Questions over Leong Hup’s acquisition of The Baker’s Cottage

By Doreenn Leong

WHEN Leong Hup International Bhd (LHIB) entered into three related-party transactions (RPTs) to acquire The Baker’s Cottage Sdn Bhd for RM20 mil cash with its major shareholder, there were worries that this will be a form of bailout of the barely profitable business.

The largest chunk of money will be for the purchase of TBC for RM17.94 mil. LHIB’s wholly-owned subsidiary Leong Hup (M) Sdn Bhd bought the 43.43 million shares from Emerging Glory Sdn Bhd, which is owned by LHI executive chairman Lau Chia Nguang, his brothers and nephews who also sat on LHI’s board.

Leong Hup (M), through unit Leong Hup Agrobusiness Sdn Bhd, also inked agreements to acquire the TBC brand bakery business from Astaka Shopping Centre (Muar) Sdn Bhd for RM1.53 mil and TBC retail business owned and operated by Poly-Yarn Industries Sdn Bhd for RM862,126.

A key concern about RPTs is that they might not be undertaken at market prices, and such transactions can be done at the expense of other shareholders.

According to LHIB, TBC Group, which owns two subsidiaries, BC Confectionery Sdn Bhd and Selasih Prospek Sdn Bhd, registered revenue and net profit of RM41.6 mil and RM593,000 in the financial year ended Dec 31, 2019.

However, filings with the Companies Commission of Malaysia showed that TBC has been loss-making for four consecutive financial years since FY15, with accumulated losses of RM27.15 mil as at Dec 31, 2018.

TBC’s net loss narrowed to RM1.5 mil from RM7.7 mil in the previous year on the back of lower revenue of RM37.8 mil versus RM43.1 mil.

It appears that TBC’s return to profitability was boosted by higher revenue in FY19. But, is there a danger of the company slipping back into the red given the tough operating environment especially with the Covid-19 being a death knell for many businesses?

Similarly for Astaka Shopping Centre. It fell into the red with a net loss of RM900,313 in the financial year ended Sept 30, 2018 from a net profit of RM189,013 in the previous year on the back of slightly higher revenue of RM49.8 mil versus RM48.7 mil.

Poly-Yarn, while still profitable, has been posting declining net profit in four consecutive years starting from the financial year ended Oct 31, 2015. In FY18, it registered a sharp fall in net profit to RM201,136 from RM669,833 in the previous year despite recording higher revenue of RM46.8 mil versus RM44.3 mil.

Minority Shareholders Watch Group (MSWG) CEO Devanesan Evanson does not think the acquisition is in the best interest of minority shareholders for the following reasons:

1. TBC’s earnings per share is only one sen in the unaudited FY19 and was incurring losses in the four FYs prior to this.

2. Under the proposed acquisition of TBC, the purchase consideration of RM17.9 mil was arrived at on a “willing-buyer willing-seller” basis. But the net asset value of TBC is only RM15.1 mil as at March 31, 2020, (the latest management accounts of TBC). Thus, there is close to RM3 mi, being paid which is over and above the net asset value.

3. MSWG is unconvinced by the rationale and benefits of the proposals i.e. that the proposals will allow LHI to own the Bakers Cottage brand and integrate vertically downward to capture incremental value added from its poultry-related product sales and provide margin stability in times of live broilers supply-demand imbalance.

Devanesan also noted that the proposals are not subject to shareholders’ approval and/or any other relevant authorities. This is because RPTs must breach certain financial thresholds in the listing requirements for an EGM to be called. If below the thresholds, the board can decide.

Some analysts do not discount the possibility of LHIB scaling back some of its regional expansion plans, which have yet to be embarked on, in an attempt to conserve cash flow amid the challenging operating environment.

If LHIB is indeed holding back expansion plans to conserve cash flow, wouldn’t it be prudent to not proceed with the acquisitions which will bring minimal impact to the bottomline?

Maybank Investment Bank Research believes the acquisitions will allow LHIB to move downstream and open up a revenue stream for its poultry products. However, the research house has maintained its sell recommendation on the stock as the acquisition is earnings neutral to LHIB.

Similarly, Hong Leong Investment Bank, which maintained its hold call on LHIB with an unchanged target price of 56 sen, pointed out that earnings enhancement arising from the acquisition is minor compared LHIB’s existing large earnings base.

Essentially, RPTs are neither intrinsically good or bad. They can have valid purposes in enhancing the company’s long-term value creation and success.

But they can also be subject to abuse, by the management or controlling shareholders, in a way that can negatively affect the company and its minority shareholders and its creditors.

In this case, since the deal can go through without getting disinterested shareholders’ approval, it is important that the RPT has been reviewed by independent directors or independent firms to convince minority shareholders that these are done in the best interest of the listed company. – June 4, 2020

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