SGX to merge with ASX, to take on debt

SGX has announced a takeover offer for ASX which will see each ASX shareholder receiving a mixture of cash and shares in the new combined entity.

Under the terms of the Scheme, ASX shareholders as at a record date to be determined will be paid, in relation to each ASX Share, a combination of:
• A$22.00 (approximately S$28.04) in cash (the “Cash Consideration”); and
• 3.473 new SGX Shares (the “Share Consideration”).

The aggregate value of the Share Consideration is S$5.8 billion (approximately A$4.6 billion), based on the last traded price of SGX Shares as at the Latest Practicable Date, and S$5.8 billion (approximately A$4.6 billion), based on the volume-weighted average price (“VWAP”) of SGX Shares transacted on the Latest Practicable Date.
Accordingly, the value of the aggregate consideration payable for the Proposed Combination (the “Scheme Consideration”), based on the aggregate Cash Consideration and the aggregate value of the Share Consideration (determined by reference to the last traded price of SGX Shares as at the Latest Practicable Date), is approximately A$8.4 billion (approximately S$10.7 billion), or approximately A$48.00 approximately S$61.17) for each ASX Share.

The value of the Scheme Consideration based on the aggregate Cash Consideration and the aggregate value of the Share Consideration (determined by reference to the VWAP of SGX Shares transacted on the Latest Practicable Date), is approximately A$8.4 billion (approximately S$10.8 billion).

The move will see SGX coughing up about S$4.9 billion in cash, which will inevitably see the combined entity take on between S$3-4 billion in debt. Depending on the cost of debt, we estimate that interest could cost SGX as much as $150 million a year, which will eat into earnings (and dividends!).


We have maintained that SGX looks terribly expensive at current levels, and it is fantastic that management can utilise the expensive stock to purchase a choice asset (ASX in this case) to benefit shareholders. However, the deal would have made much more sense if an all-stock offer was utilised. By offering cash and taking on debt, it appears that the EPS-accretion (as SGX touts the deal to be, EPS of $0.3008 to $0.3612) will be difficult to achieve after factoring in interest payments.

Sold SGX, a quarter of the portfolio in cash

Singapore Exchange Limited (“SGX”) wishes to announce an investment of $250 million in technology, comprising $70 million for a new securities trading engine and $180 million for infrastructure outsourcing services and data centres, collectively known as the Reach initiative. The investment of $70 million was previously announced by SGX on 4 March 2010.

The investment in the Reach initiative is to create the fastest access to Asia by implementing a new high-performance trading engine, a state-of-the-art data centre, as well as introducing co-location services to its customers. The Reach initiative also includes establishing presence at key data centres in Chicago, London, New York and Tokyo. The infrastructure outsourcing services will enable SGX to benefit from improved access to technical capabilities, implementation of enhanced processes and comprehensive infrastructure management tools. (3 June 2010)

We sold SGX (finally!) at $7.28 today, bringing the portfolio's cash level to almost 25%. We actually bought SGX at around the $4+ level in mid-March 2009, in the belief that the company (and its stock price) were sure beneficiaries of a market recovery. The stock's returns have been decent since, but we see little upside from current levels, despite the hype over the new $250 million trading system which promises to boost revenues. The exchange expects additional annual recurring expenses of $12 million due to this new system, which is paltry compared to the $200+ million operating expenses SGX racks up every year, but we are sceptical that the new trading system will actually provide a substantial boost to revenue.

The problem we have with SGX is that growth for the exchange is difficult to create. The new CEO, Magnus Bocker, is pulling out all the stops to try to increase revenue, and the latest $250 million investment represents a foray into algorithmic trading, which Mr Bocker hopes will drive trading velocity in cash equities trading. In our opinion, it will be difficult to induce algorithmic traders into providing liquidity for a large number of stocks listed on the exchange - either due to a low free float or a distinct lack of buying interest. The small market capitalisation of many counters also compounds the problem. More likely, algorithmic trading will be focused on the usual suspects (the market darlings which adorn the daily top volume list) and some of the larger capitalisation companies. Traders need other buyers and sellers in order to make money, so why focus on low investor interest companies where they have to make a market to induce buyers? As has been the case in the past, higher velocity and investor interest in a select group of stocks will likely drive investors away from others, more like a zero-sum game.

Moreover, Singapore's positioning as a financial hub (and "Asia's exchange") remains in question, given that Hong Kong already enjoys tremendous levels of trading volume. Much of this stems from Hong Kong's proximity to China, whose citizens possess tremendous household wealth. Hong Kong is already facing stiff competition from the Shanghai exchange, and going forward we expect to see Shanghai obtain a more-than-fair share of new large-cap listings. What does this leave SGX? Zilch (except for numerous poor quality third-tier S-Chips).

SGX's monopoly status looks safe at present, with its infrastructure setup preventing other players from quickly stealing market share in the local market. However, with the limited growth from local retail investors, SGX is looking overseas for growth. While this could be a way to boost revenue, SGX already charges one of the highest clearing fees in the world, and there could be downward pressures on pricing, reducing margins. The ASX has recently announced lowered fees as a result of the entrant of new competitors, which could be something that SGX may face further down the road.

Strong rebound in March 2010

The portfolio rebounded strongly in March, gaining 4.9% (net of an accrued performance fee of 20% based on a 6% annual targeted return), bringing NAV to $1.023, up 2.3% YTD. In comparison, the STI on a total return basis gained 5.2% in March, and is essentially flat YTD.

