MPHB Capital Berhad - Will it be forced to divest non-financial services businesses in the near future?

18/6/2013 – Applications for shares in MPHB Capital Berhad close today, and the company will list on Bursa Malaysia on June 28, slightly later than planned earlier.

The company will hold the non-gaming businesses of Bursa-listed Multi-Purpose Holdings Bhd, after the recently completed demerger.

But based on the requirements of the Financial Services Act 2013 and the conditions set by the Ministry of Finance, MPHB Capital Bhd might be forced to go through another demerger process soon.

According to the new law, MPHB Capital Bhd can't pursue non-financial services businesses in Malaysia.

So, investors should not be surprised to hear further restructuring of MPHB Capital Bhd's business after the listing.

Several other questions pop up after reading the prospectus.

First, remarkably large revaluation gains on its properties.

Second, its top officers hold parallel interests in competing businesses.

Third, the company has not confirmed or denied a recent news report which suggested it was looking to sell the insurance business.

Fourth, the company has not yet announced the verdict of Shah Alam High Court, which was scheduled to be delivered on June 5.

Fifth, the underwriters are obliged to dump shares in excess of 5% of the company within six months. The underwriters will own almost 29%, so a quarter of the shares are set to be sold on the market by the end of the year.

Finally, the demerger of MPHB Capital Bhd aimed to create value for the shareholders of Multi-Purpose Holdings Bhd.

But if our calculations are right, instead of being rewarded, the shareholders will end up paying more.

MANAGEMENT REPLY

In response to our email seeking the management’s replies to our questions, Ms Kheoh And Yeng, MPHB Capital Bhd’s COO, said she could not reply because she would need more time to give detailed answers.

In another attempt to have at least some questions answered, Ms Kheoh replied she did not want to give us "bits and pieces", but also alleged our report contains misunderstandings.

Given that Ms Kheoh is not likely to reply ahead of the listing, but because of the public interest in the listing, we have decided to publish our report, as usual with references to page numbers in the prospectus, and leave it to you to decide whether we have "misunderstood" some of the points it contains.

If/when Ms Kheoh replies, we will naturally publish her answers in full and without delay.

Mark Laudi
Executive Editor
Investor Central

BACKGROUND

MPHB Capital Bhd is predominantly involved in general insurance and property investment.

The majority of its revenue and profit are contributed by its general insurance arm, Multi-Purpose Insurans Bhd (MPIB).

Its credit business makes a negligible contribution to the group's performance.

And its investment in 2,727.1 acres of properties is spread across Selangor, Kuala Lumpur, Penang and Johor.

These properties include Hotel Flamingo by the beach in Penang and Hotel Flamingo by the lake in Selangor.

According to the pre-IPO restructuring (page 47), Multi-Purpose Holdings Bhd sold the business to MPHB Capital Bhd for RM905.4 mln.

MPHB Capital Bhd paid by immediately issuing RM715 mln worth of new shares to Multi-Purpose Holdings Bhd and RM190.4 mln in cash (before so-called debt novation) over 18 months.

Subsequent to the allotment of new shares in MPHB Capital Bhd, Multi-Purpose Holdings Bhd sold all of its 715 mln shares at RM1/share to its existing shareholders in a ratio of one new share for every two shares already held.

As for the cash portion, Multi-Purpose Holdings Bhd will return the money to its shareholders by way of a capital reduction.

Further details can be found on page 5 of the prospectus.

FINANCIALS

These were the combined results of subsidiaries, now part of MPHB Capital Bhd, for the financial year ended December 31, 2012:

Revenue: +17.2% to RM325.6 mln
Profit: +42% to RM70.6 mln
Other income: +90.9% to RM79.4 mln
Cash flow from operations: RM143.4 mln vs RM20.4 mln

Multi-Purpose Insurans Bhd (MPIB) generated 75.9% of MPHB Capital Bhd's revenue and 71.1% of its pre-tax profit in 2012.

Within the insurance business, fire and motor insurance generated 63.7% of net premiums during the year.

On the other hand, the credit business hardly contributed anything: only 0.7% to the group revenue.

Investments of MPHB Capital Bhd contributed 23.3% of revenue, mainly generated from the operations at Hotel Flamingo in Penang and Selangor, the rental of an office building in Selangor, the operations of an oil palm plantation in Johor and the share of sale proceeds from a Joint Venture project.

