Hyflux Ltd - Should it have sought shareholder approval before selling the Hyflux Innovation Centre?

3/7/2014 –Hyflux Ltd has sold its Hyflux Innovation Centre to Ascendas REIT for S$170 mln in cash.

Located at 80 Bendemeer Road, Singapore, the Hyflux Innovation Centre is the registered office of Hyflux.

Hyflux has agreed to lease back about 50% of the property from Ascendas REIT for 15 years on ‘customary terms and conditions’.

At present, the property has an occupancy rate of 83.9%.

Apart from the rental for the space it occupies, Hyflux will also pay Ascendas REIT for any vacant space at the property for the next three years.

Hyflux plans to use the S$170 mln sale proceeds for R&D, expansion and automation of membrane manufacturing operations at Tuas Hub, and for financing its infrastructure tenders.

Hyflux estimates a gain of S$84 mln on the divestment of the 10-storey property.

Analyst Tan Ai Teng at DBS Group Research says the sale of the Hyflux Innovation Centre will reduce the company’s gearing ratio to below 0.5x.

Despite revising its FY14 PATMI estimate to S$156 mln from S$44 mln previously, the broker remains sceptical about a turnaround in its core operations.

According to the research report, Hyflux is aggressively bidding for projects in Oman, Nigera, India and Singapore, but it hasn’t secured any orders yet.

DBS Group Research believes the divestment proceeds will help it execute the new projects.

However, the broker feels Hyflux’s stock will remain range bound in the absence of an operating turnaround, major order wins and a fast-track execution of its Indian project.

DBS Group Research maintains a HOLD rating on the stock with a revised target price of S$1.33, compared to S$1.23 earlier.

Investor Central. Asian insights for global investors. We ask the tough questions of Asian companies which global investors need answers to.

Question

1. Why did it sell the Hyflux Innovation Centre for less than its market value?

According to Hyflux’s announcement, the S$170 mln price tag for Hyflux Innovation Centre was arrived at on a ‘willing buyer willing seller’ basis.

Ascendas REIT was more specific.

On slide 3 of its presentation, it revealed that DTZ Debenham Tie Leung (SEA) Pte Ltd estimated the property to be worth S$197 mln.

That means, Hyflux sold the property at a 14% discount (or S$27 mln) to its market value.

That seems like a fairly steep discount which, at face value, raises the question why it sold the property so cheaply.

But there's more to it than that: the so-called land premium.

In February last year, Business Timesreported that industrial REITs can no longer avail a monthly land rental facility of JTC.

Instead, they have to pay an upfront land premium for the remaining period of the lease.

Only end users of the land could pay the land lease on a monthly basis.

According to the news report, the monthly rental scheme is attractive as the rent is payable every month in advance and the rental rate is revised annually subject to a 5.5% escalation cap.

Moreover, the rent would fall if the property market goes down.

That means, had Hyflux not sold the property, it could have continued to pay the land rental on a monthly basis to JTC.

But because Hyflux sold the property to Ascendas REIT, the Trust has to pay an upfront land premium for the remaining 24.5 years of lease to JTC.

That works out to S$21.2 mln.

So, excluding the transaction costs, the acquisition of Hyflux Innovation Centre will cost Ascendas REIT about S$191.2 mln.

Based on that, one can argue that Hyflux sold the property at an effective discount of about 3% to the market value of S$197 mln.

But that’s not the case.

Had it sold the property to another end user, the buyer could have continued to avail the monthly land rent payment facility.

Therefore the argument that Hyflux agreed to a S$27 mln discount as a goodwill gesture because Ascendas REIT had to pay an upfront land premium to JTC seems unjustified.

In other words, another end-user, who could have availed the monthly rental scheme, might have paid a higher price for the property.

JTC owns a 17.17% deemed interest in Ascendas REIT.

Question

2. Why didn’t Hyflux disclose the market value of the property in its announcement?

We are curious to know why Hyflux didn’t disclose the market value of Hyflux Innovation Centre in its announcement, but Ascendas REIT did.

After all, companies just don’t sell properties for any amount of money without finding out the market value of it.

Also, why was the property carried on the books at such a steep discount to market value?

Total number of questions in the full story: 8)

We have invited the company (genevieve_woo@hyflux.com, marian_boon@hyflux.com) to an on-camera interview, and/or to reply to our questions in writing.

At the time of publication we have not received a reply (which is why you are seeing this message).

We will update this article if we do.

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