Singapore has invested over US$5bn in Hutchison's ports, so it is not surprising that HPH is listing there. We look at the other incentives, and the governance concerns for the Business Trust structure. We also ask why China Resources Enterprise (291) has not disclosed the outcome of its profit-sharing after CRH flipped its port stakes to HPH.

HPH Trust is no loss to HK
21 January 2011

There's been much hand-wringing amongst legislators and media in HK this week about "losing out" to Singapore as a choice of listing for yet another spin-off of Hutchison Whampoa Ltd (HWL, 0013), this time the South China ports business of its 80% subsidiary, Hutchison Port Holdings Ltd (HPH, BVI). We don't think HK is losing out at all, and it would be a loss if HK were to lower its standards to attract such business, as we will explain.

The proposed spin-off involves creating a Business Trust (BT) under the Singapore Business Trust Act of 2004 (BTA), called Hutchison Port Holdings Trust (HPH Trust). The world hasn't exactly been rushing to create BTs - there are only 10 currently, over 6 years since the enactment in 2004. The first, Pacific Shipping Trust, was listed on 26-May-2006.

The Trustee-Manager (TM) of HPH Trust will be Hutchison Port Holdings Management Pte Ltd (HPH Management), which will be 100% owned by HWL, not by HPH. That cuts the 20% minority shareholder of HPH, PSA International Pte Ltd (PSA) out of the management fees.

PSA is wholly-owned by Temasek Holdings (Pte) Ltd, in turn owned by the Singapore Government, and has been a buyer of HWL's assets since at least 2005:

So after more than US$5bn of Singapore government investment in the HPH business, there is a natural affinity towards listing there.

HWL plans to initially retain only 25% of HPH Trust. If this were a HK-listed company, then it would be feasible for others to launch a takeover or to insist on board changes, particularly if they become dissatisfied with the management. It takes 50% approval of shares voted to remove a director or appoint a new one. But how do you remove the TM of a BT? Here's the catch. Section 20 of the BTA says:

"The trustee-manager of a registered business trust may be removed as the trustee-manager by the unitholders of the registered business trust only:
  1. if a resolution to remove the trustee-manager is approved by unitholders of the registered business trust holding in the aggregate not less than three-fourths of the voting rights of all the unitholders of the registered business trust who, being entitled to do so, vote in person or where proxies are allowed, by proxy present at a meeting of the unitholders of the registered business trust; and
  2. in accordance with such procedures as the Authority may prescribe."

So unitholders of HPH Trust would need 75% approval to remove HPH Management as TM. If HPH retains 25% plus one unit, then HPH Trust will be bid-proof. Even if HPH is prohibited from voting, it would be an uphill struggle to get the required majority. Short of that, unitholders will have very little say (except on connected transactions) because they will not be able to elect directors of HPH Management, unlike a listed company. In short, the only way to change the directors of a TM is to own the TM.

BTs are governed partly by Regulations made under the BTA. These require one third of the directors of the TM to be "independent" from management and from every substantial shareholder of the TM. However, they are not electable by unitholders, so in practice they serve at the pleasure of whoever owns the TM. Just like INEDs in a listed company with a majority shareholder - the INEDs serve at the pleasure of the majority shareholder, and until that changes, they are only as independent as the controller wants them to be.

Upon the sale of HPH Trust, HWL's interest in HPH will be reduced to 25%, and its interest in HIT and other subsidiaries will be even lower, while still retaining 100% of its operations and receiving fee income for doing so. Nice work if you can get it. But why should HK create a regime which makes it easier for tycoons to exercise control over assets with such a low level of economic interest? We don't need to, because they can already do it through multi-level corporate pyramids. For example, Hongkong Electric Holdings Ltd (HKE, 0006) is at the 4th level of the Cheung Kong pyramid, 38.87% owned by Cheung Kong Infrastructure Ltd (1038), which is 84.58% owned by HWL, which is 49.97% owned by Cheung Kong (Holdings) Ltd (CKH, 0001), which is 42.12% owned by Li Ka Shing. So CKH controls HKE with only a 16.4% economic interest, and Mr Li only has a 6.9% interest in HKE.

