Apollo Investment Management

Pirates attempt to seize whole Armada
Piracy on land as well as in the Straits of Malacca... pitfalls of investing in Malaysia

There are many attractions to living in Malaysia, but we cannot muster the same enthusiasm for investing here (a change from July 99, when we were defending our decision to hold; our major investment then as now was Bumi Armada). Our recent experience has been far from encouraging, and it seems timely to provide an update.

First Land & General - a saga which we can now trace back for three years, since we first bought the Euro-convertible bonds: see comments of 5 Jan 01 ("expectation of a swift and satisfactory workout"... albeit with caveats beginning to creep in; great effort in 2000 had seen little return), 26 Apr 01, 4 Sep 01 ("a messy Malaysian muddle"), 13 Jun 02, 8 Jul 02 (a) and (b), 31 Jul 02, 27 Sep 02, 3 Jan 03, 10 Feb03. Very briefly: the company should never have reached the point of default, had the management started to sell non-core assets (as apparently agreed with its board) at the onset of the Asian crisis. Years later, there were repeated opportunities to render itself debt-free and healthy in 2000 and 2001 (at least one, we are told, stymied by the length of the regulatory approval process). After four years of ever-more-draining distraction from useful management, a debt restructuring agreement was reached in August 2002. All parties were substantially poorer than they could have been had the negotiation been professionally handled, but the end at least appeared to be in sight. Little did we know of Malaysian settlement. Bonds were handed in for the agreed exchange. Nothing came back for weeks; then Bumi Armada shares were distributed to meet 32% of the outstanding claim. More months elapsed. For a long time, we could not even obtain a definitive calculation of the total amount of ringgit paper (acronym RCSLS, appropriately referred to by the locals as Rascals) and L&G shares to which we would be entitled. The 31 Dec deadline came and went. (We do not know how many foreign bondholders agreed to this, but the company claims it received 90% approval.) A 28 Feb deadline came and went. There has been no official communication from the company or the trustee (J.P.Morgan) on the status, apart from indefinite extensions to the deadline. Our old bonds are no longer in our custody, nor are they tradable, since they were handed in for exchange. The company has yet to effect any significant asset sales. Newspapers regularly report that Malaysia dealt swiftly and efficiently with the restructuring of its corporate debt.

More fool us, perhaps, for getting involved in restructuring of a poorly run company. Perhaps we should stick to well-run, attractive companies, such as Bumi Armada. (The Land & General bonds were intended as a cheap backdoor route to increase our stake in this company, of which we had long held the ordinary shares.) But here too we have a problem, although it is different: the controlling shareholders no longer want to be bothered with minority investors, and the controlling shareholders tell us that the KLSE will help them to get rid of us. The sale of L&G's stake allowed the chairman and Ananda Krishnan to buy shares from the local banks at RM7, and take their stake up to over 70%. This was announced in August, and consummated in September. A mandatory general offer ensued. There should not have been a six month gap between the offer to Malaysian banks and the offer to others, but nevertheless it is right and proper that an offer should be made. What is not right and proper is that minorities should be forced to accept, which is the 21st century equivalent of robbery on the high seas.

The problem lies in the Malaysian listing rules. If the controlling shareholders receive acceptances to take their stake up to 90%, they can proceed to compulsory acquisition: this is fairly standard, but I doubt they could get to that level, were they not threatening a delisting. If they reach 75%, they can vote to delist - and do so unless there is a 10% vote against. In Hong Kong, that would be 10% of the unconnected shareholders; the Malaysian rules are less clear, and it seems that the controlling shareholders may be allowed to vote, so that one would need 10% of the issued capital to block - but officials of the Securities Commission have apparently said verbally that the controlling shareholder would be debarred from voting, which comes to the same thing. However, according to the offer document, if the free float is less than 25% for six months the KLSE may do the dirty work for the controlling shareholders, and delist automatically. This is the crunch, and it is a policy which should be urgently reviewed. The particular reason for urgency is the vote at hand: many investors are not allowed to hold unlisted shares; many more are unwilling to do so, given the lesser liquidity and lesser protection of minorities in an unlisted company. If investors know that they will be forced out eventually, and have a choice between RM7 now and RM7 in 6-12 months' time, the only rational decision is to accept now. But it is not a fair choice, and the KLSE should not be assisting controlling shareholders to squeeze minorities (any more than stock exchanges should delist shares which have fallen a lot, which again plays right into the hands of unscrupulous promoters: remember Hong Kong's ludicrous Penny Stock proposal of last year? which was withdrawn, and a token head did eventually roll.)

Clarification from the Securities Commission and the KLSE on interpretation of the current rules and any consideration being given to reform would be very helpful to investors considering the merits of the Bumi Armada offer. It would also help if they could assure shareholders that they would receive no less than RM 7 if eventually forced out in a chain of events consequent to the present offer. (The offer document says that will be true in some cases, but it is not clear whether it will be true in all cases. Shareholders can of course make up their own minds about the daily bid and offer of Mr Market, or of his possible illiquidity, and the issue is pricing for any forced deal.)

It would help if such clarification came soon: the offer is now open, and is expressed in such a way that every day's delay in acceptance means a day's delay in receipt of funds, even though there is apparently to be a separate comment by an independent advisor, which is not yet available. (Moreover, although some international investors have yet to receive even the first details of the offer through the global custody network, HSBC International Trustee is already telling us that it would need to have an answer by 12 March in order to meet the closing deadline of 20 March in Malaysia - which surely says something strange about subcustody arrangements in Malaysia, but we have not investigated.)

