By RISEN JAYASEELAN
CLOSE to three years after the much-hyped mega-merger that created the world’s largest listed plantation company, the unthinkable has happened. Instead of creating value, value has been destroyed. Massive write-downs from engineering projects gone awry, from a cost standpoint, has hurt the giant. If not for the huge earnings from its core business of plantations, Sime Darby could easily have been crushed by the size of these write-offs, totalling some RM1.9bil since 2004. That’s more than half of Sime Darby’s group profits for FY2009.
All is not lost though, according to its newly appointed acting group chief executive Datuk Azhar Abdul Hamid. “We need to create value again for shareholders to make up for what we have lost,” he says.
While admitting that the “hole” created by the overruns is challenging to fill because of its size, Azhar says Sime Darby has “unlocked values” within the group. “We’ve not been too visible or focused enough on real value generation,” he adds.
The plantations division, Sime Darby’s single largest profit contributor, makes up more than half of profits, and which Azhar himself has headed since the group’s 2007 mega-merger, has much room for growth.
“We are yet to become a serious downstream player. Our oleo-chemicals business is not very developed and there is still a lot of unplanted acreage,” says Azhar.
Growth will also come from brownfield developments, where Sime Darby buys into existing plantation land with the idea of enhancing yield.
Sime Darby is looking to buy 300,000ha of landbank in Sarawak while it already owns 220,000ha in Liberia, both of which are greenfield and so will have a longer gestation period. Its plantation size is set to reach one million ha in five years’ time.
Tremendous potential also lies in Sime Darby’s property arm. Since the mega-merger, Sime Darby has become Malaysia’s largest property developer by land bank. A lot of its land is also in key areas poised for property development.
Sime Darby has also maintained strong niche-market leading positions in the industrial and motor divisions. It is the third largest automobile dealer group globally for German automaker BMW, and one of the world’s largest dealers for heavy equipment maker, US-based Caterpillar Inc.
Azhar, who had previously headed the group’s heavy equipment division, says that even though car and equipment sales carry thin margins, the secret is in after sales. “When I was in the industrial division, when we sold a tractor, the objective was to get back at least four times the sales margin in after-sales services. That’s going to be driving growth in our motor division too,” he says.
Disproportionate risk profile
However, what about the problematic energy and utilities division (E&U) division?
This is a division that contributed a mere 1% of group profits last year (and 4% the year before).
This division did earn a significant RM683mil in 2007, however most of that was from a one-off gain from the sale of its 29.3% stake in Jaya Holdings Ltd, then a listed Singapore-based shipping company, to Nautical Offshore Services for S$301mil.
What is crucial to note is that the size of E&U’s cost overruns indicates that Sime Darby has an extremely disproportionate risk profile. It’s E&U division, which is a minor player in the group in terms of its asset base and earnings contribution, has embarked on projects so massive and which carry risks that could rock the entire group.
E&U’s cost overruns mainly stem from work done on the Bakun hydro-electric project that involves building the largest dam in Asia (outside China) and to generate 2,400 MW of electricity once completed. Cost overruns also took place in building oil and gas structures in Qatar.
“Projects of this magnitude require a high degree of expertise, which clearly is not a core competency within the Sime Darby group,” points out an engineer from a multinational firm who specialises in the power sector. He declined to be quoted.
Ivy Ng, a senior regional analyst at CIMB Investment Bank who has been writing on Sime Darby since the late 1990s, writes in a recent report: “It remains unclear whether the group will exit the oil and gas business given the discovery of such huge losses and the fact that it is not a large earnings contributor to the group.”
Azhar says he has no plans to shut down the problematic E&U. “I want to manage the situation so that it does not deteriorate further and focus my time on generating value again. We need to be razor sharp in managing the business and managing our risk profile. While this division has been problematic with a few projects, it does not mean that it is incapable of doing business,” he says.
Azhar says there’s hope still for Sime Darby – in its current structure – to succeed. “It is about having the right approach and the right team. The chief executive has to make sure he has competent people, making sure that the business runs to its full potential. There should be a good strategy and also well-developed processes and controls that will allow enough flexibility for entrepreneurial moves to be made. I can’t change the past, but I can change the future,” he quips.
Part of his task he says is to take another hard look at this division and others to see if there is even a remote chance of any problems and quickly provide for it so as to be able to start on a clean slate.
Although Azhar says it is early days yet to ask if the group could be looking at a restructuring exercise as a means to creating value – which could include a listing of some units, according to some unconfirmed reports – it is certainly something that analysts do not discount.
Big questions are being asked as to whether Sime Darby Bhd should go on life as the unwieldy conglomerate that it is, or be broken up, in the name of better transparency and accountability.
Should Sime Darby hive off its non-core and non-performing businesses? Does the conglomerate model actually work anymore for it?
With the bulk of its earnings coming from plantations, why not keep that as a separate listed company, so as to attract more investors?
Exposure to plantation business
“Most investors invest in Sime Darby for exposure to its plantation business and not the other businesses,” says Abdul Jalil Rasheed, head of equities at Aberdeen Islamic Asset Management.
That seems to be the consensus view among investors.
But Azhar says while there are pros and cons to being split up or functioning as a conglomerate, a decision had been made at the point of the merger in 2007 to have six core businesses in the group. “If your focus is on solid value generation, then either one approach will be the right one. If all the divisions were giving healthy margins, would we be questioning the conglomerate structure?” he asks.
But value has been destroyed at the E&U division by the cost overruns that need to be provided for. This in turn eats into the profits and cash flows generated by the group’s other units.
Azhar admits that management had taken its eye off the ball for this division.