Question

1. What method did the property valuers use that resulted in such massive increases?

MPHB Capital Bhd's properties were valued about 40% more in the prospecetus than their audited net book value on December 31, 2012.

Further, the value of some of the properties soared more than 100% in 2012.

This even though all these properties were revalued just a few months earlier, at the end of 2011.

For instance, Hotel Flamingo in Selangor was valued at RM82 mln on February 28, 2013 (refer page 90).

But according to anextract from Multi-Purpose Holdings Bhd's 2011 Annual Report, the hotel, built on 12.28 acres land, was valued at RM32.6 mln on October 7, 2011.

And in the year before that, the hotel was valued at RM38 mln on December 31, 2010.

So, while there has been some fluctuation in the value of the hotel, it more than doubled between October 7, 2011 and February 28, 2013.

In another case, 207.6 acres of freehold land was revalued at RM63.3 mln on February 28, 2013.

The same land was valued at RM31.5 mln on December 31, 2010 and December 31, 2011.

Again, the valuation didn't change at all during 2011 but it doubled between December 31, 2011 and February 28, 2013.

Hotel Flamingo by the beach in Penang was revalued at RM84 mln on February 28, 2013.

The hotel, spread across 2.3 acres, was valued at RM47.3 mln on October 7, 2011 and at RM49.6 mln on December 31, 2010.

Yet again, the hotel's valuation hardly changed during 2011 but went on to rise almost 80% thereafter.

Not only are these massive increases, but also fly in the face of market expectations.

In a recentreportin The Star online, an analyst said that a revaluation of properties, to be sold to MPHB Capital Bhd, was unlikely to have a huge impact, unless the independent valuers used a different valuation method.

Therefore that makes us wonder if these properties were valued way too conservatively before the IPO, or the gains on revaluation are due to a new, more aggressive valuation methodology adopted by the independent valuers.

Further details can be found on page 214 of the prospectus.

MPHB Capital Bhd's so-called Other Income almost doubled in 2012 due to a manifold increase in its gain on disposal of investment properties, and the write-back of previous year's impairment loss.

Its gain on disposal of investment properties increased to RM12.3 mln from RM0.6 mln, mainly due to compulsory acquisition of some its land by the Land Administrator of Kota Tinggi, Johor.

Question

2. What financial assets were impaired in previous years and why?

During 2012, MPHB Capital Bhd wrote back an impairment loss of RM3 mln on its financial assets.

GROWTH DRIVERS

MPHB Capital Bhd aims to grab a place among the top 10 general insurance providers in Malaysia by the end of 2015.

MPHB Capital Bhd's insurance arm, MPIB, was ranked 15th among the 26 general insurance companies (excluding Takaful providers) in Malaysia in 2010, according to a market research report, quoted in the prospectus.

MPIB also aims to maintain a risk-balanced portfolio of products with non-motor insurance making up 70% to 80% of its overall gross premiums.

In 2012, MPIB's non-motor portfolio contributed 74.8% to its overall gross premiums.

Question

3. How will it grow its agency network by 10%pa?

MPIB is already in a bancassurance arrangement with Alliance Bank Malaysia Berhad, to sell its insurance products to the customers of the bank.

Other than the aim to expand its branch network, MPIB plans to grow its agency network by 10% p.a. in the next three years.

Question

4. How many branches and agents does it have?

Sorry, but we couldn't spot in the prospectus the existing branch network and agency network of MPIB.

So, to say it aims for a 10% increase is meaningless for investors because they have no frame of reference of what the base number is.

Further, MPIB has a target to grow its gross premiums contribution from bumiputera brokers to RM50 mln by 2015 from RM35.3 mln last year.

It also aims to enhance the sale of its insurance products online.

Question

5. How much of its premiums are generated from online sales?

We couldn't find any mention of how much of its gross premiums are generated from online sales, so it's impossible to know whether its growth targets are conservative or aggressive.

Nor does it say how it plans to improve its online presence.

In the absence of growth targets and comparative numbers, a reasonable person would be forced to discount this unsubstantiated strategy as nice-sounding but meaningless.

Question

6. Which properties will it sell, which will it develop?

Finally, MPHB Capital Bhd plans to realise its investments in 2,022.7 acres of property by developing its land bank and selling properties when the opportunity arises.

