SINGAPORE: Over the past few months, investors in Hyflux have been anxiously observing the unfolding of events.
When white knights in the form of a consortium comprising Salim Group and Medco Group (SM Investments) entered into an agreement in October last year to invest S$400 million for 60 per cent of Hyflux’s equity and to grant S$130 million in loan, things started looking up.
Then in March, national water agency, PUB, issued a default notice giving Hyflux some time to remedy defaults arising from a water agreement, failing which PUB will take over its subsidiary, Tuaspring, “as whole, or the desalination plant alone”.
A few weeks later, PUB said it will assume control of only Tuaspring Desalination Plant (TSDP) at zero dollars, and waive off the compensation sum which it is entitled to under the water agreement. This caught many by surprise.
The future of Hyflux looked gloomier than ever on Apr 4 when Hyflux cancelled the restructuring agreement with SM investments saying that it has “no confidence the Indonesian investor will complete the deal”. Hyflux subsequently sued SM investments for its repudiation of the rescue deal and for the deposit of S$38.9 million.
Time is running out for Hyflux whose total liabilities stood at S$2.8 billion at the end of March. It now has until its next case management conference with the judge on Apr 25 to indicate if it needs more time to keep creditors at bay.
The pressure has been kept on after PUB issued a termination notice on Wednesday (Apr 17), indicating it would take over TSDP in 30 days.
MAJOR ROAD BUMPS
Hyflux’s well-publicised ill-timed expansion into the energy business has been a major contributor to its financial woes. The chronic overcapacity in the power generation sector and oversupply of electricity had depressed the selling price of electricity in 2016 and 2017.
Its stalled sale of Tuaspring Integrated Water and Power Plant project and Tianjin Dagang Desalination Plant, and the S$600 million joint venture project with Hitachi and Itochu Corporation to build India’s largest desalination plant in the state of Gujarat India left in limbo, added to its distress.
A large fraction of Hyflux’s Engineering, Procurement and Construction works (about S$1 billion) generated cash inflows that were stretched over lengthy periods.
HIGH LEVERAGE A DOUBLE-EDGED SWORD
Hyflux had also aggressively expanded since 2010, with a huge footprint across China, India, and Middle East North Africa (MENA), funded by the Singapore headquarters.
In the most recent five years, the main source of funds were perpetual debt and preference shares. Its debt-to-equity ratio had been on a steady uptrend, which could have been beneficial if profits were healthy as the interest expense can serve as tax shields.
But with Hyflux’s low cash inflow, its high average debt-to-market equity of 6.49 from 2013 to 2018 became a burden. Yet it continued to command the trust and confidence of investors largely because of the strategic support for clean water solutions in Singapore.
Other major players in the clean water solutions industry are not as highly leveraged. Manila Water Co Inc, the sole provider of water and water services to the East Zone of Metro Manila, has an average debt-to-market equity ratio of 0.74.
SIIC Environment Holdings Ltd, despite past debt problems, has a moderate average debt-to-market equity ratio of 1.38, while Veolia Environnement SA and Suez, both listed in Paris, have average debt-to-equity ratios of 1.49 and 1.50 respectively.
Hyflux had also suffered losses from 2015. Profits in 2013 and 2014 were low. Net cash from operating activities had been negative since 2010.
Hyflux had managed to keep dividends positive every year, however, because it had liquidated assets for cash and borrowed heavily. It secured a sale and leaseback of some industrial property valued at S$115 million for S$111 million in October 2017.
Money raised through bond issues and preference shares were channelled towards paying off loans rather than for incremental working capital or new investments.
Hyflux was once a darling and had a huge fan club in the marketplace. Investors were attracted by its stature as a water company in an industry of strategic interest to Singapore, but that never meant that the business would never fail.
Its iconic success and Olivia Lum’s rags-to-riches story captured the imagination of many, and investors may have become careless. They may have been attracted by the high yields.
To be sure, there is no free lunch. High returns come with high risk yet obvious signs of weaknesses were ignored.
WHERE WAS THE BENCHMARKING?
Benchmarking against comparable peers would have uncovered the over-leveraging. There were clues in Hyflux’s cash flow statements - operating activities which serve as the main engine of the firm had not been producing cash for many years.
The lack of credit ratings in Singapore for local bond issuances means all investors have to do their own homework. Past corporate bond defaults include Pacific Andes Resources Development’s S$200 million three-year bond in January 2016, and Swiber Holdings' S$551 million bonds in July 2016.
Maybe it is time to make the credit risk certification of bond issues mandatory, particularly those open to the public. Sure, these issues come with voluminous prospectuses and can run into hundreds of pages.
In June 2017, the Monetary Authority of Singapore launched the Singapore-dollar Credit Rating Grant to encourage issuers in the Singapore-dollar bond market to issue rated bonds. This is a move in the right direction. It will provide greater transparency in credit risk assessment.
Issuers can claim up to 100 per cent of their credit rating expenses, subject to a cap of S$400,000 per issuer.
Maybe the barrier to obtaining a third-party credit risk assessment are the high fees charged by global credit rating agencies. But that is not an insurmountable problem.
There is an alternative public source of credit risk assessment made available by Credit Research Initiatives (CRI) at the Risk Management Institute (RMI) at the National University of Singapore (NUS), which provides a probability-of-default assessment for all publicly listed firms around the world.
And when we looked at CRI’s estimates, Hyflux’s default risk had reached the equivalent of Moody’s Ba1 rating, which is a non-investment grade (based on Moody’s historical one-year average default rate from 1983 to 2017), in February 2016.
By 2018, it was at B2 which is five grades below investment grade.
In short, the signs of financial distress had appeared as far back as February 2016.
AFTER THE PERFECT STORM
If Hyflux wishes to further extend its debt moratorium, it would need a concrete debt restructuring plan.
For now, the fate of Hyflux depends on whether it can find another white knight or white squire. If nothing is acceptable to the court, the company will be heading towards eventual liquidation.
The final recovered asset value will then depend on legal, market and even political factors related to the geographical location and business nature of those assets.
What remains then will just be the memory of a once glorious company, and traces of its assets under new owners and management teams.
Ruth Tan is Associate Professor in the Department of Finance at the National University of Singapore (NUS) Business School. Zhang Weina is Senior Lecturer in the same department.