Privatisation deals on the Singapore Exchange (SGX) are usually successful as investors are keen to cash in on the premium over the market price prior to the deal. In my last blog post, I discussed whether investors are short-changing themselves by giving up long-term gains in return for quick short-term gains. In this post, we will dissect the various types of privatisations and explore whether investors should agree to the privatisation.
Privatisation by Parent Company
In this type of privatisation, a parent company will offer to buy out all remaining shares of a listed subsidiary that it does not already own. In most cases, the parent company would already have majority control of the subsidiary prior to the privatisation deal. Recent examples of such companies include Singapore Land and CapitaMalls Asia. Since the parent company already has majority control, the main reason for the privatisation could be because the subsidiary is undervalued by the market, hence, it makes sense to buy more of an undervalued subsidiary. In such a case, investors should reject the privatisation unless a good price is offered.
There are also privatisations by majority shareholders who want to take the company forward in a different direction. In such cases, investors should ask why the company cannot move in the new direction as a listed company. Granted, it is tedious and slow to seek shareholders' approval for changes in the company's business directions, but that should not be a good reason to deprive minority shareholders of a money-making opportunity. Investors should reject such privatisations unless a good price is offered.
A unique group of privatisations is by China companies listed on the SGX, which delist from the SGX only to be relisted overseas at much higher valuations. Examples of these companies include Man Wah, Sihuan Pharma and Want Want. Most of the China companies on the SGX are trading at low values as a result of poor corporate governance in some of the companies. Without privatisation, the shares would have continued to trade at low values, unless there is a change in trading environment for these companies. Thus, for these type of companies, it is reasonable to agree to the privatisation.
In this type of privatisation, a private equity fund will offer to buy out a company that they think is capable of generating large free cash flows. The company could either be generating large free cash flows now or has the potential to do so but is currently bloated. After succeeding in privatising the company, the private equity fund will load the company with large debts and extract most of the cash from the company. The company is left with little cash but lots of debts. In order to meet its debt obligations, the company will cut all unnecessary costs and the free cash flow generated is used to pay down the debts. After a few years, when the company has become leaner and paid down the debt to a satisfactory level, the private equity fund may choose to exit from the company by listing the company again. Examples of companies taken over by private equity funds include Amtek and MMI. In particular, Amtek was delisted in Aug 2007 and relisted in Dec 2010.
For companies that are generating large free cash flows, investors should reject the privatisation so as to enjoy the free cash flows generated, unless a good price is offered. But for companies that are bloated and have the potential to generate large free cash flows, it is better to cash in on the privatisation as the company would remain bloated without any change in management.
There are companies that take over other companies because they see synergies in both companies' operations. Examples of such takeovers include Frencken acquiring ETLA and Juken Technology and SATS acquiring Singapore Food Industries. When the takeover is successful, both the acquirer company and target company could leverage on each other's capabilities and/or cross-sell to each other's customers, thereby creating more value. As the increased value of the target company could only be realised as part of a bigger company, shareholders should agree to the privatisation at a reasonable price. They could consider buying shares in the acquirer company if it is listed, but the acquirer company should be studied on its own merits rather than just because it is taking over a company.
Privatisations happen for many reasons. Investors should assess whether they could maximise their value in the target companies by keeping them independent. If they are able to, they should reject the privatisation unless a good price is offered to compensate for the loss of future profits. If they are unable to, they should accept the privatisation at a reasonable price.
P.S. I am vested in CapitaMalls Asia and Frencken.
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