(Oct 30): A major stake in railway infrastructure engineering firm Sapphire Corp is being acquired by China’s HNA Holding Group Co, which could open doors for the company to win more contracts amid a boom in infrastructure development spending in emerging markets.
On Oct 18, Sapphire said HNA’s subsidiary Hong Kong International Construction Investment Management Group would issue more than 40.5 million new shares at HK$4.08 each in exchange for more than 56.5 million shares in Sapphire held by an entity called Ou Rui, which is controlled by an individual named Li Xiaobo. HKICIM will also issue nearly 24.9 million new shares at the same price in exchange for nearly 34.7 million shares in Sapphire held by an entity called Best Feast.
These transactions will give HKICIM an approximate 27.97% stake in Sapphire. Ou Rui will no longer own shares in Sapphire but will hold a stake of 1.17% in the enlarged HKICIM. Best Feast will still own 17.33% of Sapphire, down from 27.96% previously. Best Feast will also own a stake of 0.72% in the enlarged HKICIM.
Hong Kong-listed HKICIM was once called Tysan Holdings and is in the business of construction and property development. HNA acquired a 66% stake in the company last year from Blackstone Group for US$340 million ($462.5 million) but now owns 74.66%.
According to the Financial Times, HNA is a sprawling conglomerate, of which 29.5% is owned by the Hainan Cihang Charity Foundation set up in the US. Among its flagship units is Hainan Airlines Holding Co.
The price at which HKICIM is issuing new shares to Ou Rui and Best Feast effectively prices their shares in Sapphire at 51 cents.
Shares in Sapphire climbed as much as three cents to a high of 33 cents immediately after the deal was announced, but subsequently fell back. They closed at 30 cents on Oct 26.
Sapphire has been involved in a string of businesses over the years, including loss-making forays into steel production and mining.
In September 2015, it acquired a privately held company called Ranken for RMB360.4 million in new shares. The vendors of Ranken became Sapphire’s largest shareholders, and Ranken now contributes the bulk of Sapphire’s revenue and earnings.
For 2QFY2017 ended June 30, Sapphire posted a 30.8% y-o-y rise in revenue to RMB296 million ($61 million). However, net profit fell 23% to RMB10.8 million, on higher project costs.
Teh Wing Kwan, group CEO of Sapphire, says the company could now benefit from the business network of HNA. Expanding these networks will strengthen Ranken’s position in picking up larger-scale contracts in China, he says in an interview with The Edge Singapore.
Sapphire is also in a better position now to quickly gain scale and efficiency, which is becoming increasingly important in the infrastructure sector, as margins are under constant competitive pressure.
“We can reasonably expect more rapid industry consolidation, which will affect state-owned enterprises and, of course, privately owned operators,” says Teh.
Acquisitive shareholder
Sapphire is just one of several acquisitions that HNA has made over the last couple of years. According to the Financial Times, HNA spent about US$40 billion in recent years on acquisitions. Among the assets it has picked up are stakes in companies such as Deutsche Bank, Hilton Worldwide Holdings, peer-to-peer lending platform Jubao Internet Technology and Singapore-based logistics firm CWT.
HNA is estimated to control more than two dozen listed entities now, some of which have gone on to do deals of their own. For instance, Hainan Airlines, which is known to be recruiting Singapore Airlines pilots, has drawn in George Soros as an investor.
Interestingly, the Form 3 filed by Sapphire detailing the recent change in ownership of the stakes held by Ou Rui and Best Feast ran for 68 pages. The HNA Group entity directly involved in the share exchange is called Forestar Assets, but there were 17 layers of corporate entities on top of it that also reported their indirect interest in Sapphire.
Without making reference to HNA’s recent acquisitions or shareholding structure, Teh says there have been many “gripping stories” about the group. He is confident, however, that being part of HNA will be beneficial to Sapphire’s core business.
“Ranken’s management has seen compelling reasons to work more closely with a large strategic group in China.”
Record order book
In the meantime, Sapphire has secured a slew of new contracts, pushing its order book to a record level of RMB3.4 billion. Most recently, on Oct 12, the company secured two contracts worth a total of RMB856 million.
The first contract, worth RMB561 million, is to build part of the 24.5km Metro Line 5 of Dalian, a port city in northeast China. When completed in November 2019, this new line will connect to an existing line linked to the upcoming Jinzhouwan International Airport.
The second contract, worth RMB295 million, is for a project in Urumqi, in the western corner of China. This contract is to build a 3.6km segment of the second phase of the Urumqi Airport Rail Transit Line 2.
Teh expects China to continue spending heavily on its infrastructure development to support its growth. “This big picture seems to have kept Ranken’s bidding momentum busy. They are still building major roads, bridges and railways everywhere, and in most of the cities,” he says.
Sapphire is now also looking beyond China for growth, as the country pushes its Belt and Road Initiative. In fact, HKICIM specifically made reference to BRI when it announced its acquisition of a major stake in Sapphire.
“Significant investments are still piling in under this high-profile strategy — there are no obvious signs of slowing down,” says Teh.
Even without HKICIM’s backing, Sapphire was already actively pursuing contracts in countries such as Thailand and Malaysia, which are trying to upgrade their physical infrastructure. Farther afield, South Asian markets such as Bangladesh offer good potential as well, according to Teh.
“Infrastructure investments in these developing and emerging countries are still key drivers to growth of major infrastructure businesses in most aspects,” he says.
New business model?
With the backing of HNA, Sapphire might now experiment with taking stakes in some of its projects, under the public-private partnership model. Contractors have to keep securing new jobs to generate revenue and earnings. Participating in a PPP offers the prospect of long-term, recurring earnings from these projects.
There is, of course, no certainty that returns will match the risk of such a long-term commitment.
“PPPs are specifically much larger in size, take a longer time to execute and are more complicated in deal structure,” says Teh, adding that such deals are increasingly being promoted as some governments face funding constraints.
Sapphire has in the past found PPPs in China that appeared feasible, but it shied away from pursuing them because of its relatively small size. But now that it can lean on HNA, this could change, according to Teh.
Another change that might take place at Sapphire, following its deal with HNA is the entry of new top executives. Teh hints that it could be time for him to step aside and let someone else, perhaps with a strong engineering background, run the show.
“The company is well set for faster growth ahead. I am confident that the post-turnaround Sapphire will continue to [thrive] even if there is a management change in future,” says Teh, who has a strong background in finance and joined the company four years ago, before the acquisition of Ranken.
Shares in Sapphire are down 1.64% since the beginning of the year. At the Oct 26 closing price of 30 cents, they are trading at 9.19 times earnings, and almost exactly at its net asset value of RMB1.4725 a share, or 30.18 cents.
