Innopac Holdings Ltd - Did the Megapoint factory at Tanjung Malim ever exist?

12/10/2013 – Profitability is a key measure of a company's success. In theory, profits come about as a result of higher sales and well-managed costs.

But imagine if you could boost profit independently of revenue, without revaluing buildings or changing depreciation policies.

Here's how: buy a company under the guise of diversifying your business. Let those companies fail, or report that they have failed. Sell them to a friend, together with their liabilities. And with those liabilities off the books, you can register a windfall profit.

Let's see whether this methodology applies to Innopac Holdings' acquisition of a company called Mega Highlights Sdn Bhd.

Innopac was supporting a Management Buyout of DRB-Hicom's commercial vehicle assembly business, Hicom Carriage Engineering Sdn Bhd.

Perhaps the parties involved can answer the following sets of Questions and explain some of the mysteries surrounding the following string of events. We would of course be happy to publish their answers and explanations. But unless there is some credible explanation offered by these parties, the string of events seem to suggest that when things turned sour, a minority stake turned into a full takeover, and it sold it some years later for a peppercorn fee, registering a significant profit in the process.

The money that was invested and loaned is gone, and the numbers are later reported to be different than at the time of the transactions.

Investor Central. We keep your investments honest.

Question

1. Why couldn't it put to use one of the only four automobile manufacturing licences in Malaysia?

Here is what happened:

Hicom Carriage Engineering was incorporated on May 13, 1994, to make, assemble and market buses, bus bodies and associated transport equipment.

But by late 1997, its owner DRB-Hicom was suffering from the downturn resulting from the Asian currency crisis. Hicom Carriage Engineering was making deep losses, and, with a future which DRB-Hicom described as "bleak", it was looking to divest Hicom Carriage Engineering in a fire sale.

It found a buyer in Hicom Carriage Engineering's own CEO, Khoriri Abu Sabri.

He was to pay RM 850,000 in six instalments over three years, for an 85% stake. DRB-Hicom retained the other 15%.

We know this from DRB-Hicom Bhd's announcement to this effect on November 19, 2001.

In order to buy Hicom Carriage Engineering Sdn Bhd, Khoriri had incorporated Mega Highlights a month earlier, on October 12, 2001, together with Borhan bin Kassim.

Also, Hicom Carriage Engineering Sdn Bhd was renamed as Mega Commercial Vehicle Sdn Bhd (MCV).

The transaction was completed on March 30, 2002.

Innopac, via its wholly-owned subsidiary Awana Rentak Sdn Bhd, bought a 30% stake in Mega Highlights Sdn Bhd on November 28, 2005, by subscribing to new shares in Mega Highlights for a cash consideration of RM 42,857.
Innopac said MCV had built 700 vehicles worth RM 270 mln, and the stake in Mega Highlights was "a rare opportunity to participate in the relatively uncrowded commercial vehicle market in Malaysia".

That's because, according to its announcement on November 28, 2005, MCV held one of the four full automobile manufacturing licenses issued by the Malaysian Government.

Sometime after April 2004, Mega Highlights had signed an agreement with the Perak State Development Corporation to buy 48.3 acres of land in Tanjung Malim, to build an assembly plant for commercial vehicles.

It was to be a single storey building measuring 100 metres x 33 metres x 7 metres, to be built over just two months in November 2005 by CPE Builders Sdn Bhd for RM340,000.

CPE Builders was to later sue over the deal.

At the time of announcement in November 2005, the construction of the Megapoint Commercial Vehicle Industrial Park factory was underway, and production of vehicles was expected to start in the first quarter of 2006.

In the first phase, it planned to build 750 vehicles a year.

The next phase of development would raise production capacity to 3,000 buses and trucks a year.

Apart from the acquisition of that 30% stake in Mega Highlights, Innopac also extended a RM2 mln interest-free loan to the company to build the production facility.

The loan was secured by an irrevocable and unconditional guarantee by Khoriri Abu Sabri, the 70% shareholder of Mega Highlights.

Sofar, the story is easy enough to understand: Innopac was seemingly supporting a management buyout of an asset with good potential.

