirates attempt to seize whole Armada', we wrote, 'pitfalls of investing in Malaysia'. That was more than 18 years ago.

The company that later did much to restore our faith was Daibochi, a maker of flexible packaging for demanding multinational F&B companies. Under former managing director Tom Lim, the business was refocussed, non-core assets divested, quarterly dividends paid, and a culture of transparent disclosure and routine quarterly engagement provided constructive feedback while improving investor understanding and share rating.

When a controlling stake was sold to Scientex in 2018, the new bosses explained that they had been attracted by the value-adding characteristics at the customer-solution end of the packaging business (contrasting with and potentially complementing the commodity characteristics of their standardised products, films bought by Daibochi as inputs). They assured investors that they shared our expectations of high growth potential, and would maintain and learn from Daibochi's award-winning IR practices. They would not only maintain the listing; they envisaged that Daibochi might become the listed flagship for all Scientex packaging interests. It made sense for packaging to be separated from the inherently non-recurrent and land-consuming property development business, to eliminate the conglomerate discount and raise the Scientex rating to a level closer to Daibochi's.

Less than three years on, those with inside knowledge announced a desire to buy out their co-investors, at a time of unusual information asymmetry. The offer was announced on 13th Sept, six weeks after books closed on the most challenging year that most investors will remember, and before the resultant reporting. (Extraordinarily, Scientex is now apparently allowed to buy in the market, ahead of the results announcement, and that has been scheduled eleven days later than last year.)

The historic results, when they eventually deign to share them, may not be good. Other manufacturing companies in Malaysia have reported that the on-off factory closures, policy uncertainties, and supply chain disruptions caused more problems in recent months than in earlier stages of the pandemic. Full provision against the Myanmar investment may also be prudent - and if business later recovers, then kitchen-sinking now would supercharge the future profit rebound.

The parent's willingness to trade against the minority investors is sad in some respects: we prefer to invest as partners, with long-term relationships of trust, which once in a while enable us to help with constructive suggestions or introductions.

Scientex appears to have done a good job with operational improvements; we hope that it would not risk losing its most vital asset, the trust of its long-term customers.

It has chosen to attempt privatisation, not by offering a compelling price to encourage willing sellers, but by emphasizing that companies can be delisted and it would do nothing to prevent this - although with this offer it seems unlikely to reach the level of voluntary acceptance required for compulsory acquisition. Fear can feed on itself, so investors should not relay uncritically the storyline that delisting is inevitable.¹

In the meantime, despite the lack of financial detail and investor engagement, we have one piece of information that's clear. Mr P.J. Lim, with his unparalleled information and eye for a bargain, thinks that RM 2.70 is a level at which he would wish to buy Daibochi shares in size. He'd doubtless be happy if everyone else does the opposite - but at this stage, it surely makes more sense to follow his actions?²

Claire Barnes, 16 September 2021

  1. Apollo Asia Fund before the offer held 9.4% of both ordinary shares and warrants.
  2. Apollo Asia Fund has a long time horizon. This is not intended as investment advice, but as encouragement to think independently. Fellow-investors, please consider your own circumstances, and decide according to your own interests.
  3. Update 17 Sept: we see that other investors have followed Mr Lim's lead. Transactions on 15 Sept include purchases by Samarang Asian Prosperity Fund as well as Apollo Asia Fund and Scientex.

Update 28 September:

The Edge Malaysia wrote briefly about the Scientex proposal for squeeze-out privatisation of Daibochi, in an article which appeared online paywalled on Sat 25 Sept [update: & open access by Wed 6 Oct]. The Edge article quotes former investment banker Ian Loong as recommending that Daibochi investors should sell their current shares and invest in those of Scientex. This is also what Scientex would like us to do - but again, when Scientex wishes to INCREASE its allocation to the packaging business, why should the minorities be forced to go the other way and invest in its mass-market property development business? We have already pointed out that converting land into buildings is inherently non-recurrent. The property sector is also fraught with challenges of governance (which Scientex may be able to navigate successfully) and sustainability. Apollo Asia Fund avoids the property sector region-wide, as do many other investors. Besides, Daibochi has high ROE (18% even in the dreadful year just ended), and generates strong cashflows enabling it to fund rapid growth internally. Scientex is an order of magnitude larger, its business characteristics very different. Why should investors in its crown jewel swap one for the other?

An open access investor chat forum with some discussion about Daibochi is at https://klse.i3investor.com/servlets/stk/8125.jsp. All participants are using pseudonyms but there have been some sensible comments.4 Given the low level of analytical coverage at broking firms, it is good to see this alternative forum for investor discussion.

Daibochi's results were released at lunchtime today, with an investor briefing at 2pm. The slides should appear on the website eventually (although not yet by 8pm), and explain the "perfect storm" that hit Malaysian businesses during the last two months of its financial year (ie June and July), and from which we are only now emerging. However this was apparently "not the right time" to discuss the Scientex proposal; it was suggested that the right time may be at the Scientex briefing at 2pm tomorrow, Wed 29 July. (Investors not yet signed up may wish to contact the IR agent for both companies, Aquilas.)

