When all else fails, try an Islamic bond

Elite, the subsidiary of Malaysia''s giant UEM, is readying a M$1.8 billion Islamic bond.

Recent attempts by United Engineers Malaysia (UEM), the road and construction arm of Renong, to refinance itself (and its parent) have been problematic to say the least. To lower it and Renong’s debts - recently estimated at M$22 billion ($5.8 billion) - UEM has gone cap in hand to banks, tried to entice investors on the equity markets, and even looked towards securitization, all without success.

The last doomed attempt to raise funds was set to be an IPO of between 25%-30% of the equity in UEM subsidiary PLUS - a road operator. It was expected that the deal, originally slated for November, would raise in the region of $1.3 billion. However, investors dumped shares in both UEM and Renong as a protest at the internal governance of the group, and the deal was put back to January. The New Year has begun, nothing has changed, and the PLUS deal has again been put on the back burner, with no official comment forthcoming as to whether it can be salvaged.

Having seemingly exhausted all other possibilities, the group is now lining up an Islamic bond transaction for UEM’s wholly-owned spin-off Elite. No bank has yet been confirmed to arrange the deal, but it is almost certain that the mandate will go to the Commerce International Merchant Bank, a shareholder in Renong and the bank that has arranged previous deals for the group.

Elite, the company set up to build and collect tolls from the North South Expressway Central link road that leads to the international airport in Kuala Lumpur, aims to issue M$1.8 billion of discounted paper next month. The company, which defaulted on a M$940 million loan in 1999, needs funds to clear its own debts of just over M$1 billion and will use toll revenues to pay note holders.

The decision to do an Islamic bond deal follows the failure to launch a conventional bond issue last October. Islamic bonds by definition carry a zero coupon because Islamic law bans interest payments. To get around this, investors are instead redeemed by a share of the profits from the bonds sold.

Typically, Islamic banks and funds buy these bonds, but in this case, analysts believe Malaysian government agencies will be the only buyers. In a country where the word ‘bailout’ has become a familiar part of the national lexicon, that should come as no surprise.

An analyst at a western investment bank who has been following the UEM-Renong saga over the years, and the Elite problems more recently, believes Elite suffered from poor forecasting of likely revenues. “With the Elite project, the initial projected traffic volumes using the road were too bullish, revenues weren’t as high as expected and the company couldn’t finance its debts,” he says. “Since August 1999 [when it defaulted on the bank loan], it’s been trying to refinance it. The banks were closed out because they have a lot of exposure to the group [Renong accounts for 5% of the country’s bank loans] and they’ve exhausted all the possibilities in the real capital markets. There’s no way, for example, that they could do a Euro convertible bond, but with an Islamic deal, they know that they can find state-linked agencies to buy the bonds.”

On a positive note, the same banker believes that Elite’s initial financing problems will be pretty much settled by the bond issue, and it will have no problem paying investors from its revenues, which are now much more in line with expectations.

That leads some to conclude that 100%-owned Elite is UEM’s best hope of raising new equity. With a reasonable, well-scheduled debt load, and a 40-year concession on a good toll road, Elite may be an attractive proposition even for cynical equity investors.

And UEM needs to pull some cash out of the equity markets badly. It has purchased many of sister company Renong’s assets for an estimated M$5.4 billion, and this will essentially transfer all the assets and debts to UEM’s balance sheet.

UEM’s preferred strategy would be to sell equity in Renong companies, without actually losing control of those companies. However, the continued failure to find any takers for the PLUS IPO issue highlights the reluctance of the investor community. Another IPO targeted next month by Time Engineering, a Renong company at present but one that will switch to UEM once it acquires Renong’s assets, is also expected to hit problems.

Elite may prove more attractive than either, as its debt pile is lower.

The initial offering in Time dotcom, the telecommunications part of Time Engineering, has been subject to major delays and analysts feel the issue will fall short of raising the M$1.9 billion that company officials hope for. “The problem for UEM is that when it acquires the Renong assets its capital gearing will go up from 300% to somewhere nearer 500%,” says one analyst at an investment bank in Kuala Lumpur. “It hopes that it can raise money through these IPO listings - but whether the PLUS listing takes place depends on how successful the Time listing is.”

As an alternative, it would seem likely that UEM will be forced to sell the assets outright or raise the costs of its services. “The company won’t really want to sell its assets because obviously that is going to have a negative effect on revenues,” the analyst continues. “It has been suggested that it might implement tariff increases on its roads by 33%, but that would be crazy because it would make using the roads more expensive than petrol and cause bad feeling with the public. And it really doesn’t need any more adverse publicity, particularly if it still wants to go down the IPO route eventually.”

UEM and Renong have historically been very close to Malaysia’s ruling party UMNO and every business decision they take is normally best understood in this light.

So, although the balance sheet of the group might not look the healthiest, problems are made easier by it status. “Nobody doubts that the group will continue to be around for a long time because it’s a monopoly,” the banker comments. “They will continue getting projects such as the road to the airport with concessions to collect toll revenue for the next 40 years. Unless the regime changes, the group’s position is effectively safeguarded.”