Financial management

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Financial Management
Case study 3 – Group assignment

PROTON TAKEOVER BY DRB HICOM
ACCOUNTING TREATMENT, FINANCIAL WORTHINESS & GROWTH
FOR DRB SHAREHOLDERS
INTRODUCTION
In the Automotive sector, DRB are proud to be the only establishment in Malaysia that involved in the industry’s entire ecosystem and value chain. For financial year ending 2011, DRB has 20 subsidiaries and 6 associate companies that were involed in various phase in automotive ecosystem.
DRB Group has a strong portfolio in the automotive sector, supported by experienced resources, profitable partnerships and ambitious growth plans. With the recent acquisition of PROTON, the sector gained new impetus with huge potential to deliver organic growth in the coming years. In FYE 2012, the automotive sector contributed RM4.0 billion or 59% of the total Group revenue, with Profit Before Tax (PBT) of RM265 million or 17% higher compared to last year. Moving forward, it will be crucial to further develop our infrastructure, upgrade the quality of after-sales services and undertake extensive Research and Development (R&D) to promote homegrown brands internationally.
DRB foothold in the automotive industry is stronger with the recent addition of the national car manufacturer PROTON Holdings Berhad as it wholly owned subsidiary. Overall, with their world-class expertise and facilities, DRB aspiration has been to help position Malaysia as a regional hub of excellence for automotive solutions[1].
Prior to Proton complete takeover, In the Automotive sector, DRB-HICOM is already involved in components manufacturing, and manufacturing assembly and distribution of vehicles. They have collaboration with world-renowned passenger and commercial vehicle companies such as Mercedes-Benz, Volkswagen, Audi, Honda, Mitsubishi, Isuzu, Suzuki, Mahindra, BRP, Potenza, including the national motorcycle, MODENAS and national car, Proton (via Proton Parts Sdn Bhd). With the complete purchase of Proton, Proton Parts has effectively became indirect wholly owned subsidiary of DRB Hicom.
THE PURCHASE ROUTE
In March 2012, DRB-HICOM completed the acquisition of 42.74% stake in PROTON Holdings Berhad (PROTON) from Khazanah. DRB-HICOM was successful in its bid to acquire 42.74% stake in PROTON from Khazanah. On 26 June 2012, PROTON became a wholly-owned subsidiary of DRB-HICOM pursuant to a mandatory general offer (MGO) for the rest of the PROTON shares not already owned by DRB-HICOM.
The divestment of Proton from Khaznah is made via a conditional sale with a price consideration of RM5.50 per share or RM1.291 billion. Upon completion of the sale and purchase agreement, DRB-HICOM will be obliged to undertake a mandatory general offer on the remaining PROTON shares.
DRB also acquired another 7.27% equity (or 39,927,000 PROTON Shares) from the open market at prices ranging from RM5.40 to RM5.47 per PROTON share, for a total cash consideration of RM217,431,000. With the additional 7.27% stake in PROTON acquired from the open market on 17 January 2012, PROTON became a 50.01% subsidiary of DRB-HICOM Berhad.
Post consolidation,included in other payables and accruals of the Group and the Company is an amount of RM1,510,032,199 payable to the remaining non-controlling interest shareholders under the PROTON MGO. In accordance with Section 218(2) of the Capital Markets and Services Act, 2007 and Section 9(1), Part III of the Malaysian Code on Take-Overs and Mergers, 2010, the Company is obliged to extend a mandatory general offer (“MGO”) for all the remaining PROTON Shares not owned for a cash consideration of RM5.50 per PROTON Share. The MGO was fully funded by bank borrowings subsequent to the financial year end[2].
Under the requirement of FRS 127 Consolidated and Separate Financial Statements, both the acquisition and the MGO are inter-linked and hence have been accounted for as a single transaction. The MGO was completed subsequent to the financial year-end and the PROTON Shares were fully acquired by the Company on 26 June 2012
THE PURCHASE PRICE
There are 3 purchase price DRB incurred from the purchase of Proton that make up the total purchase cost of RM3,018,504.
1. First phase, RM5.50 per share bought from Khazanah Nasional for 42.74% shares cost RM1.291 billion.
2. Second phase, purchase of 7.27% equity costing between RM5.40 to RM5.47 per share from open market with a total cash consideration of RM217,431,000
3. Third phase, balance 49.99% equity under MGO at RM5.50 per share cost RM1,510,032,199
Trading in Proton’s shares was suspended at closed price RM5.18 at 13 January 2012 pending the announcement of divestment from Khazanah to DRB
VALUATION
Market Based method
Fair Value = RM 3,990,026,000 ; Number of Share outstanding is 549,213,000. Fair Value / Share = RM 7.26
Book Value = RM 4,818,076,000. ; Number of Share outstanding is 549,213,000. Book Value/ Share = RM 8.77
Buying price (from Khazanah & MGO) = RM 5.50
DRB purchase price of RM5.50 is less RM1.77 from Fair Value/Share (RM 7.26/share)
So RM1.77 x 549,213,000 shares outstanding equal to RM 971,522,000. Therefore Proton badwill / negative goodwill is RM 971,522,000.

