Tags: Barisan Nasional | Datuk Seri Najib Razak | Deutsche Bank | FIC | GLCs | Khazanah | KWAP | Listing Petronas | Low free float | LTAT | MoE | MSCI index market cap | NEP | New IPOs | PNB | Umno
Written by Financial Daily
Thursday, 15 October 2009 10:54
THIS is the first of a two-part report by Deutsche Bank. The first part contains two key messages — 1. Why listing Petronas (or parts of it) is critical for the market and 2. A bold start by Datuk Seri Najib Razak, but largely ignored by the market. The second part, on the challenging valuations and stocks picks in Malaysia, will be published tomorrow. (Note: The Deutsche Bank report is dated Oct 4, 2009)
Restructuring the market
The market is fully aware of how Malaysia has been marginalised as an investment destination since the Asian crisis. And as an analyst, it is all too tempting to write yet another report highlighting what is wrong with the market. Instead, in this report, we have taken a hard look at what can be done to revive interest in this market. First, let us address the challenges.
• Low free float relative to the regional markets — with North Asian markets swamped with new issuances, Malaysia runs the risk of market weightings easing further than it already has. More needs to be done to liberalise ownership structures in ‘nationalistic’ assets and/or the government should consider reducing their stakes in GLCs.
• Lack of new IPOs — the government must consider listing Petronas and, if not in its entirety, the LNG and refinery businesses alone could make a significant difference.
• Fund flows into Malaysia are still lagging the region and Asean. This is the most underowned market in Asia
(1) Addressing the market’s low free float
One of the biggest challenges for Malaysia is this — the low level of market free float versus other markets in the region.
Here are a few numbers to ponder: government-related agencies (Khazanah, PNB, Petronas, KWAP, LTAT, MoF, etc.) collectively own about 28.4% of the market (based on MSCI universe). If one includes EPF’s stakes in various companies, this figure goes up to 39.4%, based on our estimates.
Although EPF (Employees Provident Fund) is considered free-float, it does provide some perspective as to how tightly domestic funds have a dominant presence in the market. Therefore, this explains Malaysia’s weighted free float of only 49%, at the lower end of the region and lower than that of Indonesia and Singapore.
What needs to be done?
This may not be much, but Khazanah’s stakes are meaningful in large-cap companies such as Tenaga, Axiata (RM3.15, hold, target price RM2.79), etc.
The positive news is that Khazanah recently ‘signalled’ its intention to improve market free float when it disposed of 5% of Malaysia Airports Holdings Berhad (MAHB, RM3.47, NR) via a private placement.
PNB loosens its grip on key stocks
Although PNB’s mandate (largest government managed unit trust funds) is very different from that of Khazanah, a reduction in its dominance in large caps, such as Sime Darby (RM8.54, hold, target price RM7.60), would also help to improve free float.
This outcome is quite unlikely given PNB’s need for consistent dividends from its major investments. The market’s free float could improve if Khazanah gradually reduced its stakes in their key holdings.
(2) Increasing IPOs and listing Petronas (or at least the downstream businesses)
The region is awash with new IPOs, and Malaysia desperately needs a few large IPOs to draw attention back to the market. Equity raising is anticipated to be higher (as a percentage of market cap) versus the last two years, but this is mostly with the inclusion of Maxis’ relisting. Much more needs to be done. Indeed, just to keep up with the region, Malaysia has to expand the depth and breadth of the market at a higher rate. Here are our suggestions:
What needs to be done to improve the IPO pipeline?
• To improve the depth and breath of the market, Malaysian companies with foreign subsidiaries should be encouraged to list on Bursa (RM8.17, sell, target price RM3.30). Bursa should encourage companies, such as Sime Darby, YTL Power (RM2.17, hold), etc to list their profitable businesses in Malaysia to raise funds for future investment plans.
• Encourage the government to list Petronas. If the government is not willing to list its prized exploration and production division (E&P), the LNG and refinery divisions are substantial enough on their own to make a significant difference to the market. After culling through various scenarios and possible options, this is the most effective means for addressing a large part of the market’s structural issues.
• Encourage Malaysian entrepreneurs to list their businesses in Malaysia (and not in HK or Singapore). With the recent liberalisation rules on bumiputra shareholdings relating to pre- and post-IPO structures, such an option should now be met with less objections. Promoters are now able to stay in control, with up to 75% (post IPO) vs 45% under the previous structure.
Petronas is large; could potentially raise Malaysia’s weightings from 3.8% to 6.4%. In a country report on Malaysia by IPE.com (dated Jan 30, 2009), it was stated that Petronas could be worth US$207 billion (RM912.6 billion) assuming 15x forward PER. This is almost the same as Malaysia’s entire market cap of US$257 billion.
Based on this and assuming that only 25% of Petronas is listed, Malaysia’s free-float adjusted weightings in MSCI Asia ex-Japan could rise from 3.8% to 6.4% based on our estimates.
This is a material change, and one we believe the government should consider. It would transform the Malaysian market and would allow the government to unlock value in Petronas but still maintain control, in our view. This could also help raise US$52 billion (25% listing) in order to help narrow the government’s fiscal deficit.
Conclusions: Petronas is critical to lifting market profile and size
• The listing of Petronas could almost double the total market cap of Malaysia, to US$464 billion from US$257 billion currently.
• If listed in its entirety, Petronas alone would be 40% of MSCI Malaysia’s weighting (assuming 25% free float).
• Petronas is such a behemoth entity that a mere 10% release of its equity interest will result in an increase of Malaysia’s MSCI index market cap from US$76 billion to US$101 billion with the index weighting rising to 4.99% from 3.84% currently.
