Path to prosperity

I recently read an article in TheEdge talking about how the company with the largest market cap in Singapore is not DBS. Instead, it has been replaced with SEA Ltd which is listed on the New York Stock Exchange. Sea has taken over the mantle of most valuable publicly-traded Singaporean company from DBS which has held it since taking over from Singtel in 2017. 

As shown in the figure above, the share price of Sea is currently up 171.1% YTD while DBS is down 19%. According to TheEdge, Sea already overtook DBS in May and the gap between Sea and DBS has widened ever since with Sea being worth $10bn more than DBS based on market cap in mid-June. Interestingly Sea has yet to turn a profit while DBS made $1.2bn in the most recent quarter. 

From an economic standpoint, DBS is a key pillar of the Singaporean economy and facilitates the flow of funds as a financial intermediary. On the flip side, Sea is most known for its e-commerce platform Shopee and its gaming platform Garena. Needless to say, the economy can survive without Sea's services but DBS is likely to be deemed 'too big to fail' from a Singaporean context. Sea's valuation has benefited from a few factors

Sea is listed on the NYSE and has an average trading volume of 5.2m shares which translates to around US$560m of Sea shares changing hands daily. For DBS, its average trading volume is 7.6m, translating to S$160m of DBS shares being traded. If we standardize the currencies, this implies that Sea has a trading value of almost 5x that of DBS! 

With a much bigger market in the US, Sea can command a higher valuation than it would have if it had listed on the SGX. I believe this is also one of the reasons why another homegrown tech company, Razer chose to list in Hong Kong rather than in Singapore. The Singapore equity market just isn't vibrant enough to give companies good valuations. 

With the crash in share prices, we are probably going to see more delistings/privatizations to come. Although the negative impact to SGX market vibrancy is offset by the increased interest in the share market as bargains emerge. In my earlier article, 'Stay at home and buy stocks', I thought that with the lockdowns, people didn't have much else to do so trading stocks could be a good distraction. 

Banks are deeply embedded in the economy and hence are impacted when the economy goes into a recession. In comparison, Sea has been an indirect beneficiary of Covid19 with more customers shopping online and lockdowns keeping people at home playing games. A key point to note is that Sea continues to turn a loss year after year while DBS has a quarterly profit of ~1bn on average. With conditions being ripe for Sea, the optics wouldn't be good if it still can't turn a profit or at least narrow its losses in the coming quarter. 

From an operating standpoint, a software/platform company should have a much higher operating leverage compared to a bank since the additional cost of providing the game/platform to an additional user is negligible. After accounting for the fixed costs of hiring staff and setting up infrastructure, any additional revenue tends to flow directly to the bottom online. For a bank, providing an additional loan usually implies going to the money markets to get funds and getting charged a 'cost of funds'. Therefore, I believe that Sea has far more scalable products compared to DBS and hence it is according a higher multiple. This can also be seen in the US where the biggest companies are in tech while the Wall Street banks are lagging. 

Overall, I believe that the outperformance of Sea over DBS may continue until the Covid-19 situation dies off and the economy recovers. In the near term, DBS could see further weakness as government support of the economy comes off and businesses and households start to really feel the pain. Globally, the Fed has already announced that it would continue to keep interest rates low and this is a definite negative for banks' net interest margins. 

The market turmoil induced by Covid-19 has depressed stock prices to the point where sponsors/shareholders feel that the value of their investments would be better realized in the private markets. Earlier this week, a consortium comprising some of Perennial Real Estate Holdings Limited's substantial shareholders announced a voluntary conditional cash offer to privatize and delist PREH at a price of S$0.95 in cash. 

This article will breakdown the terms of the deal, deal rationale and next steps for existing shareholders and potential traders. 

The consortium currently owns 82.43% of PREH and other shareholders will receive S$0.95 in cash for each share owned. Non-consortium shareholders that accept the offer will still be entitled to receive the final dividend of 0.20 cents per share for FY19. 

The offer is conditional on the consortium receiving enough acceptances to give it at least 90% stake in PREH, following which it will exercise its right to compulsorily acquire all the remaining shares and delist PREH. Overall this seems like quite a straightforward deal as it is a straight-up cash offer pending shareholder acceptances. 

Based on the stake (17.57%) that minority shareholders have, this would imply that less than half of these shareholders are required to accept the offer for it to become unconditional; the consortium requires an additional 7.57% stake in order to hit the 90% mark. 

1. Allows minority shareholders to exit their investment at a premium without incurring brokerage fees. The last time PREH was trading at $0.95 was around Jan2016. Since then it has trended downwards and last closed at $0.69 on Friday. 

2. Greater flexibility in management. Privatizing the company can free up resources to focus on PREH's strategic objectives rather than pandering to shareholders and the market's short-term whims and fancies. Additionally, a privatized PREH can save on expenses related to maintaining the listing. 

3. Support future capital raising. The current low share price of PREH makes it difficult for PREH to raise capital from the equity markets without significantly diluting shareholders' interests. From the announcement, it seems like the consortium wants to secure a new long-term capital partner possibly at a better valuation from what the market is according to it now. This push for new investors and partners is also supported by their recent partial divestment of their stake in AXA Tower to link up with Alibaba. 

The deal prices PREH at 0.6x to its last declared NAV of S$1.584 per share. I believe that the discount would be even larger if we use a revalued NAV (RNAV) as some of its stake in assets were recently divested (111 Somerset and AXA Tower). The consortium is definitely getting excellent value in their privatization offer at a >40% discount. 

While current minority shareholders are selling low, they might not really have much of a choice given the even bigger discount that the public market is according to PREH. Plus if the consortium gets an extra 7.57%, they would be able to take over the entire company anyway. Current investors should hold on to PREH and accept the offer given by the consortium unless they are in dire need of cash urgently. 

When trading reopens, I expect share price to pop to around $0.94-$0.96 to reflect the uncertainty of deal completion and also the additional dividend not accounted for in the $0.95 offer. 

With market weakness setting in, real estate players continue to be trading at large discounts to NAVs and thus could be prime candidates for privatization (as the PREH deal shows). Off the top of my head, I recall that UIC's free float is around 11-12% and this is really close to the regulatory minimum of 10%. There has long been talk of privatizing UIC by controlling shareholder UOL however such talks were always quashed by the rivalry between UOL and the other substantial shareholder, the Gokongwei family. This rivalry could have softened with the passing of patriarch John Gokongwei in end-2019. I will address this potential in another post so stay tuned!