Bursa Malaysia IPO: trading on reform

IPO offers investors exposure to upside promised by capital markets reform.

Bursa Malaysia began roadshows yesterday (February 17) for a $110 million to $140 million IPO via CIMB and UBS. The exchange is offering 166 million new shares on a price range of M$2.50 to M$3.20, with retail investors paying the lesser of M$3, or a 3% discount to the institutional price.

The deal has a split of 116.9 million shares in the institutional tranche and 49.1 million shares in the retail tranche. Specialists estimate that the institutional tranche will have a 70%/30% split in favour of international investors.

The public offering will run from February 23 to March 3, with pricing scheduled for the same day and listing on March 18. On completion the deal will have a freefloat of 33%, with the remaining 67% split proportionally: Ministry of Finance 30%, Capital Markets Development Fund 30%, domestic stock brokers 30% and domestic remisiers 10%.

The performance of listed exchanges tends to be very closely correlated to their benchmark indices and investors typically view them as a good proxy for the overall direction of the equities market and country's economic performance. In Bursa Malaysia's case, the exchange may be listing at a positive inflexion point for the Malaysian market and currency, which investors will hope to capture through the IPO.

This is primarily because Prime Minister Badawi has prioritized improving the liquidity and stature of the country's capital markets since he took office in 2003. And the inherent potential is clear.

At the end of 2003 Malaysia reported a GDP per capita of $4,141 compared to $2,265 for Thailand. However, the market capitalization and average trading volume of the Kuala Lumpur Stock Exchange (KLSE) both lag the Stock Exchange of Thailand (SET) by some margin.

The KLCI has a current market capitalization of $120 billion versus $128 billion for Thailand. Of Asia's 10 equities markets (ex Japan and Australasia), Malaysia ranks eighth and Thailand seventh, just behind Singapore on $162 billion.
In terms of trading volume, Malaysia is even further behind. Average daily trading volume currently stands at $254 million compared to $596 million in Thailand. Singapore currently stands at $344 million.

Analysts attribute Malaysia's underperformance to a number of factors. Firstly, the market has been historically weighted down by 40 government-linked companies, which account for about one third of overall market capitalization.

In order to improve their trading performance and operational efficiency, the government has embarked on a twin reform drive embracing selective divestments and enhanced accountability. As a starting point it re-grouped all of its holdings under its investment arm Khazanah early last year

This already appears to be bearing some fruit. Between May 2004 (when the re-organisation was fully completed) and December, Khazanah's portfolio rose 18% compared to 14.3% for the overall index.

Malaysia's second major handicap is a legacy of the Asian financial crisis when the Mahathir regime imposed capital controls. In 1998, Malaysia suspended trading of domestic shares on Singapore's CLOB.

Today, there are only five foreign brokers active in Malaysia and foreign investors hold just 20% of the overall market compared to nearly 40% in Korea. There are 38 members in total, down from 62 in the late 1990's.

Bursa Malaysia is now pushing for a more international outlook, with ambitions to lift short selling and stock lending restrictions. The Malaysia and Singaporean stock exchanges also hope to re-establish trading links by the end of 2006. Analysts believe this will help boost liquidity at both exchanges.

Over the longer-term, Bursa Malaysia has also proposed trading links with both Thailand and Indonesia.

Specialists say investors are looking at Singapore Exchanges as the main valuation benchmark for Bursa Malaysia's IPO. Based on its indicative price range, Bursa Malaysia is being pitched at 15.2 to 18.8 times 2005 forecast earnings. Singapore Exchanges is currently trading at 16.8 times.

On a price to NPAT basis (a valuation metric which discounts the large cash holdings of most exchanges), Bursa Malaysia is being pitched at 8.4 to 12.5 times 2005 forecast earnings. Singapore Exchanges is currently trading at 13.7 times.

A basket of exchanges in Europe including Deutsche Borse and the London Stock Exchange currently average 19.3 times 2005 P/E and 17.7 times price/NPAT.

Another valuation metric is the average P/E of the benchmark index. In Malaysia's case, the KLCI currently averages 15.5 times. Analysts say exchanges often trade at a premium to the underlying market if they have a strong monopolistic position, which safeguards margin strength. Australia's ASX, for example, typically trades at a 30% to 45% premium to its domestic market.

Bursa Malaysia has no direct competitors and lead managers have been arguing that the implementation of a new trading system - CTP (Common Trading Platform) - will strengthen this further. The new platform will allow dealers to trade securities and derivatives on one system.

A second selling point derives from Bursa Malaysia's strong cash generating abilities, which enables strong dividend pay-out ratios. Globally, listed exchanges average annual returns to shareholders of about 23%.

Post IPO, Bursa Malaysia will have a net cash position of M$620 million, which will help support a pay-out ratio of 75% in 2005 and 50% in subsequent years. This equates to an IPO dividend yield of 3.6% to 2.9%.

This pay-out ratio is lower than other Asian exchanges such as Singapore (80%) and Australia (90%), but the region as a whole tends to support higher dividend yields than Europe and the US. Singapore Exchanges, for example, is currently yielding 4.3%, whereas listed US exchanges such as the CME pay zero to 1%.

Analysts say that Bursa Malaysia currently derives 47% of its revenues from clearing fees, 5% from STORE fees, 18% from trading related fees, 13% from depositary services, 8% from listing and participation fees, 6% from information services and 3% other.

In 2002, it generated net income of M$40.6 million, rising to M$64 million in 2003 and $71.7 million in 2004. Analysts are forecasting that operating income will rise about 8% in 2005 and believe that average daily trading volume could jump about 13%.

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