Cost of Equity Capital
Cost of Capital of Proton using Capital Asset Pricing Model (CAPM) is:
Cost of Equity Capital = Risk Free + (ERP* Equity Beta)
Risk Free Rate = 3.67% based on the 10-year Malaysian Government Bond yields[5]
Equity risk premium = 8.17%
Proton Equity Beta = 1.03%
Therefore CAPM of Proton = 3.67% + (8.17% x 1.03) = 12.08%
The minimum rate of return that DRB require from Proton is 12.08%. This COE rate maybe contributed from the combination from dividend income & capital appreciation. Since DRB has privatised Proton, the COE is rate is the mimimum rate of dividend and growth expected from Proton.

Price Earning Ratio
MGO purchase price of RM5.50 represent a PE Ratio of 19.41 times based on audited consolidated EPS of Proton for Financial Year Ended (FYE) 31 March 2011 of 28.33 sen
EPS = 28.33 sen
Suspended Price 13 Jan 2012 = RM 5.18
Suspended Price P/E Ratio = (5.18/28.33) =18.28 times
MGO Price P/E Ratio April 2012 = 5.50 /28.33 = 19.41 times
CONSOLIDATION EFFECT TO DRB FINANCIAL POSITION
Proton latest acquisition by the DRB-HICOM Group in FY 2012, raise a negative goodwill equivalent to RM971.52 million which reflects the value of net tangible assets acquired and potential sustainable strategies. During the year under review, DRB untiring efforts to enhance their quality management systems, our processes and engineering capabilities helped sustain the performance of PROTON
Details of cash flow arising from the acquisition are as follows:
RM’000
Purchase consideration, settled in cash
(including the direct expenses attributable to the acquisition) 1,509,573
Cash and cash equivalents arising from acquisition of a subsidiary company (1,112,167)
Cash outflow from acquisition of a subsidiary company 397,406
PROTON contributed revenue of approximately RM312.78 million and profit after taxation of approximately RM8.29 million to the Group for the period from the date of acquisition to 31 March 2012. Had the acquisition taken effect at the beginning of the financial year, the revenue and loss after taxation contributed to the Group would have been RM8.01 billion and RM606.31 million respectively.
Details of net assets acquired, negative goodwill (gain on bargain purchase) arising from the above acquisition are as follows:
Carrying value Fair value
Assets & Liabilities RM’000 RM’000
Property, plant and equipment 2,708,738 2,663,638
Intangible assets 1,351,879 1,033,929
Jointly controlled entities 231,141 231,141
Associated companies 126,890 126,890
Investment securities: held-to-maturity 146,910 73,910
Deferred tax assets 5,828 5,828
Inventories 1,035,572 995,572
Trade and other receivables 909,279 788,779
Tax recoverable 30,165 30,165
Investment securities: available-for-sale 3,430 3,430
Short term deposits 43,534 43,534
Cash and bank balances 1,068,633 1,068,633
Trade and other payables (1,383,943) (1,615,443)
Deferred income (37,133) (37,133)
Provision for liabilities and charges (141,269) (141,269)
Bank borrowings – others (1,114,980) (1,114,980)
Derivative liabilities (95) (95)
Current tax liabilities (35,775) (35,775)
Long term borrowings (499) (499)
Net assets acquired 4,948,305 4,120,255
Deconsolidation of a jointly controlled entity (130,229) (130,229)
4,818,076 3,990,026
Negative goodwill (gain on bargain purchase) (971,522)
Total purchase consideration (including MGO liability) 3,018,504
INCIDENTAL BENEFITS TO DRB
DRB get two signififant incidental benefit from the complete takeover of Proton.
First, Proton has Cash in Current Assets in amount of RM 1.112 billion making the cash purchase of RM 1.509 billion to result on net cash outflow of only RM397 million.
Second, DRB has the option to move the old and outdated factory in Shah Alam to modern & underutilised Tanjung Malim plant. This will free the prime land of the Shah Alam factory valued at RM165 million almost 30 years ago but property players said Proton’s Shah Alam land could have a gross development value in excess of RM1 billion[9].
POST CONSOLIDATION ANALYSIS
The group recognised a one-off negative goodwill of RM971.52mil for the financial year ended March 31. Earlier this year, DRB-Hicom extended a mandatory takeover offer (MGO) to acquire all the remaining shares in Proton for cash consideration of RM5.50 per share for a total of about RM3.02bil. Presently, DRB-Hicom holds about 99.08% equity interest in Proton. The negative goodwill skyrocketed DRB-Hicom’s earnings per share up to 52.66 sen from 3.75 sen. For the period, the company declared a dividend of 4 sen per share.