Question

7. Will it be forced to sell non-financial services businesses in the near future?

According to page 110 of the prospectus, MPHB Capital Bhd will now be governed by the Financial Services Act (FSA) 2013.

The FSA deals with regulation and supervision of financial institutions, payment systems and the oversight of the money market and foreign exchange market.

One of the significant impacts of the FSA is the repeal of the existing Banking and Financial Institutions Act (BAFIA), Exchange Control Act (ECA), Insurance Act and Payment Systems Act (PSA).

Moreover, as soon as the FSA comes into effect, MPHB Capital Bhd may be required to submit an application to the Central Bank, Bank Negara Malaysia, for approval as a Financial Holding Company (FHC).

Once designated as an FHC, MPHB Capital Bhd will not be permitted to be in any business other than financial services, unless Bank Negara approves it.

Further, according to page 203 of the prospectus, the Ministry of Finance (MoF) has imposed a condition on MPHB Capital Bhd to rationalise its non-financial services businesses within three years from the date of completion of the restructuring.

And MPHB Capital Bhd is required to submit a detailed plan to Bank Negara on how it will rationalise its non-financial services business Bank Negara within three months of completion of the restructuring.

Just on the side we wonder whether MPHB Capital Bhd has been granted an exemption.

But it would appear not.

That means, by a reasonable person's reading of the prospectus, MPHB Capital Bhd will have to sell all its properties in the near future.

Question

8. Why did Multi-Purpose Holdings not retain the properties, instead of demerging them into MPHB Capital?

If our reading of the prospectus is correct, Multi-Purpose Holdings Bhd would have been better off keeping the properties.

Sure enough, it wants to focus on its gambling business, but it's going to prove a distraction for both companies.

Further details can be found on page 102 of the prospectus.

MANAGEMENT

Tan Sri Dato' Dr Yahya bin Awang is the Independent Non-Executive Chairman of MPHB Capital Bhd.

Dr Yahya has been the Chairman of MPIB since 2003.

Tan Sri Dato' Surin Upatkoon is the Managing Director.

In 1976, he became an Executive Director of MWE Holdings Bhd, one of the promoters of MPHB Capital Bhd.

In 2002, he was appointed as the Managing Director of Multi-Purpose Holdings Bhd, erstwhile owner of MPHB Capital Bhd.

Ng Kok Cheang is the Executive Director of MPHB Capital Bhd.

In 2002, he was appointed as the Managing Director of Multi-Purpose Holdings Bhd.

He resigned as the Executive Director of Multi-Purpose Holdings Bhd on May 14, 2013.

Dato' Lim Tiong Chin is the Non-Independent Non-Executive Director of MPHB Capital Bhd.

He was appointed Non-Executive Director of Multi-Purpose Holdings Bhd in 2002 and of MPIB in 2003.

Kuah Hun Liang is an Independent Non-Executive Director of MPHB Capital Bhd.

He is currently an Independent Director of Alliance Bank Malaysia Bhd, Alliance Investment Bank Bhd and Rexit Bhd.

As already mention earlier, MPIB is in a bancassurance agreement with Alliance Bank Bhd.

MPHB Capital Bhd had 725 employees on May 2, 2013 (page 120).

Question

9. Is it justified for its employees to own shares and hold directorship in a rival company?

Ms Kheoh And Yeng is the COO of MPHB Capital Bhd.

Mr Ong Kok San is the CEO of MPHB Capital Bhd's insurance arm, MPIB, since 2011.

Both, Ms Kheoh and Mr Ong are shareholders and directors of Asas Resource Holdings Sdn Bhd.

Asas Resource Holdings Sdn Bhd is a property development company with RM4.5 mln worth of properties in its portfolio as on December 31, 2012 (page 198).

The prospectus says the size of Asas Resource's portfolio is substantially less than that of MPHB Capital Sdn Bhd.

But in a larger context, a reasonable person would ask whether it is appropriate for top officers of MPHB Capital Bhd to own parallel interests in competing businesses?

Further details can be found on page 169 of the prospectus.

KEY RISKS

Ability to maintain Capital Adequacy Ratio (CAR)

According to Bank Negara's guidelines, insurance companies are required to maintain a minimum CAR of 130%.

Also, the insurance companies are required to maintain an internal target CAR which should be more than the Bank Negara's minimum requirement of 130%.

