April 13, 2017
A QUESTION OF BUSINESS | Numbers and Shifting Assets –Old Game by Sime Darby
Sime Darby Restructuring benefits Investment Bankers, but not its shareholders. Let the evidence of its past merger and demerger exercises confirm this view.–Din Merican
It will be more accurate to say that plantation-based conglomerate Sime Darby Bhd’s proposed demerger of its businesses will not create value by itself but only if benefits of the intended demerger, coming nine years after its massive merger, is realised by proper execution.
The billion-ringgit question this time around is whether the proposed demerger will create value for the group when it seemed not to have the last time around when it was merged with other major companies.
Recall that this conglomerate, majority owned by Permodalan Nasional Bhd or PNB, the operators of the national unit trust scheme, merged mainly with Guthrie and Golden Hope – both under the PNB stable too – to become the largest plantation operator in the world in 2008.
Initially at that time, the expensive merger, costing some RM500 million in fees alone, was greeted by an enthusiastic market and galloping prices of palm oil which saw Sime Darby become the most valuable company on the local market for a while.
Eight listed entities were involved in the merger, proposed end-November 2006. They were Sime Darby Berhad, Sime Engineering Services Berhad, Sime UEP Properties Berhad, Golden Hope Plantations Berhad, Mentakab Rubber Company (Malaya) Berhad, Kumpulan Guthrie Berhad, Guthrie Ropel Berhad and Highlands & Lowlands Berhad.
The early reception by the market for the merger was enthusiastic. The share price almost doubled to RM13.30 by January 11, 2008 after the completion of the merger, from RM6.75 when the deal was announced end-November 2006.
But Sime Darby would never hit that level again. Barely two years later, its energy and utilities division chalked up heavy losses of over RM2 billion, entering into areas it had no knowledge off. Its then-CEO faced charges in court but was subsequently cleared.
Paradoxically, the energy and utilities division was a minnow but was able to get contracts because of Sime Darby’s size – it turns out that size in this case was not used to get viable contracts but enter into risky ones.
Despite a new CEO, Mohd Bakke Salleh, who sold the errant division in 2011, Sime Darby’s share price has been lacklustre and languished at around the RM7-8 level until excitement over the demerger emerged last November. The share trades around RM9.30 now.
Still Sime Darby is big, representing PNB’s largest investment in the stock market after Malayan Banking and is regularly among the top five most valuable companies listed on the Kuala Lumpur stock market, with a value of over RM60 billion. And it’s the only conglomerate in the top 10.
However, although known as a conglomerate, it continues to be heavily plantation based with over half of profit coming from that sector. Its fortunes are therefore intimately tied with the price of palm oil, its main plantation produce.
Bakke said at a press conference end-November last year that the plantations unit may be demerged and listed separately next year, followed by its property division. That had sparked some interest in Sime Darby shares again.
In January, Bakke confirmed in a statement that Sime Darby will create “pure play” listed entities for its plantation and property divisions. Others, including its BMW distributorship, port operations and trading, will remain under the existing listed entity.
Meantime, PNB group chairperson, former Minister in the Prime Minister’s Department Abdul Wahid Omar, said last month that excitement over the restructuring of Sime Darby amongst others have led to a RM20 billion increase in the value of PNB’s six main listed entities.
True value creation
However, such an increase in market value arising from perception can be very short-lived as illustrated in the previous share price movements of Sime Darby. Short-term market sentiment should never be mistaken for true value creation which is creating value in the production process by improving productivity.
At the end of the day, that is the only way to create value – by improving productivity. Is a merger or demerger going to create value by itself? No, never.
It can if a merger results in economies of scale or where there are overlapping functions in which case staff can be laid off. That effectively means less people doing more work – an increase in productivity. But even so, the truly enlightened company will think of redeploying staff into other areas instead of laying off, although that’s the quickest way.
But most mergers destroy value – studies at the time of Sime Darby’s merger in 2008 showed that 85 percent destroyed value. It’s not hard to see why – sometimes mergers take years before their values can be realised and valuable time is wasted. Meantime, productivity suffers.
In a demerger, it is possible that the increased focus and concentration on the core business can result in higher productivity but there has to be a focus on that by competent management.
On balance, demergers may have better chances of creating value than mergers but the most important factor is who is managing the change. If the same people are doing the same things in the same old, expect neither mergers nor demergers to create value.
P GUNASEGARAM says value cannot be created by simply rearranging the same assets differently – someone has to work the assets more efficiently. E-mail: email@example.com.
NOTE: I am on an assignment to Kompong Chhnang from April 13-15 and will not be blogging during this period. I will also not be on Facebook either. Take care.–Din Merican