Here we go again. It doesn't seem like three years ago that Henderson Land tried to privatise Henderson Investment at $7.60 per share. Now they are back with a higher, paper-only offer, valued at $12.90 tonight. We give our views.

Henderson Investment, Round 2
10 November 2005

Three years ago, Henderson Land Development Ltd (HLD, 0012) tried to buy-out the minority owners of Henderson Investment Ltd (HI, 0097) at HK$7.60 per share, increased from an initial offer of $7.35. We urged investors to reject that deal, and they did, blocking it by the narrowest of margins, just 0.036% of the issued shares. Back in 2002, we estimated HI was then worth about $12.26 per share. Investors who voted against the deal have been vindicated by the subsequent performance.

What is HI?

As of 30-Jun-05, HI owned 37.15% of local piped gas monopoly The Hong Kong and China Gas Co Ltd (HKCG, 0003), 31.33% of Hong Kong Ferry (Holdings) Co Ltd (HKF, 0050) and 44.21% of Miramar Hotel & Investment Co Ltd (Miramar, 0071). HI also owns 1.96m sq ft of investment properties including Eva Court, where the big boss lives, as well as the Newton Hotels in North Point and Mongkok and some operating rights to mainland toll-roads and bridges through unlisted 64%-owned China Investment Group Ltd. HI also has a small chain of department stores known as Citistore, and one-third of a commercial and office building called Hollywood Plaza on Nathan Road, Kowloon - the rest being owned by Hang Lung Properties Ltd and Sun Hung Kai Properties Ltd in equal shares.

The investment properties and hotels were valued at $5.0bn and $0.77bn in the Jun-05 accounts. Highways and bridges were held at amortised cost of $0.97bn but may be worth more - the infrastructure segment made a profit contribution of $152m in the latest year. HI also had net current assets, mostly cash, of about $2.9bn. It had long-term liabilities of $1.1bn but about half of that was deferred tax which mostly will never be payable as it relates to investment properties. Capital gains on disposal of investment properties are not taxable.

Together with HKCG, HI is in the final stages of privatising Henderson Cyber Ltd (HC, 8023), the balance sheet of which consisted mostly of cash raised from the 2000 IPO. After completion, HI will owns 78.7% of it, and HKCG the rest. That privatisation was fair and reasonable for the HC shareholders, and we said so at the time. Investors get back $0.42 per share in exchange for net assets of $0.15. Of course, this doesn't make up for the inflated Jul-00 IPO price of $1.25 (for a bunch of net assets worth $0.20, mostly being the IPO cash), but nobody had to buy it and we certainly didn't. Mr Lee had got on board the dotcom bandwagon after seeing fellow property tycoons do the same with and Sunevision, but he was a bit late and the IPO was a flop.

Anyway, HKCG is by far the largest asset of HI. The stake is worth $34.7bn at market price, ignoring any control premium that the stake would attract if it is ever sold.

Although HKCG is trading on a 2004 P/E of 30.9, management appears to believe that the stock is undervalued because HKCG has spent about $1.65bn so far this year buying back 104.46m shares, or about 1.9% of the company, of which 62.3m were purchased in October at up to $16.20. The buybacks have the effect of increasing HI's percentage stake in HKCG, which we estimate is currently 37.6%. Their enthusiasm is presumably driven by the prospects for their ventures on the mainland as well as the latent value of their various gas-related property sites in HK. After decades of being a misnomer, they have begun to put the "China" back in HKCG.

HKCG also has a number of existing property developments, including 15% of IFC (which is 35% owned by HLD), a planned 1.1m sq ft redevelopment of the Ma Tau Kok Gas Works, and 50% of the Grand Promenade on the old ferry concourse at Sai Wan Ho, on the Eastern end of HK island, which they won by tender in Dec-00. The other 50% of the project is of course owned by HLD.

