Can Hyflux Retire Its Preference Shares Before They Get Dearer?

Foreword from ShareInvestor

This article “Can Hyflux Retire Its Preference Shares Before They Get Dearer?” by Marissa Lee was first published in The Straits Times on 04 Feb 2018 and is reproduced in this blog in its entirety.

It can service its perps only through divestments – therein lies the hurdle

Like me, investors who are sniffing for yield would have noticed that Hyflux’s 6 per cent preference shares, issued at $100 apiece, now trade below par at $91.30 – even with the first call date nearing on April 25.

The first of a kind at their market debut in 2011, Hyflux’s $400 million perpetual securities were an instant hit, bid up above par in the earlier years as retirees chased the 6 per cent semi-annual coupon like it was the best thing since sliced bread.

Fast forward to 2018, however, and the big question is whether or not Hyflux will be able to retire the perps come April, or incur a steep interest rate step-up to 8 per cent.

Banks would not be keen to refinance the highly leveraged water project developer, which has not generated positive cash flow from operations since 2009.

The only way Hyflux can procure enough cash to service its perps is through asset divestments, which it had expected to complete last year, but has not.

In February last year, Hyflux said it was planning to partially divest up to 70 per cent of Tuaspring water desalination and power plant, held on its books at a value of $1.3 billion.

Since October 2016, it has also been trying to sell the Tianjin Dagang desalination plant in China, which has a book value of $150 million.

A Hyflux spokesman told The Sunday Times two weeks ago that Tuaspring had attracted a long list of buyers at the start of the process, which is why the approval process took longer than originally planned. A handful of parties were shortlisted and bids were received late last year, she said.

But sceptics are scratching their heads over why anyone would want to buy Tuaspring, and for what price.

Tuaspring as a whole is loss-making. Its 411MW power plant has never turned a profit since operations began in March 2016.

Hyflux has blamed a weak electricity market and poor power spreads for the losses.

And it is not the only power generation firm that is struggling.

The fact is that Singapore’s electricity market is heavily oversupplied, and that is not going to change.

To prevent outages, the energy market regulator sets a minimum reserve margin of 30 per cent.

This is the difference between power produced and consumed.

The actual margin is closer to 90 per cent.

Amortisation Burden

Any buyer of Tuaspring would also have to take on the burden of amortisation costs since the 25-year water concession ends in 2038, at which point the plant would be returned to national water agency PUB.

Hyflux said it wants book value for the partial divestment.

For more on how the drama unfolds, investors will have to watch the company’s full-year results statement at the tail end of this month.

Until then, the 2018 perps are basically a bet that Hyflux pulls off the Tuaspring divestment.

And that would not be the biggest hurdle Hyflux has to clear.

It has another payment coming up on Sept 7, when its $100 million 4.25 per cent Series 008 notes mature. Its $500 million tranche of retail perps callable in 2020 are also trading at 75.1 cents to the dollar, reflecting market doubts over the longer-term sustainability of the business.

Hyflux describes in its annual report: “Our approach is to build up the value of an asset and divest it at an opportune time to recycle capital for growth.”

In other words, it makes more money from engineering and construction contracts than from actual plant operations.

But the desalination industry has matured since Hyflux’s initial public offering (IPO) in 2001.

With buyers getting more sophisticated, Hyflux is less able to bank on selling a Singapore brand name, so this business model is under pressure, observers say.

Besides, membranes and water polishing are not rocket science, and rivals like Sembcorp Industries, Keppel Infrastructure and Chinese state-owned enterprises like China Everbright Water have stronger financial backing.

As for Hyflux’s latest manoeuvre – the proposed distribution of shares in its fledgling consumer business, HyfluxShop – the transaction is immaterial to bond and perp investors since it returns no cash to the Hyflux mother company.

That said, it is unusual for a listed company to give its shareholders units in a private subsidiary that is still a long way away from an IPO, and promises no certainty of an IPO.

Hyflux founder Olivia Lum intends to buy out shareholders’ HyfluxShop shares, and has been required by the Securities Industry Council to make a general offer for HyfluxShop.

So shareholders can get some cash back from the proposed dividend in specie if they tender their shares, but should they?

Although the HyfluxShop group made a net loss before tax of $6.3 million in 2016, its core product, oxygen-rich water called ELO Water, may hold promise.

Hyflux claims that unlike other brands of oxygenated water that rapidly lose oxygen to the atmosphere, “ELO Water is produced via a proprietary process that allows a high level of oxygen to exist in water in a unique, stable and bound form and is believed to be easily absorbed by the body”.

This may have useful implications for cancer patients and other medical conditions associated with hypoxia.

But the water does not come cheap. With one 1.5-litre bottle retailing at $10, a lot of work needs to be done to convince customers and build up a distributorship.perpetual securities;