This article first appeared in The Edge Malaysia Weekly on October 12, 2020 - October 18, 2020

THE proposed merger between UEM Sunrise Bhd and Eco World Development Group Bhd will create a property giant with the second-largest land bank in Malaysia after Sime Darby Property Bhd.

But the idea has courted criticism from certain quarters, despite the obvious synergy between a company with a good land bank and another with the ability to sell much of what it builds even in challenging times.

On Oct 5, UEM Group, the unlisted wholly-owned subsidiary of Khazanah Nasional Bhd, sent letters to the boards of its subsidiary UEM Sunrise and competitor Eco World Development for both to consider a merger via a share and warrant swap (Read the Q&A with UEM Group chairman Tengku Datuk Seri Azmil Zahruddin below.)

UEM Sunrise will issue new shares at 44.3 sen each and exchange them for Eco World Development shares at an exchange value of 46.9 sen each, for a swap ratio of 1.058. Both prices are at an 18% premium to UEM Sunrise’s and Eco World Development’s share price on Oct 1.

(Eco World International Bhd, the listed unit overseas unit of Eco World Development, is not part of the merger plan.)

The proposal values Eco World Development at 0.3 times its book value per share. The board of directors of Eco World Development and UEM Sunrise have until Oct 30 to respond to the UEM Group proposal.

Although Khazanah’s stake in the enlarged UEM Sunrise, via UEM Group, will be diluted from 66% currently with the share swap, it will remain the controlling shareholder with the single-largest stake of 43%.

Eco World Development’s major shareholders will have a collective stake of about 24.4% in the enlarged UEM Sunrise, but they are split into various blocks. Tan Sri Liew Kee Sin and family will have an 8.4% stake. The other major shareholders are Sinarmas Harta Sdn Bhd (12.6%) and Eco World Development Holdings Sdn Bhd (3.4%), whose main shareholders are Datuk Eddie Leong and Tan Sri Abdul Rashid Manaf respectively.

Critics of the proposed merger say the enlarged entity will have a total net debt of RM6.37 billion — Eco World Development has RM2.98 billion and UEM Sunrise has RM3.39 billion.

Based on back-of-the-envelope calculations, assuming an interest rate of 5% a year on the RM6.37 billion debt, the enlarged company will have to fork out RM318 million a year, or RM26 million a month, to service its debt, the critics say.

They also say that while the enlarged company will have a lot of assets, the current economic situation, if prolonged, could spell trouble for it and Khazanah, as the largest shareholder may have to step in to support any equity fundraising the company might want to do.

According to Malaysian Rating Corporation Bhd (MARC), the higher debt-to-equity ratio of the enlarged entity of 0.9 times, from 0.56 times, could be a problem unless Khazanah Nasional is committed to providing financial support if needed.

The rating agency says that although UEM Group, and in turn Khazanah, will continue to be the largest shareholder of the enlarged UEM Sunrise, its stake will be reduced to 43% from 66%. This means that UEM Sunrise will become an associate of UEM Group, rather than a subsidiary.

This is a concern to MARC with regard to Khazanah’s commitment to support UEM Sunrise financially, once the status changes. This is because the current long-term rating of AA- on UEM Sunrise’s two Islamic debt papers of RM2 billion each is one notch above its standalone credit rating, owing to this assumed parental support.

The proposal announced by UEM Group indicated no commitment by Khazanah to inject funds into the enlarged company.

“MARC notes a potential weakening in the credit profile of the enlarged UEM Sunrise group … The aforementioned factors, along with business and financial assessments of the merged entity, will be the key drivers of MARC’s rating action on UEM Sunrise. The rating agency will monitor the developments on the proposed merger and will make an appropriate rating decision only upon conclusion of the exercise,” says MARC in a press release dated Oct 8.

Promoters of the merger say critics have chosen to ignore the fact that while the debts of the enlarged entity appear huge, both companies have unbilled sales (future revenue) of RM6.12 billion. Eco World Development has RM4.42 billion, whereas UEM Sunrise has RM1.7 billion.

