Towards nationalisation and international irrelevance?
From The Edge Malaysia, October 10, 2011.
By Yeoh Keat Seng, manager of the KSC Incrementum Fund. The views expressed here are his own.
I felt compelled to write this opinion piece after reading with great consternation Permodalan Nasional Bhd’s (PNB) launch of a takeover offer for S P Setia.
Investor reaction has so far ranged from relief (that they will be taken out at a premium) and dismay (that the offer caps the longer-term upside of S P Setia) to disillusionment (over the exchange’s possible dual loss of an illustrious property company and a highly respected entrepreneur) and downright indignation.
In this article, I would like to focus the discussion on the possible reasoning behind such acquisitions by government-linked investment companies (GLICs) and their longer-term implications rather than dwell on the S P Setia deal.
As a start, I must say that given the circumstances and the direction in which GLIC’s have been heading, the real question was when, rather than if, they would embark on such private sector acquisitions. And I would go further to predict that we can anticipate a spree of more such transactions if the landscape does not change.
The problem as I see it stems from our stock market’s inability to keep pace with the accelerated growth of our GLIC’s; the high investment concentration of GLIC’s on domestic equities; and their growing desire to exert influence on their investee companies.
GLICs such as the Employees Provident Fund, PNB, Tabung Haji and Lembaga Tabung Angkatan Tentera have grown rapidly since the 1990s for a host of reasons, including the captive nature of our mandatory pension funds, our growing workforce and high savings rate, and the exceptional appeal of our savings schemes.
By comparison, the growth in our stock market capitalization has trailed far behind owing to the lack of sizeable new listings over the last decade with a couple of exceptions, and the decompression of the valuation of our market over time. As an indication, the combined assets of the EPF and PNB have grown to an estimated 40% of our stock market’s capitalization today from only 24% in 1995.
As at end-2010, GLIC’s held domestic equities worth over RM 300 billion, translating into around 30% of the local stock market’s capitalization. Considering that ownership of between 25% and 50% is often adequate to control a company, and that some of the government linked companies (GLCs) themselves also own other listed ones, the influence that these GLICs wield in reality extends to a few multiples their fund size.
This assertion can be backed by a sampling of the top 20 largest listed companies. Of these, 10 companies accounting for 57% of the 20 companies’ total capitalization (03 32% of the entire market’s capitalization) are classified as GLCs. Of the remainder, the two gaming companies have no GLIC ownership while all the rest have at least one of them as a significant shareholder. (We consider funds managed by GLICs as extensions of themselves.)
Having GLICs as major investors in our largest capitalized companies is not an issue. In fact, GLICs are seen as strong anchor shareholders for banks, telcos and companies in the utility and heavy industry sectors with their deep pockets and long holdings tenure lending credibility, especially in times of distress.
The problem arises when GLICs move a couple of tiers down and start buying into mid-sized companies run by entrepreneurs. Putting aside PNB’s earlier acquisition and eventual privatization of Island & Peninsular and Petaling Garden of which they were already major shareholders, this trend can be traced back to almost a year ago when UEM Land initiated the acquisition of Sunrise. Sime Darby’s more recent proposal to buy a sizeable block of Eastern & Oriental may also be seen in the same light.
These deals could probably be differentiated from the latest one in that they were strategic and characterized by GLC-operating companies buying into peers with complementary strengths, and involved willing buyers and willing sellers. Nevertheless, it could just as well be said that they set a precedent that may open the floodgates for acquisitions by GLIC’s.
Why should there be more such acquisitions? Since the clause for GLICs growing faster than the stock market is structural in nature, it is unlikely to reverse for the foreseeable future. This means that as they seek to deploy their ever-growing funds in the local market, more and more companies will be acquired, starting from the larger and better managed and eventually cascading down to the smaller and less well-managed ones.
As mentioned earlier, GLICs already control half of the 20 largest companies. Over time, they should easily control at least half of the next 20 and over an even shorter period, the next 20. Assuming they continue to dogmatically pursue a policy of investing almost exclusively in the domestic equity market, a day would come when the majority of our top 100 companies will be entitled to carry GLC membership cards.
