Take-private offer for Hupsteel Limited

On Friday an offer of S$1.20 in cash was made for Hupsteel Limited (BMH.SI), a steel distributor in Singapore. The offer is made by a consortium which consists of members of the Lim family, who are the controlling shareholders of Hupsteel. I’ve owned Hupsteel since September 2017. My average cost is about $0.83 per share.

There are 122m shares outstanding and the offer values the company at $146.5m. As of March 31, 2019 the company held ~60m in cash and investments. There’s no debt and total liabilities were only $6.8m. What really attracted me to Hupsteel though was their real estate. The company’s balance sheet showed investment properties with a book value of $32.2m, but when you looked at note 20 of Hupsteel’s fiscal 2018 annual report (pages 67 & 68), it showed that this book value dated from a valuation that was carried out in August 1992. The fair value as of June 30, 2018 was determined to be $74.9m by an independent professional appraiser. I think this “hidden value” made Hupsteel a much better pick than most of the other steel stockists that were trading at depressed valuations in Singapore.

There were also some hints that the company was perhaps going to take action to monetize (some of) the real estate:

The Board and management are mindful of the concerns raised at the last and earlier Annual General Meetings. A key direction which the management will continue to pursue, will be to seek ways to unlock value for the shareholders. This can be achieved, for example, through monetizing long term assets and returning the cash generated to shareholders by way of dividends. Management will discuss with relevant experts to explore ways to unlock shareholders’ value.

Hupsteel fisc. 2018 annual report, page 7

In fiscal 2018 the company had already sold a small property for a large premium ($4.5m) to book value. It has also redeveloped a few of the larger properties. I think one of these redevelopments is still in progress.

These were positive signs that the management was looking to grow the value of its investment properties and ways of monetizing those properties. Management is now opportunistically trying to take the company private. It is no coincidence that this offer comes at a time when the customers of Hupsteel’s core business are still suffering. The oil & gas and shipbuilding sectors are important customers for the company’s products. It’s hard to find more depressed sectors today. This has caused profits to decline to close to break-even levels in the last couple of years.

Given the excess cash on the balance sheet and the value of the investment properties, management is essentially getting Hupsteel’s core business for free at an offer price of $1.20.

The lemon discount

David Webb wrote a short post earlier this year about Hong Kong’s lemon discount which illustrates some of the problems in that market. I think Singapore has a much more reputable stock market than Hong Kong, but it is not perfect.

When management gets away with taking companies private at bargain prices, it can hurt the stock prices of other listed companies, especially those that have a similar ownership structure. The investor appetite for small cap IPO’s could then decrease as well, depressing the prices at which companies can raise capital. Ultimately the good companies decide against going public at these inadequate valuations altogether, leaving just the “lemons” to go public. This leads to worse results for investors in those companies and even bigger discounts for all companies. Soon you have a result that resembles the Hong Kong market more than you would like.

You can’t expect investors to continue to pay a fair value at a company’s IPO when the end result is that they get offered an inadequate price somewhere down the road when management decides to capture much of the upside for itself. Of course, when the business does not perform well, investors get to hold the bag 100% of the time. Heads you don’t win (much), tails you lose. That’s not a recipe for a healthy stock market valuation. To be clear: I don’t think the situation is this bad in Singapore yet, but there are some problems that need to be fixed.

Investors in these markets (and me specifically) begin to realize that the intrinsic value of a business is mostly a meaningless concept, because they have no hope of ever realizing that value. Japan is a country with some good examples that illustrate this as well, take Solcom (TYO:1987) or Uehara Sei Shoji (TYO:8148). What really matters is the value of that business to you as a minority owner. Especially in Asian markets there is often a large difference between the two.

To some extent this problem exists in all markets. Even in a mature market like the US you sometimes get ridiculous situations in obscure corners of the markets. For example: a company’s management tries to buy out shareholders at 12% of book value. But in that case shareholders took the company to court and asked the judge for appraisal. The result was that management aborted its plan. Even though that company was not even listed on an official stock exchange, there were still securities laws that protected investors.

I don’t see enough of this happening in Singapore yet. Shareholders are often small, private investors and not organized. Hedge funds are largely absent in the small cap space. For the market to function well, you need some larger, stubborn shareholders to hold out and to try to get fair value for their shares. Lawmakers and regulators need to create an environment where those shareholders feel welcome. And that means being comfortable when they speak up at annual meetings, when they go to the press with their complaints or even when they take a company to court. I’m not an expert on Singapore’s securities regulations and law, but judging by the current situation, I do think some of the necessary pieces of this puzzle are still missing.

Recently a few take-private efforts have failed in Singapore. This could happen at Hupsteel as well. A UK-based fund, Buttermere Capital, reported a 6.0% stake in Hupsteel a couple of weeks ago. If they decide to hold out, it would be a big step towards Hupsteel remaining a listed company because acceptance of 90% of the shares is needed for the offer to become unconditional.

Despite what I wrote above, I’m not an idealist or an academic who wants to see efficient prices. I want there to be large mispricings. If Singapore introduces better protections for minority shareholders, many of the bargains might disappear in the process. The idea of the lemon discount is mainly useful to me because it helps explain the valuations of many majority-owned small caps in Asian markets. I think there are still opportunities to profit from these situations. Not all of them are untouchable, despite the fact that there are problems. Hupsteel has given me a decent return and I’ll probably move on to another opportunity.

Disclosure: Hupsteel Limited (BMH.SI)

Posted in Singapore stocks and tagged .

2 Comments

  1. Of course, it is also perfectly possible to both have, at least on average, good corporate governance and an inefficient market. Maybe some inefficiencies will disappear, but I doubt that misperceptions about how good or bad the corporate governance of a company is, is a huge source for mispricings.

    • You could well be right. I think this corner of the market in Singapore (small caps, majority owned by a founding family) is dominated by small, retail investors. Maybe they tend to overreact a bit more during sell-offs or things like dividend cuts. If you had some larger, long term oriented investors in there who don’t have to worry about a “delisting discount” it could make a difference.

      I’m curious what would happen if there were some larger investors in this space that other investors could depend on to never participate in these lowball offers. They take a stake of (close to) 10% of the shares and just hold out until they get something very close to their estimate of the intrinsic value (which they’d make public) of the business. If they do that a couple of times, other investors would notice and they wouldn’t have to worry about a future delisting at a lowball price for all the companies in which those larger investors hold a blocking stake. If I was a billionaire Asian investor I’d try it out. 😉 The returns would probably not be great though.

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