Multi-Purpose Insurans Bhd's (MPIB's) CAR stood at 222.8% as on December 31, 2012, comfortably higher than the minimum requirement of the Bank Negara.

But that could change.

For instance, a substantial underwriting loss might erode accumulated profits of MPIB leading to a lower CAR.

In such circumstances, Bank Negara might impose sanctions on MPIB if it fails to meet the CAR requirements.

In the worst case, the Ministry of Finance may assume control of property, business and affairs of MPIB.

Question

10. What is MPIB's internal target CAR?

Sorry but we couldn't spot the internal target CAR of MPIB in the prospectus.

Also, what would be the consequences if MPIB fails to meet its internal CAR?

Reinsurance risk

MPIB has a significant portion of its risks covered with the reinsurers.

It paid 47.1%, 49.9% and 48% of gross premiums to the reinsurers in 2010, 2011 and2012 respectively.

Despite paying almost half of its premiums to the reinsurers, MPIB doesn't guarantee that the reinsurers will be able to meet its claims at all times.

Therefore, MPIB will have to pay for the claims even after paying hefty premiums to the reinsurers.

Question

11. Why is it paying half of its premiums to the reinsurers if they cannot guarantee to settle its claims?

Intense Competition

MPHB Capital Bhd's insurance arm, MPIB, was ranked 15th among the 26 general insurance companies (excluding Takaful providers) in Malaysia in 2010.

Its market share (excluding Takaful insurance market) improved marginally to 3.5% in 2011, from 3.2% in 2010.

According to Wikipedia,Takaful, also known as Islamic Insurance concept, is a co-operative system of reimbursement in case of loss, paid to people and companies concerned about hazards, compensated out of a fund to which they agree to donate small regular contributions managed on behalf by an operator.

According to an market research report by Frost & Sullivan, the Takaful industry's gross premium clocked a CAGR of 15.8% from 2006 to 2011, compared to a CAGR of 7.1% for the general insurance industry.

Evidently, Takaful operators are a challenge to MIPB's business and its network of agents.

Apart from the Takaful industry, MPIB also faces intense competition from the general insurance companies owned by foreigners.

Recently, Malaysia allowed foreign shareholders to own up to 70% of general insurance companies, compared to an earlier restriction of up to 49%.

As a result, out of the 26 general insurance companies in Malaysia, 12 companies are majority-owned and controlled by foreigners.

Obviously, the foreign-owned insurance companies have greater appetite for risk and much deeper pockets to bear the claims.

Unauthorised construction at a property

MPHB Capital Bhd, through its wholly-owned subsidiary, Syarikat Perniagaan Selangor Sdn Bhd (SPSSB), owns a piece of land at lot 13501 in Mukim Hulu Kelang, District of Gombak, State of Selangor Darul Ehsan.

According to the condition imposed by the authorities, the land can only be used for guards' and keepers' quarters.

But the ground reality is the land has a Tenaga Nasional Berhad's sub-station and a network pumping station built upon it.

As a consequence of the breach of condition, the Selangor State Authority may forfeit the land and impose a fine on the company.

SPSSB has assured the Securities Commission Malaysia that it will ensure the compliance of the condition before December 31, 2013.

However, such an assurance doesn't guarantee that the SPSSB's ownership of the land will not be forfeited.

Question

12. Why did it violate the condition imposed on the land?

It seems SPSSB has leased the land to Tenaga Nasional Berhad which constructed a sub-station and a networking pumping station on it.

Was SPSSB not aware of the condition at that time?

Question

13. Will Multi-Purpose Holdings Bhd compensate MPHB Capital Bhd if the ownership of land is forfeited?

According to page 47 of the prospectus, MPHB Capital Bhd bought SPSSB from Multi-Purpose Holdings Bhd for RM75.8 mln.

The cash consideration for pre-IPO arrangement is payable within 18 months from the date of sale agreements.

We already know that SPSSB is the owner of lot 13501, which runs the risk of being forfeited.

Therefore that makes us wonder whether Multi-Purpose Holdings Bhd will compensate MPHB Capital Bhd if the ownership of lot 13501 is forfeited.

Also, will it compensate MPHB Capital Bhd for fines, if any, imposed by the authorities?

