Wednesday, February 17, 2010

Khazanah Responds On Oriental University Investment

The following is the response by Khazanah after I've raised questions with regards to its RM150 million investment in Oriental University City (OUC) investment in Hebei, China. You can read the Bernama report here or below.

Unfortunately, I'm still not at all convinced by the arguments put forward by Khazanah, and it fails to address some of the questions which I've raised in my earlier statement:
  1. What exactly is Khazanah's fund management philosophy? If its a conservative strategic investor (e.g., Iskandar Malaysia, PLUS Expressways), then you don't invest in high risk ventures, or become a portfolio manager and vice-versa. You don't invest out-of-the-blue RM150 million all the way in Hebei, in a high risk education venture in which you have not an iota of experience in. The above applies even if OUC does indeed pose a valid investment thesis on its own.

    Another way of putting it is, if you are in the business of building cars, you do not suddenly take your profits and start investing in fisheries (or luxury fashion or education), even if the latter provides very attractive potential returns. You should instead focus on increasing the market reach of your cars and building even better cars.

  2. For a price-earnings (PE) ratio of 58, and for it to list on a stock exchange in 2013, the earnings growth target will need to be fantastic in the next 2-3 years to lower the PE to an acceptable 12-20 times, even for a high growth stock. With all due respect to the investment team, but the forecast looks like "spreadsheet magic" to me. If I have that risk appetite, I'll take up stakes in Google, Apple or any time.

  3. If OUC is indeed such a fantastic investment (as claimed in the latest statement, "discounted cash flow valuations and internal rate of return estimates that were significantly above the risk-adjusted investment hurdle rates"), then there will be plenty of high-risk capital and funds available in China to make the investment. Why do they need to come all the way to Malaysia for what is arguably only a mid-sized investment?

I don't want to sound like a wet blanket, but my position remains that Khazanah should remain a strategic investor focused on growing and catalysing Malaysian critical sectors, and based on current priorities, would be to make a success of the RM50 billion Iskandar Malaysia where Khazanah's expected invest up to RM8 billion, instead of gallivanting all over the world conducting piece-meal investments. Leave the high-risk, sectoral or country portfolio investments to the relevant specialist funds

Khazanah response is as follows:

KUALA LUMPUR, Feb 17 — Khazanah Nasional Bhd’s RM150 million investment in China’s Oriental University City Ltd (OUCL) fulfills both its strategic objectives and financial returns requirement.

In a statement today, the government’s investment arm said the 10 per cent stake acquisition in OUCL from Singapore’s listed Raffles Education Corporation Ltd (REC) allowed it to tap into the expertise of Raffles and capitalise on the upside of China’s growing and underserved education sector which saw 26 million new students and was worth US$39 billion (RM132 billion) annually.

The detailed investment evaluation applied in the transaction as a matter of investment policy had looked significantly beyond the historical performance and valuation multiples for 2009 that was quoted in various reports, it said.

It also more than satisfied the stringent financial criteria that included discounted cash flow valuations and internal rate of return estimates that were significantly above the risk-adjusted investment hurdle rates, forward earnings multiples comparable to industry averages, and compared favourably against inherent growth rates expected in the education sector in China.

Khazanah said that the investment had a clear and liquid path for exit if so desired through a planned listing over the medium term.

“In the event that the planned listing does not occur, the conditional sale and purchase (S&P) agreement for the 10 per cent investment in OUC also comes with an inherent downside protection for Khazanah that will effectively protect Khazanah’s capital investment and adequately covers Khazanah’s cost of funds over the period,” it said.

Therefore, it said, the investment represented a strong combination of robust upside potential in a sector and geography with exceptional growth prospects and significant downside protection.

Beyond this investment, Khazanah and REC were committed through the conditional S&P agreement to jointly explore the viability of replicating such University City business models in Malaysia and other countries regionally.

It said this initiative would support the country’s human capital development objective by acquiring experience and expertise to address vocational skills shortage and improve employability of graduates. — Bernama
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