Thursday, February 09, 2006

Execution Risk


NOT The Probable Amount Of Blood On Your Hands In Carrying Out An Execution

Speak to any foreign fund manager on buying or selling Malaysian stocks, you will inevitably come across the term "execution risk". As mentioned above, it is not the penalty for getting caught with drugs in Malaysia, Singapore or Bali. This terminology is particularly useful and important a consideration with Malaysian companies. Before anyone jumps the gun here, this is not a "case-against-bumiputras" OK!

It is important in Malaysia because a large number of important and lucrative contracts are awarded, or they managed to obtain these "projects/assets" via strong networking skills, to "fresh companies" or companies with little known expertise in the respective industries. Hence therein lies the risk, the risk of not being able to carry out the terms of the contract properly or the risk of not being able to run the "project" in a professional manner. Execution risk also includes the ability (or lack of) to capture opportunities on hand, maximising potential returns, and scaling up operations when the conditions suit. Execution risk also involves the ability (or lack of) to engineer the company to the next level when the opportunity arise. There are some executives who can manage a company with RM50 million turnover but will be in over his head when turnover rises to RM300 million or more. Some are so aware of "execution risk" that the moment they get awarded the contract/project, they quickly farm it out to other companies who know how to do the job better.

To fund managers, the inherent execution risk may cause them to be averse to certain groups of companies or corporate personalities. Hence, their track records are worth monitoring constantly. Unproven companies with seemingly good contracts or projects will have their valuation greatly reduced. However, once they have shown good progress and have a couple of notches on their corporate black belt, foreign funds are more comfortable with them.

An example of execution risk reduction success is the YTL Group/Power. If one were to look at the forays of YTL Group/Power 15 years ago, not many institutional fund managers would give the company a second look. However, the ability to move into new areas (with little expertise) and accomplish well will gain enormous goodwill for the company concerned. Now, whenever YTL Power proposes a new bond offering or new project in a new country, nobody will even bat an eyelid of caution as investors are already comfortable that the company has done their homework and should be able to execute the project successfully. Bond offerings get snapped up without too much querying and at preferential rates to the company.

I would like to highlight the "execution risk" inherent with a few important group of companies - whether the perception is rising or falling. This will be a useful exercise to do constantly with important companies as the "investing risk premium" says a lot about their prospects and ability to attract strong institutional support.

Scomi - Most recent "project", using Habib Corporation to buy tugboats and barges from Singapore's Chuan Hup Holdings for RM1.3 billion. Execution risk here is minimal as Chuan Hup is a solidly managed company. Chuan Hup would still be in the picture as they want to do the deal to get access to Scomi's range of businesses in the region. Scomi Engineering (old name Bell & Order) is another counter being used for other businesses. The thinking behind all that is to use a number of listed vehicles to allow for management to stay focused on their respective companies. Scomi Group itself is getting very big after having completed the acquisition of a 70.9% stake in Oiltools International Ltd. Hence the depth of management team is crucial to Scomi Group.

Scomi Group Bhd has appointed four senior vice presidents to ensure a smooth transition and integration of its new integrated businesses in October 2004. Ridzuan Ali, a former group chief operating officer of Peremba Construction Sdn Bhd, will oversee the group’s oil and gas business operations in Malaysia. Abang Abdul Aziz, former acting head of Shell's production liaison team, will be responsible for business development and expansion plans in Asia excluding China, Malaysia and Indonesia. Alan Steedman will oversee the worldwide drilling waste management business of Scomi, while Carl Mitchell is the senior VP for north and south America. Steedman and Mitchell have 24 years and 28 years of experience respectively in the oil and gas industry. More senior appointments will be added with the absorption of Oiltools. Good "divide & conquer" strategy.

The report card for Scomi reads well. So far, so good. Management has been professional and deal making ability impeccable. Actual execution, while still too early to tell, the early signs are good. Execution Risk Report Card 2004: C , 2005: B, 2006: A-.

