Malaysia’s political upheavals will continue to cast a long shadow over its equity markets during 2019. This could leave companies struggling to achieve their pricing targets in the face of softening valuations.
Bankers and analysts believe that 2019 is shaping up to be a repeat of 2018, which has been a pitiful year for equity capital markets fundraising thanks to the electoral revolution, which swept former prime minister, Mahathir Mohamad back into power through the Pakatan Harapan coalition in May.
Dealogic figures show that companies in Malaysia have raised just $1.45 billion year-to-date, which puts the country sixth behind Thailand, Singapore, Vietnam, the Philippines and Indonesia. The largest IPO, for Mi Equipment, raised just M$213 million ($54 million) compared to Lotte Chemical Titan’s M$3.77 billion deal in 2017.
Foreign investors also have been net sellers nearly all year, offloading M$10.9 billion to the end of November according to UOB Kay Hian figures. Local bankers wonder what will make them come back given that most research houses predict that the benchmark KLCI Index will end 2019 lower than 2018 thanks to a combination of fiscal austerity, subdued corporate earnings growth and global trade tensions.
It is not an auspicious backdrop for the two companies, which have been waiting in the wings with prospective IPOs around the $500 million mark. Fast food operator QSR Brands has already filed a draft prospectus for its deal, while poultry producer Leong Hup International is not far behind.
Both deals are fairly unusual by Malaysian standards since they have private equity backers. But this means that their current shareholders also have high valuation expectations of around 25 times forward earnings according to local ECM bankers.
The consensus is that this will be impossible to achieve. Bankers suggest that a level around the low 20s is a more realistic starting point.
FOX IN THE HEN HOUSE
Malaysia has never been fertile ground for private equity companies. As one Kuala Lumpur-based M&A banker put it: “Local business owners are still frightened of the sector.”
Only CVC has made any real inroads after targeting the consumer sector, although KKR purchased a 30% stake in Weststar Aviation in 2013 and local house, Navis Capital has been active around the rest of the region.
CVC’s holdings include gaming company Magnum Corp which it partially exited in 2011, and Munchy Foods, which it purchased for about 12 times EV/Ebitda in June this year.
It acquired QSR for M$3.28 billion in January 2013 alongside Johor Corp. According to S&P Global Market Intelligence figures, CVC’s entry was fixed at 9.5 times trailing EV/Ebitda and local bankers say that it has grown the latter by about 50% since then.
They also believe that there is still growth left in the company. Smartkarma analyst Sumeet Singh backs this up. He points out that only 30% of the company’s Pizza Hut outlets offer a takeaway service in Malaysia, for example.
The group owns the KFC franchise in Malaysia, Singapore, Cambodia and Brunei, plus the Pizza Hut franchise in Malaysia and Singapore. It has a 43% market share in Malaysia, which accounted for 81% of its 2017 revenues and a 14.6% share in Singapore, which accounted for 18%.
Singh concludes that QSR’s “tepid growth outlook” means that it will “probably trade lower than average” relative to its peer group. This includes New York-listed YUM China and Indonesian Pizza Hut franchisee PT Sarimelati Kencana, which respectively trade at 20.8 and 14.83 times forecast 2019 earnings.
According to QSR’s draft prospectus, it intends to sell 1.465 billion shares (of which just 5% will be primary shares) and is aiming for a 35% freefloat. CVC intends to own 6.8% post listing.
Joint global co-ordinators are Citi, Credit Suisse, Maybank and RHB with joint bookrunners comprising Affin Hwang, AmInvest, CIMB and CLSA.
A similar lead management group of Credit Suisse, Maybank and RHB are overseeing Leong Hup, in which Affinity Capital has a 30% stake. The private equity group paid M$169.7 million in cash and M$148.9 million in debt for its stake in April 2012.
Leong Hup, which is majority controlled by the Lau family of Johor, now hopes to issue 1 billion secondary shares and 600 million primary shares to fund its continued expansion across South East Asia. The poultry and livestock feed producer has operations in Malaysia, Vietnam, Indonesia, Singapore and the Philippines in addition to owning the Agam AI and SunnyGold brands.
Its last reported net profit figure of M$192.97 million for the financial year to December 2017 and recent 5% growth rate suggest a back-of-the-envelope hoped-for valuation of around $1.2 billion to $1.3 billion.
QSR reported a similar net profit figure of M$189.98 million.
FINGER LICKIN?
Even though both QSR and Leong Hup have strong brands, bankers say that they will have their work cut out against a backdrop where foreign investors remain absent and domestic institutions sit on the sidelines.
“Government-linked companies can always rely on the government to strong-arm government-linked investors into participating,” said one Singapore-based banker. “That’s not going to be the case here.”
Not everyone agrees. “A lot of investors cashed up ahead of last year’s election and are waiting for the right opportunity to re-enter,” said a second Singapore-based banker. “As long as valuations are reasonable, they should participate.”
A second factor, which both deals will have to contend with, is Malaysia’s valuation premium compared to regional Asean peers. Many analysts do not think this will last.
In a recent research report, CIMB reduced its 2019 KLCI target to 1,674, compared to a 1,704 end 2018 target. This would put the index at 15.4 times forward earnings, or one standard deviation below its three-year average of around 16 times.
It pointed out that only 11% of the 127 Malaysian companies it tracks have outperformed its third-quarter earnings expectations. It now forecasts 4% earnings growth in 2019, down from a previous 8% forecast.
UOB Kay Hian agrees with the relatively gloomy outlook. It cites a “cocktail of global liquidity contraction, America’s erratic trade policy and less business-friendly policies,” which will enhance volatility and lead to “anaemic corporate earnings”.
Daiwa believes that Malaysian equities will revert to their mean from one standard deviation above. “The fiscal discipline that Malaysia is undergoing due to mending its inherited fiscal mess and bringing its house back in order should cap growth,” it states.
It predicts 3.2% corporate earnings growth.
“I think investors are pretty bearish about Malaysia,” one South East Asian ECM head concluded. “There’s a lot of volatility and no-one really knows if and how smoothly Mahathir will hand over power to Anwar.”
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