Corporate: Is IOI going into bio-fuel?

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9 August 2005

As far as corporate deals go, IOI Corp Bhd's move to take 61.03% subsidiary IOI Oleochemical Bhd private was not surprising. What it has done instead is to push IOI watchers into huddles trying to second-guess family patriarch Tan Sri Lee Shin Cheng's next move.
"Lee never does anything for no reason," says a foreign banker.
The fact of the matter is IOI Corp completed a US dollar-denominated Eurobond issue just this March raising US$500 million, which at exchange rates then, amounted to RM1.9 billion. This, added to some RM600 million in cash balances, left the group with over RM2.5 billion in cash.
"At first when we saw the IOI Oleo deal, we thought this was the reason for the bond issue, but no, it still does not quite add up," says a local analyst. Even if every minority opts for the all-cash option of the privatisation exercise, it would only cost IOI Corp RM880 million. If all the shareholders other than IOI Properties Bhd took the cash and share option, it would cost IOI Corp about RM130 million.
So what is the group going to do with the rest of its cash hoard, especially considering it has free cash flow of over RM700 million annually?
The speculation in the market now is that the group should be taking steps towards some other "far more expensive" venture.
"Bio-fuel?" speculates the local analyst.
Probably due to the newness of the subject matter, estimates on the cost of a bio-fuel refinery fluctuate wildly from "RM1 billion or thereabouts" to "well over RM2 billion".
Either way, if anyone can do it, IOI could. It has the cash and the acumen to pull something of this magnitude off. And of course a bio-diesel facility would neatly complete the family picture.
IOI Corp already owns specialty fats manufacturer Loders Croklaan and should by the second quarter of 2006 wholly own oleochemical manufacturer IOI Oleo as well. That takes care of the edible oils and specialty fats applications of crude palm oil (CPO). Leaving of course a conspicuous empty slot in the family picture, which could be neatly filled by the industry's new favourite talking point, bio-fuel.
"With crude oil prices hovering at US$60 a barrel, the call for increasing use of bio-fuel has started resonating around the developed world," notes the foreign banker.
Existing law in the EU requires diesel to be mixed with 5% of vegetable oil. The oil of choice has been rapeseed thus far. However, rapeseed is a far more expensive alternative compared to CPO, which is among the cheapest edible oils.
Industry estimates show that at US$50 a barrel, the price of crude oil is equivalent to RM1,380 per metric tonne of CPO. Considering that CPO is now at the RM1,400 level, that means that bio-fuel is still a tad expensive.
"However, there are expectations that crude oil prices can go even higher. But then, there is also the fact that bio-fuel is a renewable energy source and a viable alternative to fossil fuels," notes one industry player.
Of course, all such news would be great for IOI Corp.
Just to put things in perspective, a local analyst says that the US is expecting demand for bio-diesel to double in the next 18 months from the current annual estimated demand of 150 million gallons. An increase of 150 million gallons would significantly reduce existing CPO stockpiles of one million tonnes.
"Even at one million tonnes, our stockpiles at today's consumption are quite tight," comments the local analyst.
IOI, of course, as one of the largest producers of CPO in the world, would stand to benefit from any increased demand for bio- fuel. However, the real money would stand to be made if it can refine CPO into bio-fuel.

But why take IOI Oleo private
"Why not?" replies the foreign banker. "It's something they should have done. And they did it," he adds.
"It's good housekeeping. They needed to do some tidying and they have. Now the structure is a lot neater and it becomes easier to reorganise," says Scott Lim, chief investment officer at CMS Dresdner.
In a nutshell, IOI Corp has proposed to cancel the shares in IOI Oleo it does not hold, which includes 11.37 million shares or a 5.63% block held by IOI Properties Bhd. In return, shareholders will have the option of walking away with RM11.08 cash per share or a share plus cash option to swap three IOI Oleo shares for IOI Corp share valued at RM10.82 each and RM11.34 for each of the other two shares.
For IOI Corp, the deal is earnings accretive. According to a foreign house earnings, enhancements can range from 2% to 5% depending on which option the minorities take. A local house says if all the shareholders take the cash-only option, then expect additions to bottom line of 7% to 7.5%.
While the jury is still out on which option the minorities will opt for, analysts say minorities should take their time.
"We have a target price of RM11.50 for IOI Corp," says Yusree Mohd Yusof, senior plantations analyst at Southern Bank.
Thus, if IOI Corp's share price goes much higher than its close last Thursday at RM11.10, minorities stand to gain as the cash and share option values each IOI Corp share at only RM10.82.
As it stands, among the downside risks for the stock are bumper soya harvests, India increasing CPO import tariffs, China decreasing CPO imports and production at levels above expectations.
The issues pushing CPO consumption are of course the trans fats issue and the GMO issue. (GMO refers to genetically modified foods, of which CPO is not one. A significant percentage of soya oil is produced from GMO soya plants.)
Other than that, analysts say India has postponed replanting of its rapeseed crops due to unfavourable weather conditions while Brazilian soya harvests have been affected by Asian Rust disease.
"All these factors could cause a supply crunch which of course bodes well for the share price of stocks such as IOI," the local analyst comments.