King Wan Corporation Limited - MANAGEMENT REPLY: Why is it lending so generously to companies it doesn't control?

11/3/2014 - King Wan Corporation Limited says Kaset Thai Industry Sugar Company Ltd (KTISC) has deferred plans to list on the Stock Exchange of Thailand (SET).

In June 2012, King Wan Corporation sold its entire stake in two of its associates in Thailand to KTISC for S$50.2 mln.

While KTISC had paid S$2.6 mln cash (being 5% of the entire consideration) at that time, the remaining 95% consideration was agreed to be paid in terms of new shares upon its listing on SET.

On August 16 last year, the Office of Securities and Exchange Commission in Thailand approved KTISC's listing plans.

But due to political unrest in Thailand, KTISC has been deferring the launch of its IPO for the past six months.

And now, it has approached the Office of Securities and Exchange Commission in Thailand to seek the extension of approval to launch an IPO by August 15 this year.

Therefore King Wan Corporation will have to wait for another few months to receive the remaining 95% of the sale consideration.

Before we delve deeper into the deal, let us look at King Wan Corporation's recently announced earnings for Q3 FY14:

Revenue: +128% to S$25 mln
Profit: -96% to S$0.7 mln
Other income: S$1.2 mln vs S$0.3 mln
Cash flow from operations: (S$3.4 mln) vs S$9.3 mln
Dividend: Nil
Order book: S$166 mln over 3 years

Due to lower margin mechanical and electrical contracts, King Wan Corporation's gross profit margin plunged to 8% from 30.9% in the same quarter last year.

Also, administrative expenses increased 24% and finance costs surged 1.75 times.

Its share of associates' losses was S$0.6 mln compared to a profit of S$0.3 mln last year.

Net gearing has surged to 0.31x on December 31, from 0.18x on March 31.

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

Question

1. When will its associates start servicing interest on loans?

In Q3, King Wan Corporation recorded a more than 12 times higher interest income.

For the first nine months of FY14, the interest income has surged more than tenfold.

According to page 2 of the Q3 earnings report, its interest income was derived mainly from loans made to its associate companies.

A quick look at King Wan Corporation's FY13 annual report (page 41) shows loans worth S$49 mln were due from associates on March 31, 2013.

Of that, only S$23 mln bears interest at 2.5% to 5% per annum.

That means, the remaining S$26 mln worth of loans are interest-free.

Moreover, all of the S$49 mln loans are unsecured and repayable on demand only in the long-term.

To add to that, so far in FY14, the company has loaned S$5 mln more to its associates (refer page 5 of Q3 earnings report).

So, King Wan Corporation's associates owed it about S$54 mln as on December 31.

That amount is double its revenue in the third quarter.

In FY13, the company recorded S$1.2 mln interest income from associates (refer page 54 of the annual report).

But page 14 of the annual report shows that it earned only S$0.2 mln of that in cash during the year.

And so far in FY14, out of S$1.5 mln interest income, it has received only S$0.08 mln in cash.

Therefore, King Wan Corporation's associates are not paying the interest upfront.

That makes us wonder when the associates will start servicing the interest on the loans – and eventually repay them?

Management Reply: As part of its investment strategy, King Wan, together with its joint venture (JV) partners, provide loans to its associated companies. These associates deal primarily in the development of residential and commercial projects in Singapore and China. Under these arrangements, the associates will commence servicing their interest on loans when they start to have positive cashflow from the projects they have undertaken.

Question

2. Why did it extend unsecured and interest-free loans to its associates?

As on March 31, S$26 mln worth of loans to associates were unsecured and interest-free.

And we don't know if the S$5 mln fresh loans made so far in FY14 are also unsecured and interest-free.

Now, on page 49 of its FY13 annual report, King Wan Corporation said that its share of associates' net assets was just S$6.6 mln on March 31.

That means, if King Wan Corporation were to recover its S$12 mln investment in associates and S$49 mln loans to associates, it would have fetched only S$6.6 mln on March 31.

Despite that, the company made fresh loans to associates in FY14.

And because these S$54 mln loans are unsecured, the risk remains the highest.

Therefore any reasonable investor would wonder why King Wan Corporation is lending so generously to the companies which it doesn't control.

Management Reply: King Wan Corporation Limited provides corporate guarantees to financial institutions in order for its associates and subsidiaries to secure banking facilities for their operations. By doing so, it is required to recognise additional deemed interests in these associates and amortise this as an income throughout the tenure of the guarantee. This provision is made regardless of whether an actual guarantee fee has been charged to the associates. The “S$0.4 m fee income from financial guarantees to associates” relates to this provision. In general, King Wan’s interests in its associates range from 30% to 49%. Other JV partners’ interests in these ventures are also 50% or lower. The associates are operated based on the collective decisions of King Wan and its partners via their respective representation in the board of directors. No one partner is deemed to have a dominant controlling stake in the associates.

Question

3. Which associates did it lend S$54 mln to?

While page 47 of the annual report names various associates of the company, it doesn't specify which associates have borrowed the money.

(Total number of questions in the full story: 12)

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