Why some highways are less profitable

I do not quite agree when we put it that it is very difficult to project the cashflow projections of highways. Unless we are talking of flying cars and changing habits over transportation over the next 30 - 40 years, this business will be more consistent than many businesses. Yes, we do not know what the future entails but so are many other businesses. As long as cars, trucks and buses are not replaced roads will still be used.

I have been asked on why then some of the highways are not profitable or rather seemed to be not or less profitable. Take a read over this news - PLUS Expressway's profits for FY2016 was RM288 million i.e. not great for a company this size.

For FY2010, let me show what the number was. FY2010, it was already doing RM1.3 billion PAT. What happened then?

Did the traffic dropped. It obviously did not drop. By 2019, PLUS was already doing RM4 billion revenue. Let's look at this news. Post delisting, PLUS raised a RM30 billion debt. Much of the money went back to the short term funds raised and for repaying to EPF.

I provide a simple P&L calculation as below. Let's assume a project in middle of its concession and the P&L is as provided below. If the cashflow is consistent, I do not need to do much, many Investment Bankers will be approaching the company.

With good ratings, the funding rate would allow the owner of the business to take money upfront and use the funds to venture into other projects. So, when people like Warren Buffett says he has $130 billion cash, it does not mean he has no debt, he has carved out his good assets such as the utilities and made available funds for his other acquisitions. So is YTL.

Let's say the highway has 20+ years to run (and revenue is growing), when approached, the company would raise a RM20 billion debt at probably 5% and the P&L would look like below.

Now, immediately the profits is now 0. Of course, overtime the profitability would increase as it is needed to pay principal for the debt instrument but we usual investors are probably being misrepresented if we do not know the actual exercised behind it. Usually, this kind of projects may be candidates for delisting and then relisting.

The similar situation was probably seen for MTD Capital (which went delisting as well in 2011), the owner for East Coast and KL-Karak Highway.

Today, as provided to me, ECE and KL-Karak Highway together are not making much profits which is not true in actual cashflow per se.

This the reason why I mentioned of cashflow rather than profits for concessions such as highways.

Why the fundamentals for WCE does not change much

When I bought this share 6 years ago, I was looking really long term. Today, that mindset does not change. Sure enough, today the project faces some blip - not entirely due to the current government as they have promised the elimination of toll but also because there was a dispute over the alignment prior to that. Now, let us review what actually had happened and probably I will go through the bad news first.

Early delays

The alignment for Phase 7 had been changed as earlier the concessionaire faced a dispute from the government then on the alignment. Since then, it has been solved (after the change of government). This has caused delay in that phase and since it is a 50 + 10 year concession, the affect does not change much. Probably the biggest change was the cost of land acquisition has increased.

Threat over toll elimination by current government

I have written a piece on this after the change of government on May 9. So far, what is negative since then for WCE is that they have yet to collect toll despite completion certain sections. What was sort of promised by the government i.e. to eliminate tolls and force it onto the concessionaires i.e PLUS, Gamuda etc. did not happen. In fact, Gamuda's concessions is being bought at a fair price. In the event WCE is being forced to sell, they would be selling at a fair price as well.

Anyway, as we can see the government may not have the funds to purchase many of the concessions. Hence, it is possible the government is using Khazanah to purchase them. My question is this, if the idea of the current government is to privatise businesses, then this action acts on the opposite. Khazanah buying the concessions, would also mean they are collecting toll as well. Anyway, in the event Khazanah is buying, I think it is a a fair price of the concession, hence much higher value than what is being traded at - for WCE.

PLUS is being reviewed i.e. reduced toll rates

As in the Budget 2020, the government has promised that the toll rates for PLUS is reduced at least 18%. Well, it shows how profitable PLUS is. Despite not increasing the toll rates every 5 years, it can now afford to reduce the rates. Given the situation, I am not sure who will get (to purchase) the concessions, but surely we as EPF contributor is affected by the reduced rates collection.

The affect to WCE is probably minimal as I do not think over a long distance (from Shah Alam to Penang) driving the drivers would bother over few ringgit savings.

Increased value in land purchase

To me, this is the biggest negative, as it affects the pocket directly. Anyway, as mentioned in the prospectus, the land purchase deals 95% of them have been completed. What is done is done. WCE is disputing some of the acquisitions in court and it seems to be able to win a portion of it.

The increase in equity injection would affect the calculation of IRR in the project - assuming it is decently profitable around 10%. Any increase in equity would change the IRR and if we can remember the project has a IRR hurdle where in the event the concession's profits exceeds certain threshold, it is supposed to share a higher portion of the profits with government.

In the long run, hence the additional injection would not change much fundamentally given the IRR scenario.

Partial completion of the highway

This is the good part. It shows that the project is on the way and WCE is able to complete it. There is no reason to not believe they are capable of constructing despite the small situation over at Phase 4.