On a percentage basis, Best World was the strongest performer, with a 36.2% monthly return. The announcement of expansionary plans in the Phillipines was enough to incite trading in the stock. Renewed investor interest in Jardine Strategic Holdings sent the stock rising 21% for the month, a huge boost to the overall portfolio (JSH is our largest single position in the portfolio). As previously mentioned, we view the underlying businesses as highly attractive in their own right, and the parent holding company simply offers the opportunity to purchase the whole basket at a substantial discount to market value. Another notable performer was Wells Fargo, which gained 14% for the month (also a substantial holding for us). Worries over financial reform in the US appear to have subsided for the moment, and investors are beginning to focus on P/E multiples for bank valuations, instead of book value. Wells Fargo currently trades at a forward PE of 11.3X, which leaves much upside potential based on a PE multiple re-rating alone.

Noble was the chief laggard in the portfolio, as concerns over a director's share sale and uncertainty over the merger of subsidiary Gloucester Coal and Macarthur Coal weighed on stock performance. US coal giant Peabody recently made a takeover offer for Macarthur Coal on the condition that its proposed merger with Gloucester Coal does not go through. At stake for Noble is a near 25% stake in the consolidated Macarthur, which is poised to benefit from steel production in China. While uncertainty still lingers, a second refuted bid by Peabody suggests that Noble has the upper hand, but we will be watching developments closely over the next week or so (Macarthur shareholders vote for the Gloucester-Macarthur merger on 12 April).    

BEST WORLD 36.2%

JARDINE STRATEGIC 21.0%

Hotung Investment Holdings 18.3%

FRASER AND NEAVE 16.9%

WELLS FARGO 14.0%

KEPPELCORP 12.2%

GUOCOLEISURE 8.7%

Capitaland 6.9%

STI ETF 6.1%

CAMBRIDGE 4.5%

SPH 3.0%

CAPITAMALL 1.7%

BERKSHIRE HATH-B 1.3%

ASCENDAS I-TRUST 1.0%

SGX 0.3%

WBL Corp -2.8%

TAT HONG -3.3%

NOBLE GRP -3.5%


$6,000 of new money was added into the portfolio, resulting in the creation of 5865.10 new units on 31 March 2010.

Portfolio flat in February

Our portfolio dipped marginally by 0.3% in February, bringing year-to-date performance (as at end February 2010) to -2.5%. On an NAV basis, the portfolio ended Feb 2010 at $0.975. In comparison, the STI (total return) gained 0.3% in February, but has declined 5% on a year-to-date basis.

Noble Group was the strongest performer, returning 10.1% as sentiment improved on commodity plays while Berkshire Hathaway benefited from the increased liquidity following a 50 for 1 share split. Tat Hong was the worst performer, losing 8.6% as investors discounted a weaker outlook for crane demand and increased costs for the construction sector after announcements of increases in foreign worker levies in the 2010 Singapore budget.

Stock Feb'10 Returns (%) in SGD


NOBLE GRP 10.1%

TAT HONG W130802 9.1%

BERKSHIRE HATH-B 4.8%

CAPITAMALL 4.7%

FRASER AND NEAVE 2.4%

KEPPELCORP 0.5%

SPH 0.3%

JOHNSON & JOHNSON 0.2%

BEST WORLD 0.0%

WBL Corp -0.2%

STI ETF -0.4%

ASCENDAS I-TRUST -0.5%

GUOCOLEISURE -1.6%

Capitaland -2.1%

JARDINE STRATEGIC -3.1%

CAMBRIDGE -3.3%

SGX -3.5%

WELLS FARGO -3.9%

TAT HONG -8.6%

Portfolio down 2.2% in January; commodity price impact on Noble's earnings

Equities generally had a rather poor January, leading to a 2.2% decline in the portfolio for the month. Assuming the portfolio started 2010 at $1.000, each unit ended the month at $0.979. Still, this was significantly better than the 6% decline in the Straits Times Index, or the MSCI World's 4.3% decline.

BERKSHIRE HATH-B	+16.5%
WELLS FARGO	+5.5%
SPH	+3.5%
CAMBRIDGE	+2.2%
KEPPELCORP	+1.7%

CAPITAMALL	-6.1%
TAT HONG	-6.2%
GUOCOLEISURE	-7.9%
CAPITAMALLS ASIA	-8.7%
NOBLE GRP	-11.4%

Berkshire Hathaway was the outstanding performer, jumping 16.5% as investors piled into the stock in anticipation of its addition into the S&P 500 (replacing Burlington Northern). Wells Fargo turned in a respectable performance (+5.5%) while SPH also gained on better-than-expected profits.

Noble Group was the worst performer, falling 11.4% as commodity prices wavered. Noble's dependence on commodity prices is often overestimated by most investors, who choose to lump the company together with other commodity producers who suffer a large hit to earnings when commodity prices decline. Noble's business model involves hedging inventory as it is passed along the supply chain, which involves little exposure to commodity prices. 

Noble's earnings hardly fluttered as commodity prices went from boom to bust in the 2008-2009 crisis, indicating a relatively low dependence on an appreciation in commodity prices. High prices require Noble to post more collateral to hedge, a drain on cash resources, which means that Noble would prefer lower, or at least less volatile commodity prices.

Despite the sharp declines, the stock is not terribly cheap as the market attempts to factor in strong future earnings growth (Richard Elman has been quoted as targeting US$1 billion in profit sometime over the next few years). The company has excellent management and is extremely focused on shareholder value, which has resulted in the stock being the best performer on the STI in 2009. As one of the few companies in the STI with truly strong earnings growth potential, we will want to accumulate more Noble shares, but will wait patiently for a better entry level to add to our existing position.

Initial Portfolio Holdings

On 31 December 2009, we held stocks worth $104,789.07, along with cash of $4,879.03.