The results were not as bad as we expected, given the chaos in Malaysia and in international shipping from June to September. 4Q freight costs were up by about 50% yoy. Shipping and port disruption regionwide, and port strikes in Australia, caused delays and necessitated occasional resort to air freight. The cost of PP resin was up 30% yoy; PE resin 34%. Malaysian sales were down 23% yoy (and we thought COVID was bad last year), as many customers had to close completely from June onwards, and may begin to get back to normal starting this month. Daibochi, deemed essential, was allowed 60% of its normal workforce, but was also ordered to close completely for periods, and subject to other restrictions. Myanmar's political crisis was compounded by one of the world's most intense COVID waves. Amidst all this, sales outside Malaysia fell only 3% year-on-year, and the company lost no customers. Moreover, Daibochi continued to report positive earnings, and positive operating cashflows both before and after a working capital increase. The company continues to invest for expansion, accepting delivery of new machines to expand its capacity, and is now considering acquisitions within the region to broaden its footprint and diversify risks.

We salute the Daibochi team for this performance. We wish they were being allowed to focus on returning the business to normal, on customer relationships, and on the many new business opportunities, rather than being distracted at a time of such upheaval by a frivolous and opportunistic takeover bid. "We stand and fight together as one", says the Scientex website, referring to frontliners. Why distract the managers who have been working so hard, for whom a takeover bid and its defence will add a voluminous paperwork burden? Why add new stresses for board members, by requiring them to defend the minorities against the controlling shareholder? And what about the long-term Daibochi investors, to whom Scientex has a duty of good stewardship? Even the Scientex minorities, while usually happy to see bargain purchases, may be unsettled if they start to worry about future conflicts with their own interests.

Surely there are better uses of everyone's time. The Daibochi shares were cheap, and Scientex decided it would like to increase its stake. It has now done so, acquiring enough shares in the market to offset the dilution that would have occurred with warrant conversion in 2022. A graceful way out would see it make clear that it saw value in the shares, but is content with its increased stake and any further purchases it can make from willing sellers, without seeking to delist the shares or distract the management team from their growth plans.

Claire Barnes, 28 September 2021

  1. Footnote 2 Oct. New accounts characterised by aggression and partisanship started posting long-winded comments and wild accusations on the investor forum from 28th onwards: pollution of the commons in the age of pseudonymous social media.

Update 29 September:

Well that was a first. I had registered for the Scientex results briefing last week, received the login details yesterday, launched the Zoom link today and received a message familiar in format:

The host will let you in soon
Virtual Investor Relations Meeting - Scientex

- and then nothing more... nothing... nothing. I notified the designated contacts provided "in case of complications", who advised me that they were not in control of admissions and would notify the host. I logged out and in a few times to make sure that the system wasn't hanging. I am not sure if technical issues hampered the whole briefing: there are many IT problems in Malaysia now, and I have heard of major firms having trouble this week, but my own system for once was behaving, with Bloomberg & web running smoothly. The screen changed to indicate an end to the meeting after 70 minutes, which would be about the normal duration.

The slides for the Scientex presentation are online at https://scientex.com.my/investor-presentations/, unlike the slides for Daibochi which still weren't, more than 24 hours after that briefing [after-market update: they are now]. The Daibochi slides weren't especially informative, but presentation material should always be promptly available to all investors, and not just to those with time to sit through the live briefing.

(There may be a wider issue of selective disclosure in Malaysia. Regulators may wish to consider a requirement for all briefing invitations and slide presentations to be made available through the stock exchange, rather than just on each company's own website. Ideally there should be a norm for Malaysian companies to provide live and recorded webcasts, and transcripts, as per regional and global best practice. Buyside investors could help with examples; ours would include a Vietnamese company which provided an excellent virtual briefing this morning. AGM practice should also be reviewed in case of ongoing virtual or hybrid meetings; this is particularly important as it is intended to ensure an annual opportunity for all investors to pose questions to directors, and for all investors to hear the responses.)

Back to Scientex. Slide 9 boasts that acquisition at RM2.70 would be immediately earnings-accretive. I bet it would. And then there's the growth potential. That's why we do not consider it a fair price. Bizarrely, the workings are based on last year's numbers, for the year to July 2020 which ended 14 months ago.

Slide 28 emphasizes the importance placed by Scientex on consistent dividend payment, with a 30% payout policy since 2011. This is rich, as Daibochi also has a 30% payout policy, and has just omitted its final dividend, presumably on the instructions of Scientex. We're total-return investors, and happy to see earnings retained when there are opportunities to put them to good use, but any changes in policy should be flagged in advance with due consideration by the board, and clearly explained to investors.

Packaging represents 42% of Scientex EBIT and that is clearly shown in the slides. What also needs to be emphasized is that the commodity packaging interests of Scientex - eg making the plastic films - dwarf the value-added, customer-centric business of Daibochi. Those customer relationships, especially with innovation-leading multinationals, are why Scientex wanted to buy Daibochi in the first place. The commodity packaging businesses are 4 times larger than Daibochi, based on EBIT for the latest, FY2021 figures. Then there's property, which is even less attractive to us. All in all, the rest of the group has EBIT 12 times Daibochi's, it's dominated by property, and existing Daibochi shareholders should think carefully about exhortations to sell the business in hand and buy another that is so different. Certainly they may not wish to do so at current prices!

Claire Barnes, 29 September 2021

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