26 May 2016, The Business Times
19 May 2016, Chong Ser Jing
Money, Water and Risk
Hyflux began in 1989 as Hydrochem (S) Pte Ltd, a trading company selling water treatment systems in S.E.A. It was listed in SGX in January 2001. The company build and operates desalination plants, power generation plants and waste-to-energy plant as well as developing products for the wellness industry.
Revenue grew substantially from 2008-2012. It started to decline from 2013. Hyflux has been a profitable company until 2015.
Building desalination plants is a capital intensive business and this is evident in the increasing long-term debt from 2009-2013. There are varied arrangement in this business; the simplest is to build, transfer and collect money. More complex arrangement would be to build, operate and transfer (BOT). The duration operating the plant is recorded as concession in the balance sheet.
Tuaspring desalination plant is a BOT contract with a 25 years water purchase agreement. Because desalination plant consume great amount of power, a 411MW gas turbine power plant was built to supply power and to sell excess capacity to the national grid. However, with Energy Market Authority liberalising electricity market, supply outweigh demand leading to Hyflux suffering losses in the power business.
Perpetual Securities (PS) ... or bond?
Retail investors started participating in PS as early as 2011 where $400M was raised. This amount is likely embedded in 'Share Capital' in the balance sheet. From 2014, new PS were classified under 'Perpetual Capital Securities' separately (shown this the chart).
Demand for PS were strong given the attractive 6% dividends.
Tong, in The Edge this week wrote an insightful article on why perpetual securities are debts and not equity. It is an important distinction as PS classification will influence how we compute risk.
The Fall and The Fight
The combination of losses in the electricity market, and high debt eventually came to bear. By 2016, finance cost marginally outweigh EBIT. Including Tuaspring, losses amount to $109M. By 2017, the firm recorded a operating loss of $93M and net loss of $116M.
Long story short: Creditors, debtors and retail investors demanded their fair share of the remaining assets. A white knight in SM Investments came, commit and wanted out.
Water is a strategic commodity in Singapore. Tuaspring is our third and largest of four desalination plant. That Tuaspring is not fulfilling her contractual obligations as far back as 2017 would logically be a cause of great concern for PUB. Particularly when the weather had not been kind to our neighbour supplying us water and the constant harassment regarding water price contract signed decades ago.
However, while PUB cause for concern is justifiable; the timing of her notice to 'take over Tuaspring desalination plant at zero dollars and to waive compensation it is entitled to; if the company does not remedy its defaults by 5th April' was ill-timed; as it coincide with Hyflux vote on restructuring on the same date.
Charlie Munger has this to say: In the corporate world, if you have analysts, due diligence and no horse sense, you've just described hell.
PUB for all her good intention have unintentionally shifted public anger from perceived unfair distribution of Hyflux remaining assets; towards itself and by extension the government hence becoming a political issue. Her action have also opened a potential exit route for SM Investments.
34,000 unhappy retail investors is a large number in our small city. With General Election within the horizon, this is not one mistake to make.
Hyflux predicament actually began much earlier than 2014 or 2016. Z-Score consist of five components. Four of which measure Sales, EBIT, Working Capital and Retained Earnings against Total Assets. Only the fifth component relates Market value to Total Liabilities. A rating below 1.8 signal financial distress and potential bankruptcy in the near future.
As shown in the chart, Hyflux predicament began in 2011 and continue to trend lower with each passing year. The chart explain why Hyflux had to raise fund from 2011 and having to continue to do so since.
6 things investors should know about Hyflux Ltd's new perpetual securities by Chong Ser Jing dated May 19, 2016.
Points 4-6 in the attachment explains PS risk with much clarity. It was published about a week before public subscription.
Prior knowledge of this risk does not give me joy. Hyflux have benefited our society and my hope have always been that they could dispose of Tuaspring at a reasonable price, strengthen their balance sheet and continue to do good work.
I attended Hyflux protest at Hong Lim Park to learn more about investors issues. Instead, at the end of the hour long protest, I walk away thinking how do we explain risk to the persons behind & before the speaker Tan Kin Lian (former NTUC Income Chief Executive), in the midst of all the enticement to get a piece of the perpetual securities that pays 6% dividends annually, simply by pressing a few ATM buttons ... that, though the name is perpetual, fine print clearly states it is anything but perpetual and that prevailing risk was considerable.