This project which has been talked about for so long is now really moving. The biggest beneficiary is Perak especially Lumut and I am sure many are waiting for the completion.

It is a long term project

Again, whatever the share price changed in the short term, there is little impact. At the moment, WCE has yet to collect toll so the financials that we see on quarterly and annually basis is no relevance. The biggest relevance is the costs and progress of construction.

Losses in the first few years

I have been asked on this, and would like to clarify. Profit and losses is not the main basis for calculation, as it is accounting (little bit deep to write in this article). What is important after the project is the cashflow. As an example, PLUS today on paper is making losses and I have read the Minister in past gladly presented the loss making fact (this loss actually is good for PLUS owners given the tax planning situation).

Let me put this in perspective, if it is making losses, why are there so many wanted to offer the purchase of PLUS?

Post 2038

There is potentially one big factor when PLUS is taken out of the tolls collection. Although PLUS is a parallel highway to WCE, there are various trends which is positive for WCE. One of them Pulau Indah port. WCE is closer to Pulau Indah, and the government is developing those areas. It is encouraging the expansion of the ports or even a new one. By then, given the development, WCE will have its own additional strength. As mentioned in past by the management, WCE's strength is its flat terrain which is a bonus for heavy vehicles.

I believe the traffic is so heavy by 2038 that, PLUS will be quite badly congested that we would have needed an alternative highway anyway. Hence WCE. I have also seen the maintenance of a non-tolled highway in Malaysia - which is not a good sight.

The PLUS asset should remain where it is now

Frankly, with proposals by various parties on the toll assets - where it is reported there are a total 15 highways in proposal and under review. Among them, the Gamuda, IJM and PLUS's highways. Let me put these thoughts from the 3 proposals perspective:

1) proposal by MOF to buy the 4 highways controlled by Gamuda - which we know is the government's money, although Tony Pua's argument is that the government does not need to come out with extras. That's what he said. But he also claimed that Malaysia's debt has exceeded RM1 trillion. Buying the Gamuda's highway will add the debt no doubt, despite it is ring-fenced against the proceeds from the toll collection. The idea is buying over the assets will increase the country's debt no doubt. Additionally at a time where we are promoting privatisation for Malaysia, this act is in the opposite which is nationalisation of assets. This is also against PH's manifesto.

2) proposal by Khazanah - it is reported that Khazanah has submitted a proposal to purchase 15 highways owned by Gamuda, IJM and including the PLUS highway. Among them, the largest in contention is the PLUS asset. As we know, PLUS is already controlled by Khazanah through its 100% unit - UEM. In my opinion, Gamuda and IJM can manage these assets better than Khazanah. Can Khazanah have other ways besides not collecting toll? If yes, I would like to listen. The largest asset among the many is the PLUS asset which is around RM30 billion or more. Can Khazanah afford to reduce the toll collection fee? The other 49% owner of PLUS highway is owned by EPF which is the bulk of Malaysians money anyway - the owner is the one which will use the assets anyway. Why pass to the government. As an EPF contributor, I would prefer this asset. Can EPF find any better alternative after this sale? Also, this exercise seems like a left pocket - right pocket exercise as IJM and Gamuda are largely owned by the Malaysian institutional funds anyway. Why give more fees to the investment bankers and for them to take home more bonuses next year? Isn't that what we do not want? Giving money to the rich again for doing nothing much but shuffling assets.

3) proposal by Maju - Maju is a private party. In the past, its proposal was backed by Evercore - a large Private Equity. Maju as it is, is not very rich. Tun Mahathir's past has shown that he was willing to support entrepreneurs if they are willing. (Think Yahaya Ahmad, and many more) However, tolled highways are not difficult assets to manage, as long as managed well - unlike building a car. Hence, there is a huge probability that foreign PEs will make a killing as Maju itself may not have the capability financially to do this. Why give a large part of EPF's earnings for example to parties like Evercore and several more? They do not bring any additional value to us besides again shuffling papers.

All in all - I feel that it should remain status quo as the assets are owned largely by Malaysian institutions. This is just like what we like to term "Small little problem, but we go and dig (create) for more problems."

The Edge: Dr Mahathir on toll concessionaires

The most recent Edge Weekly is quite a meaningful edition as it had the opportunity to interview Tun Dr Mahathir i.e. the first to do so in a private setting after GE14 where Pakatan Harapan had won the election.

I managed to get a copy during the weekend, and Dr Mahathir was enquired about his views on toll abolishment in stages as in the Pakatan Harapan's manifesto.  Here are some of it (but please go and buy a copy as there are much more to read especially on ECRL, HSR etc).

TheEdge: The national debt is already so high. The government has zero-rates GST, reintroduced petrol subsidy and is reviewing toll charges. These will cost the government money. How is it going to handle the situation?

Tun Dr Mahathir: Much of the work being done now is to downsize the financing of the government. By doing away with all these expensive projects, we are already reducing (debt) servicing costs.

