To protect investors, boards should expose the divergent interests of controlling shareholders

THIS column recently called on the board of Singapore Airlines (SIA) to properly address the question of how it manages the interests of its equity holders versus those of its mandatory convertible bond (MCB) holders.

Temasek owns more than half of SIA’s shares and nearly all its MCBs. When the MCBs are mandatorily converted into new shares in 2030, minority shareholders could suffer significant dilution.

So, should SIA use its surging cash flows to redeem the MCBs over the next couple of years? Or, should it use its financial resources to aggressively pursue strategic growth objectives and allow the MCBs to convert into new shares in 2030?

As SIA’s controlling shareholder and the largest holder of its MCBs, Temasek may prefer to see the airline group extend and entrench its position in the commercial aviation market rather than quickly redeem the MCBs.

At its heart, this is about managing the sometimes-conflicting interests of controlling shareholders and minority investors – and it is not a problem faced by SIA alone.

In fact, the possibility of SIA’s minority shareholders facing significant dilution because of the strategic objectives of its controlling shareholder is reminiscent of the tension that often exists between the managers of real estate investment trusts (Reits) and their unitholders.

Reits are popular among investors for the income they provide. For the sponsor groups behind the Reits, the purpose of these structures is to securitise assets and recycle capital.

When Reits fail to garner decent market valuations, unitholders would rather see their managers focus on enhancing the income generating potential of the assets they own. But Reit managers are incentivised to keep pushing for asset growth.

The presence of independent directors on the boards of Reit managers alone does not address the sometimes divergent interests of their sponsor groups and unitholders. Instead, it is the willingness of those directors to expose those divergent interests and properly address them that makes the difference.

Reit mergers

In particular, the boards of Reit managers could have done better during the recent spate of Reit mergers.

These transactions were presented as being beneficial to unitholders of both the acquiring Reit and target Reit. The Reit managers promoted the narrative that the mergers would create larger and more liquid Reits that would garner better market valuations.

While this was not untrue, it underplayed the fact the mergers were also about the sponsor groups wanting to reposition themselves and their Reit platforms.

For example, the merger of CapitaLand Mall Trust and CapitaLand Commercial Trust – which created CapitaLand Integrated Commercial Trust – was arguably an important element of the CapitaLand group’s pivot away from retail property, which is under pressure from the rise of e-commerce.

The merger of ESR-Reit and Ara Logos Logistics Trust – which created ESR-Logos Reit – was clearly proposed because the sponsor groups of the 2 Reits had agreed to merge, resulting in the Reits having overlapping mandates.

The merger of Mapletree Commercial Trust (MCT) and Mapletree North Asia Commercial Trust (MNACT) – which created Mapletree Pan Asia Commercial Trust – seemed to be about MNACT struggling to garner a decent market valuation and the Mapletree Investments group wanting a more effective Reit platform for the Asian region.

Indeed, the importance of the deal to Mapletree Investments became very clear when it backed a S$2.2 billion preferential offering of new units by MCT at a premium to market price in order for unitholders of MNACT to be paid in cash.

The move placated unhappy unitholders on both sides of the deal, and ensured the merger succeeded.

Sembmarine-KOM deal

Exposing where the interests of major shareholders lie could also be the key to minority shareholders of Sembcorp Marine being properly informed before they vote on the proposed merger with Keppel Offshore & Marine (KOM).

Under the deal, minority shareholders of Sembmarine will end up owning shares in a much larger O&M group that will probably have superior growth prospects. But the terms of the deal are such that shareholders of Sembmarine will suffer a significant dilution in net tangible assets – from about 12 Singapore cents per share to just 7 cents per share.

For the board of Sembmarine, this is a worthwhile trade-off. They have plainly stated the proposed combination is the best way forward for Sembmarine.

But the merger isn’t just about Sembmarine. For Keppel Corp – which owns KOM – the deal is part of its plan to get out of the O&M sector.

Besides merging KOM with Sembmarine, Keppel has also proposed to carve out its stranded rigs and associated receivables – valued at some S$4.05 billion – and park them in a separate entity.

All in, these transactions will allow Keppel to realise more than S$9.4 billion in value.

Keppel has said it will subsequently offload a 46 per cent stake in the merged Sembmarine-KOM entity via a distribution-in-specie to its own shareholders. This will see Temasek receiving nearly 6.8 billion additional shares in the combined entity, based on its 20.6 per cent stake in Keppel.

Temasek currently holds about 17.1 billion Sembmarine shares, which it obtained through its support of Sembmarine’s rights issues and Sembcorp Industries’ distribution in-specie of its Sembmarine shares in 2020.

The average price of these shares – which represent a 54.6 per cent stake in Sembmarine – is 6.7 cents.

If the combination of Sembmarine and KOM is voted through, Temasek will end up with more than 23.9 billion shares in the combined entity – representing a 33.5 per cent stake – at a lower average price of 4.8 cents per share.

On the face of it, this could mean a heightened tolerance on the part of Temasek for further dilutive corporate moves.

While the merger might be the best way forward for Sembmarine as a company, its board should carefully consider if it is also the best way forward for its minority shareholders and advise them accordingly.