But this is where it started to get complicated.

In response to SGX queries on November 30, 2005, Innopac disclosed the Net Asset Value (NAV) of Mega Highlights was negative RM1.1 mln as at October 30, 2005.

In other words, Mega Highlights had net liabilities of RM1.1 mln.

Innopac said it had paid more than RM 40,000 in cash for its 30% stake as a nominal fee, because of the intrinsic value of the full manufacturing license and the land for the Megapoint Industrial Park.

But the book value was only RM 245,315, implying that while intangible value outpaced its liabilities, it's still a small amount, in the context of the RM 270 mln in sales value MCV was supposed to have generated when it was still called Hicom Carriage Engineering.

Further, in the same announcement, in reply to an SGX query on why Innopac extended a loan interest-free, despite owning just a minority stake of 30% in the company, Innopac said the loan was a condition of the 30% stake purchase.

Almost a year later, on September 6, 2006, Innopac signed a supplementary loan agreement with Mega Highlights to raise the loan amount to RM2.5 mln from RM2 mln earlier.

But the loan was no longer interest-free and would carry an interest rate of 5% pa, back-dated to July 1, 2006.

The loan was to be repaid with interest before June 30, 2007.

But it didn't happen.

A few months later, on August 21, 2007, Innopac announced that Mega Highlights defaulted on the RM 2 mln loan and therefore, Innopac invoked a claim over Khoriri Abu Sabri's 70% stake in the company.

Also, Mega Highlights would settle part of the loan by issuing 2 mln fresh shares at RM1/share to Innopac.

As a result, Mega Highlights became a wholly-owned subsidiary of Innopac.

As was its right, Innopac appointed its own directors, namely, Innopac's Chairman Dato' Moehamad Izat Emir, Director Md. Abdul Wahab bin Md Shahir and Managing Director Wong Chin Yong.

Innopac's August 21, 2007 announcement said this about Mega Highlights:

"It had successfully designed and built two prototype buses in late 2006 and was scheduled to commence commercial production in early 2007, However, this did not materialise. The directors are reviewing Mega Highlights' business and evaluating its future plans".

According to Innopac's circular to shareholders on November 5, 2007 (page 27), Mega Highlights completed the construction of its factory in May 2006.

So, the production facility was ready by mid-2006, behind the original target of Q1 2006, but it could not kick start commercial production for unnamed reasons.

Overall, Innopac had lost its RM 2.5 mln loan and the RM 42,857 it paid in cash for the initial 30% stake in Mega Highlights.

So, that's about RM 2.54 mln loss on investment.

But some things don't add up.

Innopac's Annual Reports reveal a lot more about the deal and various other transactions surrounding it.

According to page 74 of the 2008 annual report, Innopac invested S$ 2.01 mln in Mega Highlights before acquiring a 70% stake in it.

At the conversion rate at the time, this works out to about RM 4.5 mln.

This was RM 2 mln more than the RM 2.54 mln Innopac disclosed to the market.

Therefore that begs the question:

Question

2. When did Innopac invest an additional RM 2 mln in Mega Highlights? And when was this announced to shareholders?

We couldn't find any such disclosures.

But the story continues.

On June 4, 2007, Innopac sold MCV to Mohamed Azhar bin Haron for a token RM1.

This is important for two reasons: first, the date of June 4, 2007.

Question

3. Did Innopac keep the investors in dark about the actual state of affairs at MCV?

Innopac's 2008 annual report also says that it took control of Mega Highlights on May 21, 2007.

But this was about six weeks before the deadline for Mr Khoriri to repay his loans.

The date was also exactly three months before it even acknowledged that there were problems at Mega Highlights.

That August 21 announcement said it was reviewing Mega Highlights' business and evaluating future plans – but it had actually already sold the MCV business six weeks earlier!

Second, the token sum for which it sold MCV was just that, a token. It was worth next to nothing.

But for Innopac, this RM1 turned into a S$7.9 mln gain.

That's because MCV had accumulated S$7.9 mln in net liabilities (refer page 63 of the2007 annual report).

Therefore, by selling the company, Innopac could book an accounting gain of S$7.9 mln, having offloaded those liabilities for a single Malaysian Ringgit.

