A bird in hand…
Although the news took the market by surprise, perhaps it is not totally unexpected. Investors have, arguably, consistently undervalued the company. Prior to the general offer, the stock was trading at RM17.58 — valuing Tanjong at just about 11 times our estimated earnings for FYJan2011.
This is well below prevailing valuations for power and gaming companies — for instance, shares for YTL Power and Berjaya Sports Toto are trading at approximately 14 times forward earnings — as well as the broader market’s average P/E of roughly 15 times.
The general offer, 24% above the pre-announcement price, effectively re-rates the stock to about 13.9 times our forward earnings estimates. The breakup value for Tanjong is estimated at around RM22.50 per share — although this has not taken into account Tropical Islands, which is somewhat hard to value at the moment given its loss-making status and the uncertain time frame for a turnaround. Tanjong acquired the business for about €17.5 million and is estimated to have invested up to €130 million (RM541.9 million) in the resort.
Thus, taking a snap shot view, the GO pricing is a relatively fair valuation for Tanjong. In this respect, minority shareholders will be, understandably, tempted to accept the offer.
Or two in the bush?
On the other hand, hanging on to Tanjong’s shares will allow investors to participate in the company’s future growth. And the prospects, particularly in the power sector, are good.
It has successfully bid for power assets with effective generating capacity of some 2,261MW in 2006-2007. The subsequent global economic downturn resulted in few new projects. But with the recovery, there are now quite a number of greenfield power projects on the block, including those in the UAE, Egypt, Bangladesh, Oman and Saudi Arabia — a region where Tanjong has already an established track record as one of the larger private power generators.
Thus, the company is fairly upbeat on its chances to secure some of these projects. Management has indicated it could double the existing power generating capacity of 3,951 MW within the next four to five years.
Assuming a similar level of returns as its current portfolio of overseas power assets, a 2,200-4,500MW capacity addition priced at just 11 times future earnings — all else being equal — could translate into compounded annual returns of between 15%-22% for investors based on the pre-announcement share price.
Note that earnings for power generators are lumpy. There is a typical two to three years gestation period from award to commissioning, which means that earnings will be flattish until the plant is up and running, whereby earnings will register a steep increase.
As such, gains in the stock price — tracking earnings — would also be back loaded. This is different from the more usual gradual, yearly earnings growth pattern but we have calculated the equivalent annual compounded growth rate for comparative purposes.
Upfront gains vs longer-term returns
In short, minority shareholders should weigh the upfront gains from the general offer against the potential returns on the stock over, say, the next four years.
For those who intend to stay invested in local equities, we estimate they will have to find alternative investments that give consistent returns exceeding 9%-16% per annum — to make accepting the offer worthwhile.
While that may not seem too far a stretch, investors should also take into account Tanjong’s defensive qualities. Its power earnings are relatively recession proof and secure under long-term power purchase agreements. The numbers forecast totalisator (NFO) income and property rentals are also very steady.
As a comparison, risk-free investments such as bank fixed deposits currently earn 2.85% per annum while recent government bonds offer 5% per annum returns. Slightly more risky assets like real estate investment trusts (REITs) give net yields ranging from 6%-7.5%. Investors can also earn net yields of about 5%-6% from most high dividend paying and relatively low risks consumer stocks like DiGi, Maxis, BAT, JT International, Amway.
We believe Tanjong can maintain its relatively generous dividend payout despite the cost of new acquisitions. Power generating assets are usually project financed, up to 90% borrowings. Principal repayments and interests are serviced by the project’s income stream, with no recourse to the company’s other assets.
Tanjong’s power arm is believed to have gross cash in hand totalling RM1.3 billion, which should be sufficient to finance the equity portion of any new project. The gaming and property business are mature, with annual earnings totalling some RM250 million that are largely free for distribution to shareholders.
The market expects Tanjong, if successfully taken private, to be restructured to separate its current mixed portfolio of businesses. And most believe that the power arm, in particular, would be later re-listed either on the local bourse or overseas. However, it is highly likely that if that does happen, it will no longer be at discount pricing.
Case in point, Maxis was valued at about RM40 billion when it was privatised in 2007. That is almost the same as its current market capitalisation — but minus the Indian and Indonesian operations.
Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.
This article appeared in The Edge Financial Daily, August 6, 2010.
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