Wednesday April 21, 2010
The dangers of offers conditional on due diligence
THE anti-climax that hit investors in KNM Group Bhd after the attempted takeover fell through raises some issues.
For minority shareholders, the KNM case highlights the downside of the takeover route involving buying the assets of listed companies.
Under this route, buyers are allowed to conduct due diligence on the assets they are buying.
In comparison, when a buyer is making a general offer for the shares of a target company, it only has access to publicly available information on the company it is buying.
In such a case, there is more clarity on whether the deal will go through. It all depends on the acceptance level of the target company’s shareholders. There can hardly be a situation where a price is revised downwards.
But in a takeover of assets situation, the buyer can withdraw the offer or lower his price after the due diligence.
On the flip side, deal-makers say the opportunity to conduct due diligence on the assets is one of the main advantages of the assets and liability route of takeovers.
Some buyers tend to opt for this route in cases where the target company has very large operations, such as banks, or has assets in diverse geographical locations, like KNM.
That the threshold of shareholder approval for this type of takeovers may be raised to 75% from a simple majority, does not mean that this takeover route will disappear.
While it may be harder for buyers to take over companies (if the rule change is implemented), this route still remains attractive to buyers because it gives the opportunity for due diligence.
Investors should be aware that there is a chance buyers taking over companies using this method could change their minds after their due diligence, or reduce their prices.
That could be advice too late for those who took the bet that the KNM deal would have been done at the indicative price of 90 sen a share.
But it may be sound advice for investors buying into EON Capital Bhd (EON Cap).
While the RM7.30 per share offer by Hong Leong Bank Bhd (HLB) may look attractive, coupled with the possibility that another bidder could be interested, investors should look at the fundamentals of EON Cap.
That would give them a good indication of how the buyer would assess EON Cap and thereby, the price they would be willing to pay for it, post due diligence.
Some points to ponder can be found in recent analyst reports on EON Cap. For example, EON Cap’s Islamic banking pre-tax profits seem to be on a downtrend, raking in only RM4.9mil in its fourth quarter ended Dec 31, 2009, compared with more than RM30mil the year before.
DBS Vickers Securities had said in an earlier report that EON Cap has some exposure to collateralised debt obligations in the Middle East that could potentially see further provisions. HLB’s due diligence will surely examine this issue thoroughly.
In addition, it expects EON Cap to incur higher credit costs as it may need to bump up its loan loss provisioning, which stood at 84.9% as at September 2009, to the industry norm of closer to 100%.
Another issue that the buyers of EON Cap should pay attention to is the weighty exposure EON Bank has to small and medium enterprise and hire purchase loans, which are deemed riskier than other loan segments.
HLB could also discover that it has to pour in more money into EON Cap in the merger exercise to ensure, for example, that both banking groups enjoy the same credit ratings and best practices and information technology systems at their branches.
This in turn could have an impact on the price the buyer is willing to pay for the asset.
Learning from the experience of KNM, investors should dissect analysts’ target prices of EON Cap to see if these prices are inflated by the potential takeover.
Knowing the fair value of EON Cap, excluding the offer on the table, should help investors know the downside risk to buying into EON Cap today.
Deputy news editor Risen Jayaseelan wonders how much money punters lost betting on the possibility that the KNM takeover would have gone through at 90 sen a share.