Temasek’s SMRT buyout offer of $1.68 per share is not lowball

By: Chris Kuan

A number of bloggers have made claims about SMRT under the New Rail Financing Framework (NRFF), seemingly based on reading the headlines and running it with their ingrained prejudice and preconceptions, especially the anti-establishment sort.

For example, blogger Philip Ang wrote: “The government announced a $991 million transfer of tax dollars to SMRT. (SMRT stated there would be no special dividend payout, ie Temasek will eventually receive the $991 million transfer.)”

Now how is it that Temasek will eventually receive the $991m when SMRT does not pay that special dividend? More to the point, SMRT did not suddenly made $991m – the payment from LTA is in exchange for assets that already have a reported net book value in SMRT’s balance sheet. In terms of enterprise value, little has changed. Therefore if Temasek were to eventually receive $991m as alleged by Mr Ang, obviously the value of SMRT to Temasek would have decline by the same amount.

Mr Ang went on to write: “Without debt, capital expenditure and maintenance costs to worry about, SMRT will morph into a company managing rental of super prime properties and marketing advertising space. Why should such a “pow chiak” company be handed to Temasek on a silver platter”?

In fairness, others have inferred the “pow chiak” claim by opining that the $1.68 tender price by Temasek for remaining share is a low ball. In this Mr Ang and others not incorrectly claimed that with the risk of capital expenditure and maintenance costs removed from SMRT, the company will no longer be burdened by these and then the assumption must be that profits will rise.

However they completely failed to account for the remainder of the NRFF which requires SMRT to share any EBIT above 5% with the LTA who will use the proceeds to reinvest in rail infrastructure. The LTA will also share in the shortfall if EBIT falls below 3.5%.

Since the NRFF refers SMRT Trains, it is assumed by some that this do not include rental and advertisement. This is wrong – the relevant EBIT is composite of rail, rental and advertisements because most of the latter two are considered revenues derived from the rail network.

According to DBS and Phillips analysts reports, in 2016 SMRT derived revenues of $681m from rails plus $134m from rental and advertisement from within the rail network. These will all be included in the tiered revenue sharing structure with LTA with as much as 95% going to the LTA at high EBIT (Earnings before Interest and Taxes) margins. SMRT have an overall EBIT margin of 14.6% last year. Rail network revenues are more than 60% of total revenues.

This is the reason why I wrote that the $1.68 tender price must be seen not in light of the pre NRFF SMRT closing share price of 1.545 but a forecast price of $1.28 considering the reduced profitability of SMRT in exchange of being relieved of capex under the NRFF. Therefore the $1.68 tender price in reality reflects a 30% premium.

I have no problems with anyone making a wrong call on share price or anyone marking a reasoned anti-establishment argument but should be careful with half baked ideas used to burnish anti-establishment credentials.