But why would someone buy your liabilities – unless he owes you something, or you are selling him a highly-undervalued asset which he can sell to repay liabilities.

In both the circumstances, Innopac would have to have revealed the scheme of arrangement between the buyer and seller.

If the buyer owed Innopac something and in return was taking over Innopac's liabilities, it means Innopac would have to write off that receivable.

And if MCV and MH had highly undervalued assets on their books, Innopac should have informed the shareholder the market value of business on the date of the sale.

But it didn't – at least, not that we could find it.

That leads us to the next question:

Question

4. Did it sell highly valuable assets of MCV for only RM 1?

Well, had it revalued the undervalued assets, the net liabilities would have shrunk, or even translated into net assets, thereby reducing the accounting gain Innopac could show in its P&L.

We couldn't know if that was the case, unless we have the management's response.

Just to highlight the significance of the one-time accounting gain from the disposal, had Innopac not booked this gain, FY07 earnings would have swung to a net loss of S$3.36 mln, as opposed to the S$4.56 mln net profit it eventually showed for that year.

This would have meant 1.9 times larger net loss in FY2007 compared to FY2006.

Still, many more questions need to be asked.

Question

5. Who would buy a company with S$7.9 mln of liabilities which are not backed by assets?

Even if you consider the full manufacturing license as highly valuable, this was carried at a very small sum on the books of Mega Highlights.

Question

6. What benefit could Mohamed Azhar bin Haron get from buying MCV, when the land and factory was still owned by Mega Highlights?

Question

7. What stopped Megapoint from starting commercial production when the site was ready in 2006, having successfully produced several prototype buses?

Question

8. What happened to the automobile manufacturing license, claimed to be one of only four in Malaysia? Was it still valid at the time MCV was sold?

In fact, we could wonder whether Hicom Carriage Engineering had such a license to begin with.

It was a subsidiary of DRB-Hicom before it was sold to Mega Highlights. It would seem logical that DRB-Hicom had one manufacturing license – which applied to all its subsidiaries.

Assuming this is correct, why did Innopac's announcement say that Hicom Carriage Engineering has one of the four licenses? Why would DRB-Hicom sell Hicom Carriage Engineering if it had a separate full manufacturing license?

Question

9. Why was Hicom Carriage Engineering wasting time assembling buses and trucks when it knew that the market for these vehicles wasn't good?

Why did it not start producing cars if it really had a 'full' manufacturing license?

Question

10. When did Innopac announce the sale of MCV?

We couldn't find any announcement immediately after the sale was executed in June 2007.

The first reference we could find to it was in January 2008, six months later.

Question

11. Was MCV actually wound up?

According to DRB Hicom's announcement on May 2, 2003, the New Straits Times 29 April 2003 edition published an advertisement of petition for the winding-up of Hicom Carriage Engineering Sdn Bhd (later renamed as MCV).

Who filed the petition and on what grounds?

Did the petitioner succeed in winding-up MCV?

Why didn't Innopac highlight such a critical fact at the time of acquiring Mega Highlights and MCV?

Moving on, things at Innopac, after the disposal of MCV, got even more complicated.

After selling MCV in June 2007, Innopac didn't revive the operations at Mega Highlights (refer page 8 of 2008 annual report).

Apart from a big chunk of liabilities, namely S$ 13.69 mln as per page 74 of the 2008 annual report, Mega Highlights was left with the only two fixed assets Innopac acquired – leasehold land and the factory under construction.

We already know that Mega Highlights had signed an agreement with the Perak State Development Corporation in 2004 to buy the leasehold land to set up its factory.

But this is what we never knew, until a revelation in Innopac's 2011 annual report:

'By a novation agreement signed by the Perak State Development Corporation, Mega Highlights and Awana Rentak Sdn Bhd on 30 December 2009, the leasehold land was to be owned and registered in the name of Awana Rentak instead of Mega Highlights'.

Recall, Innopac used Awana Rentak, its wholly-owned subsidiary, to acquire Mega Highlights in 2005.

