I chanced on this archived article on SPH which serves a reminder to those who are interested in value investing in stock. Do pay attention to this para in the article:

Obviously, the latest cash distribution will not be the last for SPH. The group has set a three to four-year time horizon for divesting its other non-core assets.

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Published April 10, 2004

Creating $530m out of thin air
Just by announcing its plans for a capital reduction, SPH has seen its share price rise $1.70 in two days

HAS the management of Singapore Press Holdings (SPH) created shareholder value of some $530 million out of thin air?

On Tuesday, SPH shares closed at $19.30. At the end of the day, the group announced its half year results and more importantly said it planned to 'return about $1 billion of cash to shareholders'. Shareholders will receive $2,865 for every 1,000 shares held.

But the $2,865 cash is not 'free'.

The group intends to reduce its capital base by about 15 per cent. So, it is returning $2,865 cash to shareholders in exchange for 150 SPH shares. In other words, SPH is buying its shares back from its shareholders at $19.10 apiece.

The remaining 850 shares will then be split into five to give the shareholder 4,250 SPH shares.

On the face of it, shareholders do not actually 'gain' or 'lose' from the deal.

For a person who owns 1,000 SPH shares, his holding is worth $19,100, prior to the announcement and based on $19.10 per share.

After the capital reduction, he will have $2,865 cash and 850 SPH shares. Assuming SPH shares stay at $19.10, his wealth will remain at $19,100.

The market has full knowledge of the assets under SPH and its business operations. With all that information, it has valued SPH at about $19.10.

But just by announcing its plans for a capital reduction, SPH has seen its share price rise $1.70 in two days.

This leads me to my point, which is that capital structure matters. Based on Thursday's closing price of $21, the holdings of someone with 1,000 SPH shares are effectively worth $20,715, that is $2,865 in cash to be received from SPH and the remainder in shares. That's more than 7 per cent higher than the pre-announcement value.

Why capital structure matters

Say company A has $100,000 of capital, divided into 100,000 shares. About $30,000 of its capital is invested in its core business that is raking in profits of $12,000 a year. The remaining $70,000 is in cash or short-term investments and yielding only $2,100. So the total profit of company A is $14,100, or a return on equity (ROE) of 14.1 per cent. Earnings per share (EPS) comes to 14.1 cents.

If the market is valuing the company at 20 times its earnings, than the shares of company A would be trading at $2.82.

Now, assume that company A has decided it has too much idle capital and plans to return 15 per cent of the capital to shareholders. Its capital and share base will fall to $85,000 and 85,000 shares, respectively.

On the business front, company A's core operations will not be affected by the move and will still bring in profits of $12,000. But with cash reduced to $55,000, its investment income will decline to $1,650, assuming the same yield at 3 per cent.

The new profit figure will come to $13,650. That, divided by capital of $85,000, will raise ROE to 16.1 per cent. Meanwhile, EPS will also increase to 16.1 cents, up 14 per cent from before.

With a multiple of 20 times, the shares will now be worth $3.21 each. That, in effect, is what SPH is doing.

Based on the group's 2003 annual report, its newspapers and magazines division employed total assets worth some $740 million. But it generated pre-tax profits of about $300 million in FY03 - a return of 40 per cent!

Meanwhile the group had double that amount, $1.46 billion to be exact, in treasury and investment. That sum yielded a pre-tax profit of only $39 million, or a 2.7 per cent return.

By reducing its capital by 15 per cent, SPH said, its proforma ROE for the year ended Aug 31, 2003 would be boosted to 30.1 per cent from 16.7 per cent. Excluding exceptional items, EPS improvement is 7.1 per cent.

Even after the capital reduction, SPH still has $700 million cash available for future investments. Meanwhile, its newspaper business is generating more than $200 million in free cash flow every year.

Obviously, the latest cash distribution will not be the last for SPH. The group has set a three to four-year time horizon for divesting its other non-core assets.

There may be $1 billion or so locked up in Paragon and $400 million in Belgacom and MobileOne. Another $200 million a year in free cash flow may also be returned.

How SPH compares to News Corp

Do SPH shareholders benefit from all the cash distributions? Or should SPH have gone on an empire-building spree like what Rupert Murdoch has done for News Corp?

The problem faced by the group is that it is hard-pressed to find a project that can reap as good a return as its domestic newspaper and magazine business. Of course, that is no excuse for not trying.

SPH chairman Lim Chin Beng said the group's growth strategy is to go into businesses connected to its core business, in and outside Singapore.

Just out of curiousity, I compared the shareholders' return for SPH and News Corp in the last 10 years.

Murdoch's News Corp is a truly global media group. His satellites deliver TV programs in five continents. He publishes 175 newspapers, including the New York Post and The Times of London. In the US, he owns the Twentieth Century Fox Studio, Fox Network, and 35 TV stations that reach more than 40 per cent of the country.

David and Goliath

In the year just past, News Corp's net profit totalled $1.85 billion on revenues of $30.7 billion. Its revenues were 34 times those of SPH's and its net profit, five times.

Its market capitalisation, meanwhile, is 10 times larger than SPH's.

According to Bloomberg, between March 31, 1994 and March 31, 2004, News Corp's share price appreciated by 128.2 per cent in Singapore dollar terms. SPH, however, managed only 62.7 per cent.

But if we take the total return, ie including dividends - surprise, surprise, SPH beat News Corp.

The total return for SPH during those 10 years was 141.8 per cent, outperforming News Corp's 135.6 per cent by 6.2 percentage points. On March 31, 2004, SPH was trading at $18.90. Now that it is $21, the outperformance would have been even greater.

Viewed in this context, SPH has not done too badly by its shareholders.

Of course, going forward, News Corp would conceivably have far greater growth potential given its much wider reach.

But its risks, too, would be greater. Less than a decade ago, Murdoch nearly lost his debt-laden company to his bankers. And the group chalked up combined losses of some $12 billion in 2001 and 2002, before returning to profitability in 2003.

The fortunes of SPH, on the other hand, will be tied to the economy of Singapore. Assuming there are no changes in the competitive environment, and that SPH can improve on its efficiencies, the group can continue to generate bottomline growth that's ahead of Singapore's GDP growth. And with further capital restructuring, EPS can grow at an even faster rate.

The writer, a BT senior correspondent, is a CFA charterholder.