Sales Call – Bumi Resources - JPM

Bumi Resources: a good deal in transit, Buy. There are reasons to believe that the CB deal is just a transitory deal. The transition period may not be a long one and the end-game could be very positive. Watch BRMS IJ for potential mandatory tender offer at Rp850, with 50:50 chance. Bumi Resources: a good deal in transit (Verdi Budiman)THE EVENTOn 10 June 2011, it was announced that BUMI IJ intend to transfer its 75% stake in BRMS IJ, for a total consideration of US$2.07bn or Rp850/share. The consideration will be in the form of listed CB with a 2.0% coupon and £15.88 initial conversion price. The buyer proposes to engage with the Indonesian regulator to review whether a mandatory tender offer for the remaining shares in BRMS would be required as a result of the reorganisation.

MY TAKEEarnings impact on BUMI IJ, per today’s information disclosure: Consensus is expecting BRMS IJ to deliver US$78mn and US$79mn net profit for FY11-12. On full year basis, BUMI IJ will loose its 75% share of the profit that would amount to US$59mn and US$59mn for FY11-12. In return, BUMI IJ will earn US$40mn interest income per year from the CB in FY11-12. As a result, a marginal earnings downgrade for BUMI IJ in the order of 2-4% for FY11-12. Market sentiment: the deal may confuse the market. In its current form, the deal does not reduce BUMI IJ’s overall debt level and cause its interest expense burden to fall. BUMI IJ’s management has promised the market to meaningfully reduce its debt load in FY11. There are reasons to believe that the CB deal is just a transitory deal (in other words, I speculate that BUMI IJ will either sell its CB for cash to pay down debt, or pass-on the CB to its current debtors to cancel up to US$2.07bn of BUMI IJ’s debt. The transition period may not be a long one and the end-game could be very positive for BUMI IJ, for these reasons:
(1) The CB appears to be designed for quick conversion into shares, with low coupon rate and small premium to the market value of its underlying shares. Under UK law, BUMI IJ cannot convert its CB holding into shares, as it will result in a cross-shareholding. The fact that BUMI IJ is willing to receive the CB as form of payment could mean that there is already captive taker(s) for the CB, pending on some further events such as the step-up transaction and premium FTSE listing. (2) There is 50:50 chance that the BRMS stake sale could classify as an affiliated transaction (transaction with a company that directly or indirectly controls BUMI IJ, under Bapepam law), which will require approval from independent shareholders. For the independent shareholders to vote for the transaction at the time of EGM, they will need convincing on the prospect of BUMI IJ monetizing its CB holding. Beyond legal definition, this particular transaction clearly smells like an affiliated transaction, more so than the controversial Pendopo deal in year 2008. WHAT-IFWhat-if CIC is willing to accept the US$2.07bn CB as a form of payment for its US$1.9bn lending to BUMI IJ? On full year basis, BUMI IJ will loose its 75% share of the profit that would amount to US$59mn and US$59mn for FY11-12. In return, BUMI IJ will see interest cost reduction of US$361mn per year in FY11-12. In this scenario, we could see major upgrade in BUMI IJ’s recurring earnings expectation, in the order of 25-40% for FY11-12.

THE RISKOn legal definition one may argue that this is not an affiliated transaction and the Bapepam may keep a blind eye. Such scenario can point to the prospect of a Mandatory Tender Offer for BRMS IJ, as the non-affiliation verdict would imply that BUMI IJ and the CB issuer are not being controlled by the same shareholder.