20-04-2011, 08:12 PM
We have to simply look at Hyflux's proposed $200m - likely to be up-sized to $400m, i.e. by 100%! - 6%p.a. cummulative pref share issue as just another way for the company to borrow money. And we should bear in mind that Hyflux will use the money from the pref share issue to invest in overseas greenfield water projects under various BOT, BTO, etc. investment structures, including the use of large amount of additional long-term non-recourse debts to be borrowed by the individual projects. While water projects appear basic and great, we should also bear in mind the usual risks, including potential sponsor related problems (e.g. Dubai, Libya, etc.) or default, cost overrun or delay, technical/engineering problems, change of rules/regulations in the host countries, tax issues, forex restrictions, etc. - and the fact that many of these risks just cannot be effectively 'boxed', and when any becomes a problem it will hurt and cause a major loss to Hyflux, and the company may not be able to handle/resolve them, even though Olivia Lum may try her best.
In such kind of high-profile issues, many local investors - insurance funds, wealthy individuals, laymen, etc. alike - are simply quite willing to part with their money because (1) Hyflux is a well-known and therefore perceived as an 'acceptable' name; and (2) the 6%p.a. yearly return is perceived as attractive, when compared with the prevailing low rates/yields from bank deposits, SG and stat board bonds, etc.
But the fact remains that Hyflux's proposed pref share issue is a quasi or near equity risk. There should be no argument that the actual underlying risk is closer to equity, as Hyflux will use the money to inject into stand-alone water projects as equity or subordinated (to the projects' non-recourse lenders) shareholders' loans. 2 relevant questions: (1) What is a reasonable yearly return for such kind of risk?; and (2) Is a return of 6%p.a. good enough? For me, the answer for (2) is definitely a "No". We just have to bear in mind that even for a leading local bank like OCBC, most smart investors or institutions would expect a projected return of 12%p.a. before they will bite on a new major equity fund-raising deal by the bank. O.K., people may argue that pref shares are not as risky as equity, but neither is Hyflux as safe as OCBC. Perhaps a fair return is 10%p.a., and 6%p.a. is just not good enough for the underlying risk.
If my above argument is true, then after its issuance and listing, a more rational Mr Market, having understood the underlying risk, may choose to price the Hyflux pref shares at an expected yield of 10%p.a. instead, which means that its market price will have to go below its par. If for whatever reason Hyflux misses a dividend payment on the pref shares, I think in all likelihood Mr Market will choose to price it like a 'junk bond', in which case the market price will almost certainly fall below its par.
I was very disturbed when I first read that Hyflux could up-size the proposed pref share issue by 100%, to $400m, and DBS (as Arranger) is supporting it. A relevant question: If the original deal size is a well-conceived one by Hyflux's CFO, Olivia Lum and the BOD, and supported by professional advice from DBS - and is duly structured based on Hyflux's projected funding requirements and borrowing capacity - under what circumstances now can the company justify doubling the amount to be raised?? It appears totally irrational!!
If not because of desperation, why would Hyflux take on a new debt load of $400m which incurs 6%p.a. in cost in one single go? For sure, Hyflux can never deploy the entire $400m sum quickly into new water projects. So at best as a gap measure the money could be applied to pay down its outstandinfg bank debts which cost 3+%p.a. That means from Day 1, Hyflux's shareholders will have to suffer and pay for a negative funding cost burden of 2+%p.a. on $400m, before counting the issuance fees and other expenses (legal, PR, SGX related, etc.). I am just happy that I am not a shareholder!
Let's be rational! - Investors should not just look at the "Hyflux" name and the 6%p.a. yield to invest in the proposed pref shares.
In such kind of high-profile issues, many local investors - insurance funds, wealthy individuals, laymen, etc. alike - are simply quite willing to part with their money because (1) Hyflux is a well-known and therefore perceived as an 'acceptable' name; and (2) the 6%p.a. yearly return is perceived as attractive, when compared with the prevailing low rates/yields from bank deposits, SG and stat board bonds, etc.
But the fact remains that Hyflux's proposed pref share issue is a quasi or near equity risk. There should be no argument that the actual underlying risk is closer to equity, as Hyflux will use the money to inject into stand-alone water projects as equity or subordinated (to the projects' non-recourse lenders) shareholders' loans. 2 relevant questions: (1) What is a reasonable yearly return for such kind of risk?; and (2) Is a return of 6%p.a. good enough? For me, the answer for (2) is definitely a "No". We just have to bear in mind that even for a leading local bank like OCBC, most smart investors or institutions would expect a projected return of 12%p.a. before they will bite on a new major equity fund-raising deal by the bank. O.K., people may argue that pref shares are not as risky as equity, but neither is Hyflux as safe as OCBC. Perhaps a fair return is 10%p.a., and 6%p.a. is just not good enough for the underlying risk.
If my above argument is true, then after its issuance and listing, a more rational Mr Market, having understood the underlying risk, may choose to price the Hyflux pref shares at an expected yield of 10%p.a. instead, which means that its market price will have to go below its par. If for whatever reason Hyflux misses a dividend payment on the pref shares, I think in all likelihood Mr Market will choose to price it like a 'junk bond', in which case the market price will almost certainly fall below its par.
I was very disturbed when I first read that Hyflux could up-size the proposed pref share issue by 100%, to $400m, and DBS (as Arranger) is supporting it. A relevant question: If the original deal size is a well-conceived one by Hyflux's CFO, Olivia Lum and the BOD, and supported by professional advice from DBS - and is duly structured based on Hyflux's projected funding requirements and borrowing capacity - under what circumstances now can the company justify doubling the amount to be raised?? It appears totally irrational!!
If not because of desperation, why would Hyflux take on a new debt load of $400m which incurs 6%p.a. in cost in one single go? For sure, Hyflux can never deploy the entire $400m sum quickly into new water projects. So at best as a gap measure the money could be applied to pay down its outstandinfg bank debts which cost 3+%p.a. That means from Day 1, Hyflux's shareholders will have to suffer and pay for a negative funding cost burden of 2+%p.a. on $400m, before counting the issuance fees and other expenses (legal, PR, SGX related, etc.). I am just happy that I am not a shareholder!
Let's be rational! - Investors should not just look at the "Hyflux" name and the 6%p.a. yield to invest in the proposed pref shares.