Settlement procedures also come as an unwelcome surprise to international investors, who thought that Malaysian authorities had years ago made the transition to delivery-versus-payment. Shares are to be handed into the central depository; 14 days later, payment cheques will be consigned to the Malaysian postal system, at the risk of the shareholder. It is not even clear to us who will be paying the cheques - RHB Sakura is extending an offer on behalf of OBSB, but does not guarantee that it will pay; there is reference to the Registrar, but no clarity as to who this actually is (as with other Capitalised Terms which go undefined, such as Relevant Day); etc. Probably this is all done in good faith, and we have little experience of Malaysian takeovers, but with our only other Malaysian securities out of the custody network and unsettled after six months, we would prefer DVP.

To go back to the merits of the shares: in the five years since we first bought Bumi Armada, revenue has tripled. This corresponds to growth of 25% per annum, which is perhaps slightly higher than the growth in other aspects of the business, but broadly reflective. In purely qualitative terms, before thinking about valuation, this is one of the gems of the Malaysian market. It has an excellent service record, it has good relations with its customers in the offshore oil and gas sector, and apart from 1997, when it recorded unrealized FX losses on an appropriately matched loan book, it has sustained returns on equity of comfortably over 20%. It is highly cash generative, and when the Land & General stake was overhanging the market we put forward an MBO-and-buyback proposal which would have seen the debt paid down in short order while generating phenomenal growth in earnings, net assets, and cashflows per share. This opportunity was not taken, but delisting aside, the shares would remain attractive; the offer is far from generous, and clearly includes no premium for privatisation. We didn't sell at RM8.00 two years ago, and Mayban Securities on Friday published a buy recommendation valuing the shares at RM12.20, which is arguably conservative.

Bumi Armada reported earnings per share of RM1.01 for 2002, with an upbeat assessment of outlook for the year ahead, so is on a current-year PE of 6-7 - perhaps half that of the market, despite better-than-average business characteristics and growth prospects, although some discount is normal for illiquidity. In its recent announcement, it has however cut back on operational background, provides no details of major contracts, and omitted any final dividend despite its earnings growth. (This last has particularly incensed some minority shareholders who are surprised 'that Ananda Krishnan should be involved in such a deal'.) This reticence is unfortunate given the conflicts of interest involved.

In the event of a forced delisting, we believe that there would be a legal case against the directors and the controlling shareholders for oppression of the minorities, but costly and time-consuming legal action is a last resort for investors in any jurisdiction.


Previous comments on Bumi Armada, for the record, are dated 5 Sep 02, 27 Sep 02, 3 Jan 03, 10 Feb03; and in happier days 20 Mar 2000 ("PE 6-7, outstanding growth prospects"), 9 Apr 00 (why we were not sellers of our largest holding at peak prices of RM8.00...), and 13 Apr 01.


The major immediate issues are set out above, but I shall make a few further comments for the record.

We were pleased to see that Mayban remains optimistic about Bumi Armada's prospects, but admit to being surprised by the timing. Maybank, its parent, was amongst those which originally jumped at the RM7. This must be proof of their Chinese walls - or of the different thought processes of bankers and investors. We are more impressed by this than by the role of RHB Sakura, which also agreed to sell its Bumi Armada shares in August, and wonder whether it was already advising the company or the buyer: as far as we know, the invitation was extended only to Malaysian banks, and not to a single foreign bondholder. Bondholders who expressed a desire to participate immediately after the deal became public were told that it was already too late - which is presumably lawful, but was certainly discriminatory, and not the sort of thing to make foreign investors think they are on a level playing field.

If an offer is mandatory, it is not necessary to have bureaucrats review the decision. In this case, the controlling shareholders have to pay RM7, but they only have to pay it much later to minorities than to the favoured few. In other cases, it might suit a cash-strapped acquirer very well to avoid a general offer altogether; again, why should officialdom help him? (To avoid any confusion, we would like to be absolutely clear: if a shareholder acquires control, there should be a general offer at the same price, but minority shareholders should be free to refuse.)

Information flows are important, and much more troublesome than they should be in the era of electronic communications. International investors frequently cannot obtain announcements and circulars through the global custody network in time to consider them adequately; frequently they arrive too late to meet corporate action deadlines. Listed companies should be required to copy the local stock exchange and international wire services with all announcements relevant to investors - such as announcements to Euroclear. This responsibility should not be left to companies: they respond when it suits them, and forget when it doesn't.

Unauthorised holidays: public companies should be open for business, except on public holidays and as declared. I now appreciate the Thai stock exchange announcements which previously seemed most boring: each company's calendar of public and additional holidays for the year ahead. Both Land & General and Bumi Armada have apparently shut their offices on days (or weeks) when investors are most likely to wish to contact them. L&G issued an announcement through Euroclear on 6 Dec announcing that it could not meet a year-end commitment to settle its outstanding bond restructuring (for reasons including New Year holidays!), and shut the office for a substantial part of the month; key directors did not return calls until January. Bumi Armada's switchboard went unanswered throughout the Monday following the belated issue of its public offer document.

The role of trustees needs review, and fee levels should be commensurate with responsibility and practical function. See proposal of 5 Sep 99 for a Super-Trustee, and comments of 10 Feb03 on Moody's alarming findings as to how trustees see their role.

I remain convinced that Asian countries could and should develop regional bond markets which work better than the rusting international models. There is a clear macroeconomic case, there are few real practical obstacles, and Asian savers deserve better choices.

Claire Barnes, 10 Mar 2003

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