• While the listing of Petronas as a whole entity remains uncertain, a plausible scenario would be for Petronas to list its downstream subsidiaries such as gas/LNG and refineries while preserving its upstream E&P. The current outlook for LNG is positive, thanks to an increase in the current and future global demand for a cleaner, greener energy source. Malaysia is currently the third-largest LNG producer in the world.
• A partial listing of Petronas’ gas/LNG and refineries alone would also create a dramatic impact on the market. Just a 25% injection of Petronas gas/LNG and refineries equity stakes combined would push Malaysia’s MSCI index market cap to US$123 billion and index weighting to 5.95% by itself.
• Combining the Petronas possibility and Khazanah’s 25% uniform reduction of holdings, Malaysia should have an MSCI index market cap of US$130 billion and weighting of 6.28% within Asia ex-Japan. This combination can provide the catalyst that would allow Malaysia to command a more meaningful weighting and one that is on par with Singapore.
• Petronas will be a critical component in determining how sizeable Malaysia can become in the MSCI Asia Pac, ex Japan Index, we believe. Divesting the holdings from Khazanah and possibly other GLCs is certainly a good start. However, if the intention is for Malaysia to be able to tip the scale, and PNB is certainly unlikely to scale back its holdings, any strategy or attempt has to include Petronas as part of the equation. This is absolutely essential.
(3) Fund flows into Malaysiastill lagging
Fund flows into Asia ex-Japan rebounded in late August/early September, largely led by India, Korea, and Singapore. Again, Malaysia lagged. This would explain why foreign ownership in the market has barely changed since the start of the year. Malaysia’s weightings and fund flows are in sharp contrast to Indonesia.
Najib’s first six months
Surprising his critics: delivering punchy initiatives so far...
Najib’s first six months in power as prime minister have been closely watched by all. So far, so good — he had a positive start despite inheriting a weak economy, a fractured coalition party, a disenchanted voter base, and an unloved market facing significant structural challenges.
Three significant market-related initiatives were introduced by Najib. Critics may argue that these capital markets initiatives were late in a regional context. We do not disagree with this view, but in the context of Malaysia’s national economic policy (NEP), these changes should be viewed as bold. No other prime minister has attempted to address these issues.
• In June, the Foreign Investment Committee (FIC), which oversees mergers, acquisitions and equity stakes (viewed largely as an administrative roadblock by many), was abolished. Pre-IPO bumiputra ownership was also reduced from 30% to 12.5%, with no requirement post-IPO or for future fund raising.
This, in our opinion, was positive as it provided clarity on ownership rules and should allow promoters of companies to maintain a comfortable majority (75% vs. 45% previously) post-IPO.
The re-listing of Maxis may be an important step in forcing investors to reconsider the Malaysian market again. The positive ownership liberalisation measures will take time to translate into greater depth and breadth in the market. Unfortunately, Malaysia faces stiff competition in the region.
• Foreigners are now able to own 100% of a commercial property asset if acquired from a non-bumiputra controlled entity. Also, ownership in selected sub-sectors of the financial industry was liberalised too; eg, foreigners are now able to own 70%-100% of a local fund management entity, 70% of local stockbrokers vs 40% previously.
• CONSTRUCTION [] jobs are finally hitting the economy. The lack of policy implementation was one of the weaknesses of the previous administration. The good news is that contractors’ feedback so far tells us that government infrastructure jobs have been awarded and the knock- on effect is beginning to have an impact on the real economy.
... but much still needs to be done; politics still a dominant issue
Politics matters more than ever for this market, especially when investors’ confidence in Indonesia’s political backdrop has improved significantly over the last 12 months. There has never been a time when all political parties are at odds with their own identity.
The ruling coalition party, Barisan Nasional (BN), remains fractured, with Umno trying to find the right balance between embracing structural change to stay relevant to its increasingly young voters and on the other hand, being seen to be protecting Malay rights, where applicable.
Rebuilding confidence and renewed aspirations in the ruling coalition party
Najib has made some strides in trying to rebuild confidence and political momentum within the party.
The recent proposal to abolish the nomination quota structure for Umno elections was a significant milestone for the party and it sends a clear message that the party has little choice but to reform. But BN has other challenges too, especially with other key component parties like MCA and MIC squabbling internally.
Challenges within the opposition party, too
The opposition coalition too has its own challenges. PKR component parties have aired their internal disagreements publicly on issues perceived to be minor. Datuk Seri Anwar Ibrahim, the opposition leader, appears to be distracted by his court proceedings.
Eighteen months since the March 2008 general election, Malaysians are still unsure what PKR truly stands for given the absence of a manifesto and a much-needed shadow cabinet. Critics argue the opposition party may well be squandering a rare opportunity to gain greater support.
All eyes on the outcome of the Bagan Pinang by-electionon Oct 10
The Bagan Pinang by-election, the ninth since the general election, is an important bellweather to determine how BN has fared since Najib became prime minister. The polling date was for Oct 10 and BN was tipped to regain the seat as it is the clear incumbent supported by sizeable postal votes. If BN loses, this would be negative for the market. BN won the Bagan Pinang by-election by an increased majority of 5,435 votes.
A positive start; much more required
Najib has surprised the market so far by delivering much-needed market reforms in his first six months. The market will now be watching to see if these initiatives can be implemented effectively. Much still needs to be done to lift investor confidence in Malaysia.
This will certainly take time to take effect, especially given the competitive environment for capital across the region. In fact, we believe Malaysia has to work doubly hard to win back investors’ “mind share” in order to keep up with the dynamism of structural reforms in the region.
This article appeared in The Edge Financial Daily, October 15, 2009.