For financial year 2012, DRB-Hicom’s net profit was up 173.67% to RM1.29bil on the back of a 1.09% increase in revenue to RM6.88bil. Hence, earnings per share rose to 66.88 sen from 24.44 sen. In notes accompanying its results, DRB-Hicom said the initial accounting has resulted in a negative goodwill amounting to about RM971.52mil, which had been recognised as other income (non-cash item) in its consolidated statement of comprehensive income.
This was mostly due to recognition of negative goodwill of RM971.52mil arising from the acquisition of Proton.
Negative goodwill refers to income, perhaps even a profit, that comes from the sale of an asset at less than its fair market value.
Upon the acquisition of Proton becoming unconditional, the MGO was triggered whereby the company was required to offer to the non-controlling interest shareholders of Proton to sell their shares at an offer price of RM5.50 per share.
Under the requirement of FRS 127, both the acquisition and the MGO are inter-linked and hence is accounted for as a single transaction. The amount payable under the MGO of RM1.51bil has been reflected as current liability in the statement of financial position as at March 31.
In the financial year ended March 31, 2011, the group had recognised a one-off negative goodwill of RM71.22mil arising from accretion of interest in a subsidiary company which was shown under other income.
DRB Performance Exclude Negative Godwill
When excluding PROTON negative goodwill, DRB-Hicom’s operating profits dropped by 12.8% to RM549.58mil from RM630.31mil. This was mainly due to lower share of results from an associated company which was affected by the automotive components supply constraints arising from the flood in Thailand. It was also due to the one-off financing costs incurred on borrowings to finance the acquisitions of Pos Malaysia and Proton.
DRB-Hicom now has cash of RM7.21bil compared with RM7.74bil previously. It has short-term borrowings of RM1.88bil and long-term borrowings of RM3.48bil.
For the full year, DRB-Hicom has given out total gross dividends of 6 sen, which is similar to what it paid in the previous financial year.
FUTURE DIRECTION
Proton’s acquisition a win-win situation for both DRB-Hicom and Proton as the former will be able to leverage on Proton’s strong sales volume and extra manufacturing capacity from the underutilized Tanjung Malim plant. On the other hand, Proton will gain from DRB-Hicom’s partnerships with renowned automakers.
Also with Proton under its stable, DRBH is now the country’s single largest automotive group, enabling it to rival the strong alliance between Perusahaan Otomobil Kedua Sdn Bhd (Perodua) and Toyota Malaysia.
In order to cushion the winning bidder financially, there are possibilities of consolidating Proton’s plants in Tanjung Malim, hence unlocking the value of Proton’s Shah Alam land (fetches a surplus of RM440mil)[10], as well as the sale of Lotus (past indicative price by interested parties were RM800mil-1bil). However, analyst questions as to why these measures to unlock value in Proton have not been done under the previous management.

POST TAKEOVER : 4Q 2011/2012 vs 1Q 2012/2013

CONCLUSION
The takeover & privatisation of Proton by DRB have significant impact not only to the future growth of DRB Group but also to the growth of national automotive industry. The positive immediate impact of takeover to DRB Group has been seen from the result of 4Q 2011/2012 vs 1Q 2012/2013 as quoted above.
In FYE 31 March 2012, the automotive sector contributed RM4.0 billion or 59% of the total Group revenue, with Profit Before Tax (PBT) of RM265 million. With the inclusion of Proton in the group, this performance will be boosted, taken into account Net Profit attributable to equity holder contributed by Proton (FYE 2011 is RM155.6 million but for FYE 2012 is unknown because Proton has become private under DRB Group).
National automotive sector also have positive future with Proton under DRB Group because DRB has managed to arrange strategic deal between Proton with Honda in the most recent announcement in 4Q 2012. DRB-Hicom said the partnership will explore collaboration in "technology enhancement, new product line up, platform and facilities sharing" which will enable Proton to have better presence in international market.

Required :
1. Summarise and present a comparative costs and benefit data for take over of Proton Bhd by DRB Hicom.
2. Analyse the take over of Proton Bhd from both persepctive of :
a. The seller – Khazanah Malaysia
b. The buyer – DRB Hicom
3. What are the relevant qualitative information in the decision
4. Critically evaluate the justification of selling Proton Bhd with some quantitatve and qualitative evaluation on the deal.

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[1] Pg 9, DRB Hicom Annual Report 2012
[2] Ibid pg 213
[3] Ibid pg 219
[4] http://www.theedgemalaysia.com/highlights/199507-drb-hicom-buys-proton-at-rm550.html
[5] Pg 33, Independent Advice Circular, in relation to Mandatory General offer (MGO) by Affin Investment Bank on behalf of DRB Hicom Berhad dated 13th April 2012
[6] Pg 3, Unconditional Mandatory Take Over Offer by Maybank Investment Bank & Hong Leong Investment Bank on behalf of DRB Hicom Berhad dated 4 April 2012.
[7] Pg 87, DRB Hicom Annual Report 2012
[8] Ibid Pg 220
[9] http://www.theedgemalaysia.com/highlights/199507-drb-hicom-buys-proton-at-rm550.html
[10] AmResearch Company Report on Proton Holdings, 16 January 2012