Like all developers, both UEM Sunrise and Eco World Development are facing challenging times, as affordability and tighter mortgage financing conditions have capped sales even though there is demand.

The property down cycle started in 2014 after Bank Negara Malaysia restricted bank financing and stopped the popular Developer Interesting Bearing Scheme. The pain started to kick in in 2018 and worsened because of the Covid-19 pandemic.

UEM Sunrise recorded a net loss of RM115.3 million in the first half ended June 30, 2020 (1HFY2020), compared with a net profit of RM40.36 million in the previous corresponding period, on the back of a 78% drop in revenue to RM307.8 million.

UEM Sunrise is especially hard-pressed because of its large exposure to the highly overbuilt Johor property market. As at June 30, 2020, its remaining gross development value (GDV) in the southern region made up 77% of its total remaining GDV of RM77 billion.

In contrast, Eco World Development’s remaining GDV from the southern region comprised only about 24% of its total remaining GDV of RM68.6 billion. The group has a larger exposure to the central region, with remaining GDV of RM43.9 billion, compared with UEM Sunrise’s RM17.4 billion.

In the nine-month period ended July 31, 2020, Eco World Development generated RM463.2 million in cash from its operations. However, it expended RM479.09 million for repayment of bank borrowings and lease liabilities during this period.

Meanwhile, UEM Sunrise generated RM807 million over the nine-month period ended June 30, 2020 from its operations. The group expended RM597.3 million in repayment of borrowings and lease liabilities during the period.

Investment analysts Lum Joe Shen and Marie Suwrna Vaz of Kenanga Research say UEM Sunrise stands to gain from tapping Eco World Development’s marketing prowess and world-class township planning, which will help boost sales.

Also, a larger domestic earnings base will help reduce earnings volatility from its lumpy overseas contribution, they say, especially in countries where earnings recognition is based on handover, as in Australia, for example.

“On the flip side, we have some lingering questions in our minds as to the rationale for Eco World to agree to the merger,” the analysts note in a research report dated Oct 6.

“From a management and operational standpoint, Eco World’s key shareholders would lose their majority ownership, brand name (potentially) and possibly become less agile in terms of decision-making. Also, there may be concerns as to the fit in terms of culture.”

Under the proposed merger, the chairman of the board will be from UEM Sunrise and the CEO is expected to be from Eco World Development. In a latest development, UEM Sunrise last Friday announced that its CEO and managing director Anwar Syahrin Abdul Ajib had tendered his resignation to pursue other opportunities. The 46-year-old was appointed to the job on Sept 1, 2014.

Despite these concerns about fit and culture and debt, promoters say the respective strengths of the two companies make it a compelling case for a merger.

They cite the following:

•    Eco World Development has a strong brand following in Iskandar Malaysia in Johor, where, in just six years, it has developed four townships and three business parks and achieved cumulative sales of RM6.6 billion. UEM Sunrise, on the other hand, has a huge land bank of 3,600ha in Iskandar that has yet to be developed;

•    Eco World Development has a strong following and sales capability. In the six short years of its existence, it has built and sold RM20.5 billion worth of properties in Malaysia and another RM13.4 billion in the UK and Australia;

•    UEM Sunrise has a sizeable presence in Australia, and Eco World Development, via its 27% stake in Eco World International, has two projects there on top of projects in the UK;

•    The combined strength of both brands — with UEM Sunrise’s legacy as a top-notch developer of integrated high-rise projects and Eco World Development as a township developer — will create a sizeable entity with a compelling growth story; and

•    The backing of Khazanah Nasional will provide the financial muscle to develop the huge land bank in Johor into townships targeted at the RM500,000-to-RM800,000 segment for the M40.

The proposed mega merger has its critics and fans, and it is now up to the companies’ respective boards to decide, by Oct 30, which direction to take.

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