Ranhill - Ranhill did well as a construction unit and reaped the benefits in the days when the government was doling out huge infrastructure projects. That dried up a couple of years ago. Last 2 years saw Ranhill doing damage control on their US$239 million oil processing facility in Sudan (engineering, procurement and construction). However, thankfully Ranhill Utilities has been doing much better with its water concession project in Johor. The other notable new star is Ranhill Power with its 120MW plant in Sabah. The dangerous part to all this is that Ranhill is still going further ahead to do a RM3.5 billion deal from Libyan government to build a new township there. African ventures for Malaysian companies have not fared well so far. Ranhill also has its fingers in oil & gas with its involvement in the Citarum field (Indonesia) - based on the reserves, Macquarie Research says that it could be worth between RM0.66 to RM14.41 per share to Ranhill (Ranhill's most recently traded price RM1.48).

The report card for Ranhill will say stay away from African ventures. If ever there was a case for Ranhill to spin off the utilities/power/oil & gas into a seperate vehicle, this is it! By doing that, the spinoff vehicle would get very good valuation than by being under Ranhill itself. The parent company can still get access to the cash flow - easiest case for merchant bankers. Ranhill overseas ventures (African continent) 2005: D , 2006: D-. Ranhill's power, utilities and oil & gas ventures 2005: B , 2006: B+.

MMC/Syed Mokhtar Al-Bukhary - Syed Mokhtar has acquired a strategic stake in DRB-Hicom. His 51.74% stake in Johor Port injected into MMC, same for Port of Tanjung Pelepas. MMC proposed to take its 74.99-per cent owned MMC Engineering Group Bhd private in January 2003. Syed injected the 2,400 MW Tanjung Bin power plant into Malakoff for RM840 million cash. His 70% stake in Bank Mualamat is probably to be injected into Bank Islam. Next, his Senai assets, including the Senai airport. Now he is negotiating to buy an additional 3,000 acres of land in Senai from Lee Rubber before injecting the whole Senai play into one of these 4 vehicles - DRB-Hicom, MMC, Tronoh or Tradewinds. (I tend to favour Tronoh).

Most institutional fund managers avoid Syed Mokhtar's counters. Its a lot of wheeling and dealing. On closer examination, the deals are not all hot air, rumour has it that he has strong Middle East financial backers (i.e. he does not own all the assets reported). His deal making ability has been fantastic. Initially many regarded him as a market maverick, but there is more behind the deals - its shrewd and he keeps the numbers ticking along. He dares to take on large, difficult and risky projects (esp the ports around Johor) and comes out better-than-alive-and-kicking each time. Operation wise, very much a hands-off personality. Report card for Syed Mokhtar - 2004: C+, 2005: B, 2006: B+.

Ananda Krishnan - What can you say about the man, much more than just a successful oil trader. The main thing he did very well, hire well. As you get more success along the way, get a small but reliable finance team to pore through the numbers religiously at every juncture to ensure that expansion plans and progression plans are intact. Hire well again, reward the top guys well. Hob-nob and make good use of contacts and network like crazy but only with the really important people. Just look at the achievements via Tanjong, Astro, Powertek and Maxis. His companies always manage to eke out the most returns from their investments - ROE is so important, makes me feel that that is their only KPI (key performance indicator). The only iffy one so far is that satelite thing still waiting to take off, but it should sometime soon. Report Card: A+ throughout. Star pupil.

Goverment Linked Corporations - That's where "execution risk" usually resides when foreign fund talk about GLCs. At least Azman Mokhtar knows it and have given them KPIs to work with. Its pointless to keep giving "big things" to GLCs if they have trouble carrying them to fruition in the most effective manner. The report card is still out while waiting for the new regime to work its magic. I am hopeful, but results have to show soon. If the results are mediocre, how the key leaders are treated will be crucial. Reward those who produce, replace those who don't, GLCs are not retirement homes or some elaborate pension scheme for the priviledged.

Petra Perdana/Sapura Crest - Both were caught up in the oil & gas whirlwind last year. Share prices have climbed through the roof but both have shown little in terms of getting the a slice of the growing oil & gas contracts on offered. Management seems to be lacking in depth and is failing to engineer and leverage from a position of strength to grow exponentially over the last 2 years. Report card for both - 2004: C, 2005: D-, 2006: D.

3 comments:

zentrader said...

I sure give this article report card A+ :)

Very well done.

Salvatore_Dali said...

Zentrader,

TY for yr kind words.

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