Subsequent to the novation agreement, due to various issues, the title of leasehold land was finally transferred to Awana Rentak in 2012 (refer page 61 of 2012 annual report).

In 2011, Innopac reclassified the leasehold land to 'investment property' saying: 'the Group has decided to hold it for other than the original purpose of developing an automotive hub. The Group is exploring alternative opportunities for this leasehold land' (refer page 47 of 2011 annual report).

Question

12. Did the Megapoint factory at Tanjung Malim ever exist?

A strange contradiction has emerged from the information in Innopac's 2005-2006 announcements and its annual report for 2012.

In its announcement on November 28, 2005, Innopac said that Mega Highlights signed the lease agreement with the Perak State Development Corporation, to acquire a 48.3 acres land in Tanjung Malim, after April 2004.

This is repeated in Innopac's 2011 annual report (page 68), where it says that Mega Highlights signed the lease agreement with the Perak State Development Corporation in 2004.

But in its 2012 annual report (page 61), Innopac says the land has a lease period of 99 years expiring on February 12, 2106.

So, that means the lease agreement commenced on February 12, 2007.

That is a good three years later than Innopac and Mega Highlights' claims in several previous announcements.

What could possibly have led to this three-year gap?

How could Mega Highlights construct the factory at the leasehold land in 2005-2006 when it didn't even own the lease in those days?

Innopac said that the construction of the factory was completed in late 2006 and it had produced two prototype buses at the factory.

But the factory couldn't commence its commercial production due to mysterious reasons (mysterious because Innopac never shared the reasons).

That would mean the factory was built and failed to commence commercial production just weeks before the lease was granted on February 12, 2007.

That makes us wonder if the factory existed in those days.

Could this be the reason why the commercial production never happened?

Question

13. Does Innopac have anything in common with Enron in the way it disposed of liabilities?

First of all, Innopac paid cash to acquire net liabilities of Mega Highlights.

In 2007, Mega Highlights and MCV became wholly-owned subsidiaries of Innopac.

Therefore, both these subsidiaries and their assets and liabilities would have reflected on Innopac's book, for the first time, on December 31, 2007.

But before the net liabilities of both these companies could appear on Innopac's books, MCV was sold, together with its S$7.9 mln net liabilities, to Mohamed Azhar bin Haron for RM1.

By doing so, Innopac recorded an accounting profit of S$7.9 mln in its 2007 profit statement.

In simpler terms, MCV's liabilities were translated into profit (non-cash) even before these liabilities could have appeared on Innopac's Balance Sheet on December 31, 2007.

So, what's the big deal?

Well, not only did this S$7.9 mln gain bring Innopac into a net profit position for 2007, but also wiped-off about a third of accumulated losses on its Balance Sheet.

So, those net liabilities of MCV, which would have figured on liabilities side of Innopac's Balance Sheet and correspondingly increased the 'goodwill' on the assets side, ultimately reduced the accumulated losses of the company.

In 2012, the sale of Mega Highlights generated similar accounting gain of S$0.8 mln for Innopac.

Again, the buyer was some unrelated party, Mr Vijayan A/L Gopal, who bought S$0.8 mln net liabilities for a consideration of RM1.

Probably, both these transactions are not illegal as the Auditors have already approved the disposal of MCV and resulting gain in 2007.

But the bigger question is – should companies be allowed to adopt such transactions to beautify their books?

Just imagine if every listed company in Singapore, Malaysia, or anywhere in the world buys companies with net liabilities, only to sell them off to a private entity for free, and mints millions of dollars in gains in the process.

As a result, the listed companies will go debt-free and even wipe off accumulated losses.

Perhaps the parties involved can provide some credible explanations as regards the above string of events and mysteries? We would be happy to provide their rationale and explanations (or any other alternative theories offered by any of our readers).

But if they do not, and there is no other logical analysis other than that set out above, it begs the question:

Isn't this just what Enron did?

We have sent these questions to the company (info@innopacific.com) and its IR agency, August Consulting Pte Ltd ( lily@august.com.sg), to invite them for an on-camera interview, and/or seek their written response.

Sofar, we have not had a reply (which is why you are seeing this message).

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