HKF is basically just a property investor and developer of its old shipping-related sites, including the Metro Harbour View project which is 50% owned by HKF and 50% by HLD, on the former shipyard of subsidiary The Hong Kong Shipyard Ltd, which was relocated to Tsing Yi when the West Kowloon reclamation took away its waterfront. HKF also owns the quaint Silvermine Beach Hotel in Mui Wo, Lantau which is managed by Miramar. Despite its name, HKF doesn't operate many ferries any more - just harbour cruises and the Dangerous Goods Vehicular Ferry Service which gets petrol tankers across the harbour without blowing up the road tunnels, and occasionally goes to Mui Wo. HI's stake in HKF is worth only HK$1.04bn at market price, excluding control premium.

Similarly, the stake in Miramar, with its eclectic mix of Hong Kong and Californian property, is worth about $2.65bn without a control premium. This is not the focal point of the deal.

The Offer

Now, HLD is offering 1 share in HLD for every 2.6 shares in HI. Based on tonight's closing price of $34.15 per HLD share, less the pending HLD dividend of $0.60, that values the offer at $12.90 per HI share, a premium of 69.7% over the 2002 offer. HI shareholders also get to keep the $0.15 final dividend per HI share, which they've earned. HI has 2,817m shares in issue so the offer values the company at $36.3bn.

But how much better is this offer, in relative terms? Since 31-Dec-02, the last trading day before the vote on the previous offer, HKCG has gained 65.8% from $10.10 to $16.75, HKF has gained 63.2% from $5.70 to $9.30, and Miramar has gained 79.3% from $5.80 to $10.40, on the back of the mainland tourist boom and the recovery of the retail and property sector. In the same period, the Hang Seng Index has gained 57.0% from 9,321 to 14,633. We exclude dividends in each case to keep it simple.

So in the light of this, the market prices of the portfolio which comprises the bulk of HI's assets have gone up by about 67% but the offer is increased by about 70%. This amounts to only a 2% relative increase (1.70/1.67), and many investors are likely to find that disappointing. And this offer is in paper, not cash, so it carries additional closure risk. The offer value of $36.3bn is only $1.6bn more than the market value of the stake in HKCG, without any control premium added.

In terms of recent share performance of HI, the offer value, plus the final dividend, is only 11% more than the $11.75 at which the shares closed as recently as 3-Aug-05. Again, disappointing.

What's it worth?

As a rough guide, take the balance sheet, strip out the associates, include the market value of the stakes in HKCG, HKF and Miramar without any premium for control of those companies, add back the deferred tax on investment properties, and you get about $47bn, or about $16.7 per HI share. That puts the offer, including the dividend, at a 22% discount to fair value.

As we mentioned, we don't include control premiums on those stakes in our valuation, but one of the benefits of this deal for HLD and its controlling shareholder is that it gets to increase its economic interest in all 3 companies without triggering a bid under the Takeover Code. For example, HLD's economic interest in HKCG goes up from 27.6% to 37.6%. Under the Takeover Code, controlling stakes between 30% and 50% can only increase at 2% per annum. And if HI were to dispose of any of those stakes in a block, it would almost certainly get a premium which would benefit all HI shareholders.


One of the difficulties with this recommendation is that as an investor, is a bear on the local property market. We believe that we are in a property bubble, and that the recent declines in residential property prices of around 5% from the highs of the summer are just a taste of things to come. So if you agree with us, then you probably don't own HLD or HI in the first place. However, if you do hold HI, then you apparently believe that the property market is not overheated, or that the future of the gas business offsets the downside risk on the property element. Alternatively, you may have hedged out the risk and are just looking to make a quick buck on the takeover.

It is notable that HLD has not ruled out an increase in its offer. If it had done so, then it would have been prohibited from making an increase under the Takeover Code. This indicates that they have something in reserve. It is also a fact that the last time they tried this, they low-balled the offer and the minority who rejected it were vindicated by the subsequent performance of the assets. Finally, investors should note that the new shares in HLD would increase the number of shares in its free float by over 38%, so this may lead to some selling pressure on HLD, lowering the value of the offer further. So they need to make an increase to be confident of winning this deal.

So shareholders of HI who believe in the valuation of the property market should reject this deal and hold out for a better exchange ratio. However, if you take our view on the property market, then you shouldn't be holding the shares in the first place.

©, 2005

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