Still, that may be putting it mildly. While an investigation is still work in progress, the massive overruns indicate serious weaknesses in the way the Sime Darby group or at least its E&U division is run.
What also irked the investment community is that the news came out so late in the day and whether the internal and external auditors and the board were slow to warn investors.
“These were projects that had been on for some time, indicating that disclosures about their overruns could have been done sooner,” says an analyst.
Adds CIMB’s Ng, “We were disappointed by the group as the recent revelation of the huge losses for the E&U division reflects poorly on the group’s transparency.”
The board has acted swiftly by removing group chief executive Datuk Seri Ahmad Zubir Murshid and putting Azhar in the driving seat.
The jury is still out on the board, with some applauding it for taking the bold steps it did and others leveling blame on the board. The fact remains that the board has brought in the necessary third party expertise (lawyers and specialist accountants) to delve deeply into the matter. If fraud was present, they board says, necessary action will be taken.
Fighting “fires” in Sime Darby though, has happened before.
In early 1998, Sime Darby’s financial arm, Sime Bank Bhd (formerly United Malayan Banking Corp Bhd), made headlines after it announced huge losses to the tune of RM1.57bil with provisions for non-performing loans totalling RM1.8bil.
The debacle dragged Sime Darby into the red for the first time in 20 years. It also subsequently led to the resignation of Sime Bank chief executive officer Datuk Ismail Zakaria.
In June 1999, Sime Darby decided to exit the banking sector.
The group sold Sime Bank and its subsidiary, Sime Securities Sdn Bhd, to banker Tan Sri Rashid Hussain, for pittance.
That raises another complication, going forward. If Sime Darby now heeds the call for hiving off its non-core units, will it be selling them at the right valuations?
To be fair, that is Azhar’s concern. He reckons even if a plan is made to list its plantations arm, more needs to be done to it to get a better valuation.
In addition, the plantation arm remains the bedrock of the group. It enables the group to raise money for other divisions and its strong cash-flows also help support it from securing large projects, say for its E&U division.
On hindsight though, that may not seem like a great idea.
Sime Darby’s model is to try to grow its other divisions into the size of its plantations business. This way, the group will supposedly have strong earnings streams that buffers it from the volatility of crude palm oil (CPO) prices.
To some extent, it has achieved this goal.
Still, the other divisions are relatively smaller compared to plantations. Hwang DBS sum-of-parts valuation gives Sime Darby’s plantation arm a value of RM6.36 per share, the closest to that being industrials at RM1.61 per share.
To be fair to Sime Darby, due to historical and legacy issues, it has inherited a wide range of small businesses.
Press reports last year quoted Zubir as saying that before he took over in 2004, it was in just about every business including furniture, tiles, paint, property, supermarkets, toilets, and petrol stations. Zubir had since then divested more than 300 companies deemed unrelated to the core businesses of the new Sime Darby group.
There are still remnant non-core businesses ranging from mattress makers, hotels to travel agencies and even a small stake in Tesco Malaysia. Some analysts feel that Sime Darby has been too slow in ridding itself of these non-core assets.
“It is a hodge-podge of businesses. It’s hard to know what Sime Darby is about today,” says an analyst.
Some of its larger businesses have also remained status quo, which raises the question of whether there is a growth strategy attached to them. For example, Sime Darby’s power division, through which it owns two power plants, one in Port Dickson and another in Thailand, has not significantly changed since five years ago.
Does the conglomerate model really work?
There are conglomerates that work, like General Electric Co (GE) and the UK-based Virgin group. But there are more that have failed. Indeed, the trend at the end of the 20th century was for conglomerates to move from being large, unfocused behemoths to firms that created organisations focused on core capabilities.
This means more companies began to avoid acquisitions that clashed with their business mix and focused on acquiring companies with related synergies.
For both GE and Virgin, the key to their success, says management expert Roshan Thiran who had worked in GE before, is a cohesive culture and brand name that is present throughout the group.
“Everyone in the group knows the vision and mission and this is inculcated very strongly and across every single segment of the group,” he says.
Needless to say, these successful groups also adhere to very strict corporate governance standards and have impeccable internal audit functions.
Another consultant says that while most conglomerates today actually destroy value, there a few who create value by doing “some pretty straightforward things exceptionally well.”
He says this includes intensely managing risk and performance; having management processes that develop and allocate the group’s scare resource (in terms of capital and human resources) to the biggest opportunities and having synergies and capabilities that can be exploited throughout the group.
In Sime Darby’s case, it is still a puzzle how the systems did not capture the overruns early on and nip them in the bud.
Indeed, when the now-ousted Zubir had taken the helm of the group in 2004, he had inherited the problematic Bakun project, which at that time had already suffered some cost overruns. Insiders say Zubir should have then paid close attention to this ticking time bomb and address the problems early on. “Instead, the cancer was allowed to grow,” quips a source. Zubir could not be reached for this article.
Now Sime Darby’s board, it is understood, is making sure that any new chief executive will be closely watched and not be allowed to sidestep controls.
The danger though, could be over-control and stifling decision-making in today’s fast corporate environment.
One of Azhar’s first steps, he says, is to focus on creating value to help return the value lost.
His appointment has its pros and cons. On the one hand, he is familiar with the systems in place and has had a wide field of working in the group, having done stints at its motors, industrial and having helmed the most important asset, its plantations, since even before the 2007 mega merger.
But others reckon Sime Darby needs an outsider to revamp it. “It could be tough for an insider to take drastic and unpopular steps. It’s always easier for someone from the outside to do this.
What Sime Darby needs is a big culture change,” says an industry player who declined to come on record.