Cover Story: GLICs on M&A trail

This article first appeared in The Edge Malaysia Weekly on August 28, 2023 – September 3, 2023

After weeks of speculation about a possible corporate exercise in Permodalan Nasional Bhd’s automotive portfolio, Sime Darby Bhd last Thursday announced its proposal to acquire parent company Permodalan Nasional Bhd’s (PNB) 61.2% stake in UMW Holdings Bhd at RM3.57 billion, or RM5 a share.

The all-cash deal came as a surprise, however, as Sime Darby will need external funding to make it happen. The group could be financing up to 90% of the deal through borrowings, which will raise its net gearing ratio.

On Aug 24, Sime Darby made an announcement to Bursa Malaysia that it had signed a sale and purchase agreement with PNB for the share purchase. It will then trigger a mandatory general offer (MGO) for the remaining shares it does not own, at the same price.

The total cost of acquisitions will be RM5.84 billion. Assuming 90% of the consideration will be funded through borrowings, Sime Darby’s net gearing ratio will rise to 0.4 times post-acquisition and post-MGO, from 0.2 times.

At RM5 a share, the offer is at a 23.32% premium to the six-month volume weighted ave­rage market price (VWAMP) of UMW shares of RM4.0545, and a nearly 30% premium to the 12-month VWAMP of UMW shares of RM3.8489.

UMW’s shares traded at RM5.88 in February 2019 and as much as RM14.70 in June 2013. Nevertheless, the higher share price in June 2013 also coincided with the oil boom between 2010 and 2013, when crude oil traded above US$100 per barrel.

UMW owned UMW Oil & Gas Corp Bhd before it was demerged to form Velesto Energy Bhd in 2017. In the financial year ended June 30, 2013 (FY2013), UMW’s net assets per share were RM5.39, compared with RM3.70 in FY2022.

Given the current businesses that UMW is involved in, and that Malaysia is not a large automotive market, some observers see little in the way of exciting growth for the group. Only its aerospace manufacturing business enjoys good growth potential.

Furthermore, competition is expected to intensify in view of the possible changes in public policy on electric vehicles (EVs) — an area that is rather new to UMW.

In an Aug 25 note, MIDF Research says: “The RM5 per share offer by Sime Darby, though not great, is fair, at a decent 9% premium to our SOP (sum of the parts)-derived fair value of RM4.60 a share. The offer values UMW at 13.3 times FY2024F PER (price-earnings ratio), which is at a slight premium to UMW’s five-year historical mean of 12.9 times and at 1.3 times FY2023F book value.

“Broadly, we believe UMW has had a good run since the trough of the auto demand cycle back in 2020. The year 2023 is expected to see TIV (total industry volume) hit another record high of 725,000 (the Malaysian Automotive Association’s forecast) for the second year running, driven mainly by Perusahaan Otomobil Kedua Sdn Bhd (Perodua).

“We see this buyout offer as a good opportunity for UMW’s minorities to exit at the peak of the auto demand cycle.”

The valuations derived from the offer price are deemed to be a premium to passenger automobile peers’ average of 11 times PER and price-to-book value of one time, says Kenanga Research in a research note.

“This deal offers shareholders a chance to exit UMW, as the major shift towards the EV space could spark a price war, which could affect its margin in the longer term,” it says.

“Furthermore, UMW Toyota and Perodua do not have affordable EV offerings to challenge the influx of China EV cars as well as EV leader, Tesla. Thus, we recommend that shareholders take up the offer.”

UMW shares closed at RM4.74 last Friday, rising 37.39% so far this year, from RM3.45.

While UMW shareholders are now presented with the opportunity to exit the automotive business, Sime Darby’s shareholders will have more exposure to the sector. The group will not only add more brands, but it will also be more entrenched in the automotive spectrum.

In announcing the deal, Sime Darby says it will scale up and strengthen the group’s motor business, as it will be the leading automotive player, with more than half of the market share in Malaysia.

“Sime Darby Group will be able to leverage this stronger foothold in Malaysia to tap into the increased market opportunities and customer base, and unlock the potential for revenue growth and operational efficiencies,” the company says.

Sime Darby group CEO Datuk Jeffri Salim Davidson says that by working with Japan’s Toyota Motor Corp, the group will be open to opportunities in the future, perhaps in other countries.

On the surface, one can appreciate the streamlining of Sime Darby’s automotive business through the acquisition of UMW, as it will provide the group — which has had a long association with luxury marques — with mass market brands and models that will expand its reach.

UMW Toyota Motor Sdn Bhd and Perodua — the main arms of UMW’s automotive business — are predominantly domestic players. As the local market is unlikely to expand beyond 800,000 units a year, the automotive business has to move beyond the domestic market to be a growth sector for the merged entity.

Nevertheless, it cannot be ascertained as to why Toyota would want to work with Sime Darby in other countries, as the Japanese automotive giant already has a global footprint. Its assembly sites in Shah Alam and Bukit Raja, Selangor, serve only the local market, whereas Indonesia is its regional hub.

Sime Darby’s strength is in its regional distribution business of luxury marques such as BMW, MINI, Rolls-Royce, Ford, Land Rover and Porsche, to name a few. But with the automotive retail business transitioning from the distribution model to the agency model, Sime Darby might be looking at ways to mitigate the risks in this development.