It is true that a Singapore Business Trust (SBT) can pay distributions out of cash flow even if they are not making a profit, but that is really not relevant to HPH's decision, because regular listed companies which have racked up losses can always reduce their share premium or share capital to pay out cash, with a relatively simple process, and besides, HPH is highly profitable. So that's not a good reason for choosing an SBT.

One incentive might be that Singapore offers a tax break for trustee-managers of SBTs which are involved in offshore infrastructure. That presumably includes ports, and means that HPH Management, if it qualifies, would only pay 10% income tax for the first 10 years. Well, that's Singapore for you, always playing around with tax incentives to direct its centrally-planned economy. It is something that HK has avoided, and long may that last. We don't "do" tax incentives - although we do have a Government which cannot resist the temptation to designate industries as "pillars" and dish out land allocations for them.

There's no Singapore stamp duty payable on the transfer of BT units or REITS though, unlike HK stocks and REITS.

Singapore does tax its residents on some dividends from domestic companies (although this may have reduced to nothing after changes to a "one-tier corporate tax system" in 2002), but not foreign dividends. It does not tax distributions from unit trusts, including BTs. But HK doesn't have that problem - there is no taxation of dividends here, nor should there be: dividends are paid out of profits after tax, so taxing dividends would amount to double taxation. So we have no need to create a BT system to avoid a HK dividend tax which doesn't exist.

All in all, we can see no good reason for HK to emulate Singapore Business Trusts. There's no tax reason for doing so, and there are governance reasons why we shouldn't. We should not race to the bottom just to win business from tycoons who are not willing to work with existing corporate governance standards, nor should we offer tax incentives for trustee-managers (or any other business sector).

Payout for CRE?

Before announcing the spin-off, HWL "(or its subsidiaries)" increased its interest in part of the business. It wasn't clear which of HWL and its 80% subsidiary HPH was making these acquisitions. On 31-Dec-2010, HWL (or HPH) agreed to buy from China Resources (Holdings) Co Ltd (CRH) 10% of HIT Investments Ltd (HITIL, BVI), 10% of Hutchison Ports Yantian Investments Ltd (HPYIL, BVI), 12% of the A-shares in Omaha Investments Ltd (Omaha, HK), stakes in two other minor subsidiaries, and the remaining 45.45% of a property at 9 Chong Yip Street. This increased HWL's stakes (including via HPH) to 99% of HITIL (which owns 100% of HIT), 99% of HPYIL, 100% of Omaha, and 100% of the Chong Yip Street property. The total price was HK$5,700m. The announcement didn't say what Omaha does, although the HWL annual report says "property owning".

The sale by CRH to HWL (or HPH) came 14 months after CRH had bought the same or similar assets along with a textile business from its listed subsidiary, China Resources Enterprise, Ltd (CRE, 0291) in an asset swap. In that deal, the 10% interests in HTIL and HPYIL were valued at a total of $3,319m. Interestingly, the terms of that sale included that if CRH subsequently sold the port interests or any part of them for more than $3,300m, then it would pay 50% of the excess amount to CRE. It now appears that CRH has done just that, selling the assets for $5,700m.

It is unclear whether the stake in Omaha and the Chong Yip Street property were part of the CRE-CRH deal, but if they were, then the excess was $2,400m and CRE could be entitled to a $1,200m payout. The attributable NAV of the 12% of Omaha at 31-Dec-09 was $214m, and the book value of the Chong Yip Street property at 31-Dec-2010 was $390m, so 45.45% of that was $177m. So even if those two assets were not part of the CRE-CRH deal, there is still a gain by CRH of about $2,009m, which should yield about $1bn for CRE under the agreement.

So far, CRE has failed to make any announcement about this, even though it is substantial relative to the $3,783m of net profit for 2009. Given that this entitlement to a profit-share arose from a connected transaction with its parent, CRE should announce whether or not there is a payout due from the on-sale by CRH, and if so then how much.

©, 2011

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