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Extracts from Hyflux Reply to SIAS Letter

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I have been following the Hyflux implosion and restructuring (which is still ongoing). It is one of the most painful experiences for Singaporean investors in recent memory given its widespread uptake by retail investors. For the record, I have no position in any of Hyflux stock or its related securities.

You have investors who are understandably upset and angry at what has happened. Many of these grievances were taken up by SIAS who sent and publicly released a letter airing a lot of these concerns of which Hyflux has recently replied today.

There are several questions and answers which are extremely useful and relevant to all investors whether vested or not of which I have highlighted. Just to note, I have only highlighted the relevant points and you have to read the full document here if you want the full transcript.

 

Why did the Board continue to pay dividends, when the operating cashflow was negative and accumulate more debt during this time?

It should be further noted that due to the nature of Hyflux’s business, namely the ownership and development of infrastructure projects for subsequent divestment and sale, during the construction phase of any project there is necessarily a negative cashflow recorded by Hyflux in relation to such project, as Hyflux is required to invest and fund substantial capital expenditure to construct such a project, but has no incoming revenue derived from such project until construction is complete and operations have commenced.

In the case of projects where Hyflux is both contractor and owner, the quantity of the negative cashflow is correlated to the size of the project (i.e. the larger the project, the greater the negative cashflow).

 

Despite the negative operating cashflow, Hyflux reported profits in each year up to 2017. How was this possible?

Hyflux’s profits are largely derived from EPC activities, O&M and divestment gains. In the case of EPC activities, revenue and profits are recognized progressively in the Income Statement in accordance with FRS 11 Construction Contracts.

Cashflow is a separate financial metric which sets out cash outflows and inflows over a specific period of time, but does not necessarily correlate with profit and loss in the same period. Consistent with its business model, Hyflux recorded negative operating cashflow due to its heavy investment in the construction phase of its large infrastructure projects such as Tuaspring, Qurayyat and TuasOne.

 

On what basis was Tuaspring being valued at SGD1.4 billion? This has proven to be overstated by at least SGD900 million as Hyflux has confirmed any bids received in the 2018 sale process for Tuaspring were for less than Maybank’ s outstanding project finance debt of approximately SGD500 million?

When Hyflux was first awarded the Tuaspring project in 2011, based on the financial model which modeled the cashflow projections from the project, the power plant was expected to generate profits from day one. This financial model was audited by an external financial model auditor and furnished to the offtaker.

2013 when Tuaspring was able to secure a non- recourse project financing loan, the lender commissioned an independent market study of the project which arrived at similar conclusions supporting the book value of approximately SGD1.4 billion.

When the Tuaspring power plant entered into commercial operations in 2016, the lender commissioned another independent market study before the drawdown of the second tranche of the project finance loan, which valuation also then supported the book value ascribed to the Tuaspring project.

However, while the 2017 divestment process attracted three preliminary non-binding bids that also supported the book value of the project, the 2018 sale process for Tuaspring during the moratorium did not yield a similar bid due to the limited number of parties pre-qualified to perform due diligence at such time.

EY have indicated that in a liquidation, unsecured creditors are estimated to receive 3.8% to 8.7% recovery and SGD900 million perpetual and preference shareholders received zero return. Can EY state the assumptions used to justify its calculation of the liquidation value?

The liquidation analysis details a range of estimated realisations from a theoretical liquidation scenario of Hyflux Ltd.

Hyflux Ltd is a holding company with the group’s projects and assets contained within subsidiaries or associate companies.  In a liquidation, recoveries for creditors of Hyflux are dependent upon value being recovered from these subsidiaries / associates (including outside of Singapore in a number of cases), which need to settle their own liabilities first before any remaining value (“equity value”) can be passed up to the Hyflux holding company level for its creditors.

Some key overarching assumptions underpinning EY’s theoretical liquidation analysis are as follows:

  1. Upon commencement of a liquidation of Hyflux Ltd, many of the other Hyflux Group entities (including Hydrochem and the EPC business generally) are assumed to enter liquidation on or around the same time;
  2. Construction activity on projects such as, but not limited to, TuasOne and Qurayyat, would immediately cease;
  3. Most of the Hyflux Group’s employees would have their contracts of employment immediately terminated, although EY assumes a small base of skeleton staff would be retained by the liquidator to assist with the realization of assets;
  4. In order to maximize returns for creditors, EY have assumed that certain asset owning entities / investments which do not require financial support from Hyflux Ltd, do not enter liquidation and are instead realized through the sale of shares via an orderly sale process.
  5. Tuaspring – assumed sale process in a liquidation scenario is not likely to yield any excess net sale proceeds over the secured bank debt.
  6. Magtaa and Tlemcenn – unlikely to be any value in the shares taking into consideration inter alia, bank security, shareholder agreements and offtaker obligations.
  7. Realisation values mainly attributed to China assets (including Tianjin Dagang, Tus Water), PT Oasis (which has since been sold), SingSpring Trust, and Hyflux Shop.
  8. Crystallisation of all contingent liabilities which include performance bonds and corporate guarantees was assumed, amounting to approximately SGD1.9b of senior unsecured liabilities and SGD900m of subordinated unsecured obligations.

 

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