As such, it might make business sense to take over UMW’s automotive manufacturing and assembly businesses.

The EV space is where most automotive makers are heading, and Sime Darby is no exception. The group is now the distributor of BYD’s EV in Malaysia. The BYD Atto 3 has been its main product offering, along with the Hyundai Ioniq 5 and Kona Electric.

But the same argument persists. If Hyundai and BYD changed their business model to the agency model, Sime Darby’s bread-and-butter could be affected. By acquiring UMW, Sime Darby would have a stronger partnership with a principal that has made substantial investments in Malaysia.

UMW CEO Datuk Fuaad Kenali believes there is still room for Toyota to grow in Malaysia, perhaps to 120,000 units a year. In 2022, UMW Toyota sold 100,042 Toyota cars and 993 Lexus vehicles.

At 120,000 units, that means a market share of roughly 16% for the brand, assuming a total industry volume of 750,000 units. In 2022, 720,658 cars were sold in Malaysia.

“[Growth] will come from the new-energy vehicles — battery EV and hydrogen,” Fuaad tells The Edge, when asked about the potential of the local automotive market.

He concedes, however, that it would not be so easy for anyone to set up manufacturing facilities for the new energy vehicles, owing to the lack of volume in the local market for now.

While the acquisition of PNB’s UMW shares could well be a done deal, Sime Darby would still have to obtain the approvals of the principal brands that are the strategic partners of UMW’s automotive and industrial businesses.

In the past, when UMW proposed to acquire MBM Resources Bhd’s 20% stake in Perodua, it was reported that Perodua’s Japanese shareholders opposed the acquisition because they did not believe it should have a single controlling shareholder.

Had the deal gone through, UMW’s 38% stake in Perodua would have increased to 58%, making it the controlling shareholder. Meanwhile, PNB has a direct 10% stake in the Rawang-based carmaker.

The Japanese interests in Perodua are represented by Daihatsu Motor Co Ltd, with 20%; Daihatsu Malaysia Sdn Bhd, with 5%; Mitsui & Co Ltd with 4.2%; and Mitsui & Co (Malaysia) Sdn Bhd, with 2.8% — or a combined 32% stake.

This time around, according to industry observers, the Japanese are open to working with Sime Darby, possibly because the change in shareholders does not constitute a change in control over the group.

“Suffice it to say, the relationship between UMW, Toyota and Daihatsu could be better with Sime Darby. I think they [the Japanese] are more confident with Sime Darby than UMW,” says an observer.

In terms of balance sheet strength, Sime Darby’s total assets of RM30.23 billion is 9.2 times that of UMW, while its total equity of RM16.37 billion is 8.2 times more.

The merged entity will have a pro forma RM19.13 billion of total equity, according to Sime Darby’s announcement.

“Some potential capital expenditure and investments and allocations for factories could be more palatable, with Sime Darby — rather than UMW — as a shareholder,” says the observer.

Another observer says he does not see the principal’s agreement for the change of shareholders as a major risk to the proposed acquisition at the moment. This is because engagements with them had started in the first quarter, before the decision to sell PNB’s stake in UMW to Sime Darby was made.

Still, some revisions could be made to UMW’s various businesses post-acquisition. Sime Darby says it intends to undertake a comprehensive review of businesses within UMW upon completion of the proposals, to determine the strategic plans for the integration of UMW group into Sime Darby.

“As part of the comprehensive review, Sime Darby group also intends to identify strategic options to streamline UMW group’s businesses through the divestment of non-core assets, in addition to competing assets that would be required to be disposed of.

“In respect of the foregoing, Sime Darby wishes to highlight that the aforementioned divestments shall be explored at the appropriate time and subject to acceptable terms,” the group states in its announcement to Bursa Malaysia.

Market observers see UMW’s heavy machinery business with Komatsu Ltd as one to be put on the chopping block, post-acquisition, because Sime Darby already has a strong presence in that segment through its partnership with Caterpillar Inc.

UMW’s relationship with Komatsu began in 1965, when United Motor Works (Malaya) was awarded the distributorship of the Japanese firm’s heavy machinery in the country. Then, in 2018, a joint-venture agreement with Komatsu was executed to establish a strategic partnership between UMW and Komatsu.

UMW Komatsu Heavy Equipment Sdn Bhd, in which UMW owns a 74% stake, is the distributor of Komatsu machinery in Malaysia. UMW also owns UMW Niugini Ltd in Papua New Guinea, UMW Engineering Services Ltd in Myanmar, and UMW Heavy Equipment (S) Pte Ltd in Singapore.

In FY2022, the heavy equipment division contributed RM1.53 billion, or 9.66%, to UMW’s total revenue of RM15.8 billion. The division made RM152.84 million in profit before tax (PBT), which was 17.04% of the group’s total.

In comparison, Sime Darby’s industrial division contributed RM15.1 billion, or 35.5%, to the group’s total revenue of RM42.5 billion (excluding discontinued operations) in FY2022. It also contributed RM803 million, or 43.6%, to the group’s total PBT of RM1.84 billion (excluding losses from the discontinued operations).

The merger between Sime Darby and UMW would create a behemoth industrial and motor group with a presence in various markets in Asia-Pacific. Can the merged entity leverage its size to become better? 

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