Where does this leave our local entrepreneur owners who hold less than a controlling stake in their listed companies? Feeling stifled and paranoid about being the next candidate to be bought out and coming under pressure to defend their companies.
This trend creates several highly disconcerting possible implications for our market.
First, GLICs buying out mid-cap companies run the risk of eliminating entrepeneurs and crowding out the private sector. If our GLICs had taken over S P Setia, AirAsia, IOI Corp or JobStreet in the early days of their growth trajectory, it is doubtful these would have grown to become the industry champions they are today.
I am not saying that institutional shareholding is incompatible with entrepreneurship as the phenomenal success of the late Steve Jobs and Apple Inc would attest to. Apple was already listed and owned by institutional investors when Steve Jobbs returned in 1997, turned it into an icon and generated 100-fold value creation in the process.
However, Apple’s shareholders are commercial organizations with an uncomplicated profit-making motive. None of them had control over the company and management was given free rein as they continued to deliver.
In comparison, our GLOC CEO’s have KPI’s that often extend beyond maximizing shareholder value. It could be difficult for a strong-minded and successful shareholder entrepreneur to peacefully co-exist with new controlling shareholders that may want to impose their influence on areas such as management composition, CEO compensation, business direction, capital funding, corporate culture and so on.
Even a decision as fundamental as whether the company should retain the bulk of its earning for reinvestment or whether earnings should be largely paid out to meet the income needs of GLIC shareholders could be a source of tension.
Singapore and China too face the highly sensitive issue of GLICs or state-owned enterprises (SOEs) crowding out the private sector. Over there, the crowding out takes place via GLICs or SOEs out-competing smaller companies by virtue of being endowed with subsidies or other unfair advantages, having better access to credit or by simply being better run.
Malaysia seems to be formulating its own model in the game – buying out publicly listed companies that presumably will then compete aggressively with the private sector.
Second, the free float of our stock market will decline over time and minority investors risk getting squeezed out as liquidity becomes a problem. Even more importantly, their voting rights will diminish in value, weighted against the holdings of these giants. The idea of using GLICs to buy out foreign investors to defend our stock market was first mooted during the Asian financial crisis and sadly, it could become a reality someday even though this is not longer the desired direction.
Third, the Malaysian market’s weighting on international benchmarks such as the MSCI, which takes into account free float, will shrink even further. Already, Indonesia’s market capitalization has almost caught up with ours while its trading volume has surpassed ours.
Fourth, it will inevitable create an equity bubble as the market cannot grow fast enough to absorb the inflow of new funds. With too much funds chasing too few stocks, prices are bound to inflate. If we extrapolate this far enough, it is possible that our market could someday trade at stratospheric levels that Japan did in the 1990s.
Why should we argue against the creation of a bull market where stocks could get inflated to PER levels of 30 times, 40 times or even 50 times? Simply because we know it will not last. For an idea of the after-effects, please refer to Japan’s double-decade bear market.
From being the most dynamic market in the region, Bursa Malaysia has traded down to a stature where the market’s velocity is one of the lowest around. The same applies to its foreign shareholding level. This can be attributed to many reasons, but certainly the risk of being semi-nationalised and becoming internationally irrelevant ranks high.
Today, with international investors having their choice pickings of investment markets, we cannot offer an attractive proposition if their view of our market is that the entrepreneur community is shrinking, liquidity is poor and the voice of minority shareholders will shrivel over time.
To prevent the problem from escalating, there has to be immediate recognition of the potentially destructive nature of this trend. The longer we wait, the greater the inertia, and the harder it would be to contain it.
What are the possible solutions? Since the continued fast-paced growth of GLIC assets can be taken as a given, the most optimal solution is to open up the funds to invest in a broader spectrum of asset classes beyond domestic equities, such as international equities and bonds, private equities, real estate, commodities and so on.
To achieve this goal, it is imperative that GLICs undertake a holistic review of their mandates and conduct a comprehensive asset allocation exercise. This should take into account not just their own needs and comfort zone, but also that of the domestic capital market’s ability to accommodate them as well as the long-term risk implications of their actions today.