.....

I must admit that when we were campaigning, we proposed things so that the people would want us to be the government. But, of course, we have to manage these promises. For example, the toll review is not going to be immediate, it will be in a gradual manner.

Is the government going to acquire all the toll concessionaires?

Some we have already acquired. But we have to work with the private sector. I have read some of the proposals; they sound quite reasonable. You see, the main point is we don't want to punish the people (toll operators). At the same time, we have to ensure the government has some money to build roads.

Based on the above, it is unknown what he meant by "Some of the toll we have already acquired." Could he have meant that PLUS was for example is already 51% owned by Khazanah, the only government owned that I know which is owned by the government. Many other toll businesses are either owned through PNB (a government managed fund), EPF or some of them the shares are passively owned by Malaysian funds.

Toll business which traditionally have been the safer bet assets, have been hammered especially when several individuals have appeared to justify that they will follow the Pakatan Harapan's manifesto of abolishing toll in stages. From there, the toll concession shares have suffered drastic drop and some of them have been owned by my investment fund. These are WCE, Ekovest, LITRAK, MRCB.

What was initially feared is that the government will be using a clause which is available in the toll contract i.e. in the "expropriation clause" where the government can acquire them for national, public interest or public security.

Of course, the argument from many (including me) is that in doing so, it will collapse the capital and bonds market where toll concessionaire's bonds are among the highest in total.

What I think may happen?

As mentioned by EPF's CEO, the toll business acquisition has to be looked at holistically. In my mind, holistically means it has to be looked at in its entirety and it may involve Khazanah, PNB and EPF in acquiring these assets. The bonds may also be repackaged and new shares may also be offered in the capital market.

One may ask: But, it does not eliminate toll charges. Yes, but in reducing the toll charges, it is already a win. When the government together with the funds are able to negotiate a package with the toll owners, they can relook at an optimum charge towards the users as well as a decent return for the investors i.e. the funds.

It has to be understood, rightly so, some of these toll businesses have made quite a lot throughout the concession period. Among them are LITRAK and PLUS and these have been the topic of contention among the politicians like Tony Pua.

Hence, by acquiring the concessions outright at a fair price and repackage the toll rates, they may seem to be the best option.

Is UEM Edgenta sweating?

Today, The Star came out with the news that UEM Edgenta is looking at a longer term contract between UEM Edgenta and PLUS. I wonder why suddenly...

We also have read of news that there is a proposed acquisition by Abu Sahid to acquire PLUS at a price of RM36 billion. I am also wondering whether there is a possibility of savings in the maintenance of PLUS highway considering that the proposed acquisition is quite bold at a price higher than when UEM and EPF did a buyout of the highway back in 2011. At that time, the Enterprise Value (cash plus debt) paid for PLUS was RM34 billion. And one can imagine, for a concession that has enjoyed about 6+ years of revenue, another party would come and propose for an acquisition at a higher price considering that the concession period is now reduced.

The below is the filing made during Faber's acquisition of PROPEL in 2014. We now know that the icing in the cake for UEM and UEM Edgenta is Edgenta Propel (formerly PROPEL), the maintenance outfit for PLUS highway.

I can only imagine that if ever this very hard to maneuver deal is pulled through, contract between PLUS and Edgenta may not continue. Hence, I can also imagine that another sweet side of the cake besides the highway revenue is the maintenance contract.

Stopping PLUS toll collection - REALLY?

I am hearing from Lim Guan Eng that he can eliminate the toll for PLUS based on the youtube video below.

Not so easy. PLUS has RM30 billion debt. Who is going to pay off that debt? EPF owns 49% of PLUS while Khazanah owns remaining 51% of it. Is the government going to pay off that debt for PLUS? Agree on the return for PLUS but I do not think one can so easily dismantle the debt issue. To be frank, it was actually a very smart move by all the parties involved in the privatisation of PLUS. It is structured in a way where if we are to stop the toll or soften the price hike, it will affect the EPF contributor's pockets - i.e. yours and mine. Damn if you do, damn if you don't. They are quite smart people out there structuring this deal!

In restructuring to take tolls out of PLUS, one will definitely need to obtain the approval from the bond holders. Easy? Nope. Otherwise, they would need to find RM30 billion to pay the bondholders off.

Based on the principal amount of RM30.6 billion debt and at weighted average yield of 5%, its interest is more than RM1.5 billion/year. Ever wonder how it can be barely profitable? Huge interest costs of course.

So now on investments - with its ability to fund a RM30 billion debt, do you know what is PLUS cash generation capacity? HUGE!

Interest payment alone is going to be around RM25.4 billion. Total repayment including interest over the 27 years is going to be about RM56.2 billion. That's how much the banks think PLUS can generate free cashflow over the 27 years from 2012 to 2038, at the very least. This comes to on average more than RM2  billion a year.