Underwriters to dump shares soon after the listing

According to page 26 of the prospectus, about 28.4% of the IPO is underwritten (ie, about 202.7 mln shares out of 715 mln shares on sale).

But Ministry of Finance Malaysia has laid down a condition that underwriters to the IPO shall dispose underwritten shares in excess of 5% of the issued and paid up capital of MPHB Capital Bhd within 6 months of the underwriting agreement (refer page 204).

Obviously, the sale of such a large number of underwritten shares will hurt the stock price after the listing.

Question

14. When within the six month period will the underwriters dump their shares?

Further details can be found on page 30 of the prospectus.

ONGOING LITIGATION

Question

15. Did the Shah Alam High Court rule in its favour on June 5?

Mulpha Kluang Maritime Carriers Sdn Bhd, a 70%-owned subsidiary of MPHB Capital Bhd, commenced legal proceedings against Liew Yee Tiam, Thong Honn (Housing Development) Sdn Bhd, and Messrs. Chin & Co on February 8, 2010.

Mulpha Kluang claims to have overpaid RM3.3 mln for the acquisition of lands from the defendants.

The hearing of the case in the Shah Alam High Court was concluded on November 19 last year.

The Court fixed June 5 for pronouncing the judgement.

So, how did the court decide?

Further details can be found on page 422 of the prospectus.

DIVIDEND POLICY

MPHB Capital Bhd cannot distribute dividends without prior approval of Bank Negara.

Bank Negara will permit distribution of a dividend only if it doesn't impair the Capital Adequacy Ratio.

As a result, MPHB Capital Bhd cannot have a formal dividend policy.

Question

16. Isn't a CAR of 222.8% good enough to distribute dividends?

As already mentioned, MPIB's CAR stood at 222.8% as on December 31, 2012.

Visibly, this is comfortably higher than Bank Negara's minimum requirement of 130%.

Therefore that makes us wonder why the company isn't committing itself to distributing a dividend, at least in 2013.

Further details can be found on pages 18 & 44 of the prospectus.

IPO PROCEEDS

RM 702 mln for capital repayment to shareholders of Multi-Purpose Holdings Bhd
RM 11.6 mln for listing expenses to be borne by Multi-Purpose Holdings Bhd
RM 1.4 mln for listing expenses to be borne by MPHB Capital Bhd

Question

17. Did the demerger really create value for the shareholders of Multi-Purpose Holdings Bhd?

In the restricted offer for sale, shareholders can buy one new share in MPHB Capital Bhd for every two shares held in Multi-Purpose Holdings Bhd.

Therefore, at offer price of RM1/share, Multi-Purpose Holdings Bhd will raise gross proceeds of RM715 mln from the sale of shares in MPHB Capital Bhd.

After paying for listing expenses, Multi-Purpose Holdings Bhd would be left with RM702 mln in net proceeds.

Now, Multi-Purpose Holdings Bhd will distribute the entire net proceeds to its shareholders by way of capital repayment exercise within six months from the date of the listing of MPHB Capital Bhd (subject to approval of the High Court).

Therefore, if everything goes to plan, the shareholders of Multi-Purpose Holdings Bhd will be paid about 48.5 sen per share in the capital repayment exercise (Source).

Now here is the thing:

Assuming a shareholder owns 100 shares of Multi-Purpose Holdings Bhd, he/she can subscribe to 50 shares (one for every two) of MPHB Capital Bhd for RM50 (at the offer price of RM1/share).

After the listing of MPHB Capital Bhd, Multi-Purpose Holdings Bhd will pay RM48.5 to the shareholder for his 100 shares, in the capital repayment exercise (based on 48.5 sen repayment per share).

Apparently, the entire process is nothing but transferring money from one pocket to another.

Rather than "unlocking value", it seems to us that the shareholders of Multi-Purpose Holdings Bhd end up paying about 1.5 sen per share in the demerger of MPHB Capital Bhd.

Therefore that leaves us wondering what value Multi-Purpose Holdings Bhd unlocked from the demerger and the listing of MPHB Capital Bhd.

Unless the share price of both companies goes up, didn't the shareholders end up paying more out of their pockets?

And on a more fundamental point:

Question

18. Why could Multi-Purpose Holdings Bhd not keep the entire demerger much simpler by distributing new shares of MPHB Capital Bhd as dividend-in-specie to its shareholders?

Further details can be found on page 24 of the prospectus.


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