Examining The Need For Mergers And Acquisitions In The Energy Sector In Malaysia

FOLLOWING GLOBAL TRENDS: EXAMINING THE NEED FOR MERGERS & ACQUISITIONS IN THE ENERGY SECTOR IN MALAYSIA Case studies, Concepts, and Debatable Ideas Kenny Ong CNI Holdings Berhad www.myCNI.com.my www.OOBEY.com

M&A Trends in the Energy Sector

Rationale for M&As in the Energy Sector

Strategies, Structure, and Optimizing Value in M&As

Considerations, Risks and Pitfalls

Investment Opportunities

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How to fail without trying

The Roadmap to Failure by Fred Wiersema and Mike Treacy

Before we start… www.myCNI.com.my www.OOBEY.com

The Roadmap to Failure Fred Wiersema and Mike Treacy Performance Time www.myCNI.com.my www.OOBEY.com Clear Sailing Today’s performance Ad-hoc Tactics Denial & Defense Doom Projections Overdue Failure The Moment of Truth X Performance Freefall Tomorrow’s actual performance Downpresure of Unclear Strategy

Denial and Defense

“ It’s not really good value our competitor is offering, because it doesn’t include a lot of our features.” - ABC vs Air Asia

“ It’s good value but not in our preferred customer market.” - ABC vs Toyota

“ Sure they’re hurting us, but with their unfair advantage, what can we do?” – ABC vs MILO

“ The rules we are playing by have always worked before” – AMEX vs VISA

Ad Hoc Tactics

Selectively hold discounts to hold business that has started to go elsewhere

Introduce new promotions, terms, conditions, and offers to confuse and cloud the market

Beef up customer service by adding people to fix mess-ups and quicken delayed shipments

Delay capital investments and adjust accounting methods to portray quarterly financial results more favorably

Introduce “new and improved” products that are new in form, but not in substantive ways that are of consequence to purchasers

Merge, Acquire, Joint Venture and Ally out of desperation or without proper considerations

“ What is the moral of the story?”

1. M&A Trends in the Energy Sector www.myCNI.com.my www.OOBEY.com

M&A Trends in the Energy Sector – Malaysia (1/2)

MMC purchase of Malakoff, 2007: largest M&A in Malaysia, 2 nd biggest in Region

Seadrill Ltd (Oslo Stock Exchange, offshore drilling operations) SapuraCrest Petroleum Bhd, raising shareholding from 10% to 18.51%

Sarawak Corridor of Renewable Energy (Score) – hydroelectricity, aluminum, steel, oil and gas, glass and agriculture

Perisai Petroleum Teknologi Bhd - acquire SJR Marine (L) Ltd for US$42mil, an anchor handling tug (AHT) for US$11.5mil, a portable saturation diving system (SAT system) for US$4.25mil and the disposal of two subsidiaries Corro-Shield (M) Sdn Bhd and Orinippon Trading Sdn Bhd for RM40mil.

M&A Trends in the Energy Sector – Malaysia (2/2)

Budget 2008: Stamp Duty exemptions for PLCs and Petronas vendors

Budget 2008: Investment Tax Allowance for energy conservation, energy savings

Budget 2008: Tax Exemption of income from Certified Emission Reduction (CER)

Europe’s ban on Biofuel i.e. Palm Oil

Excess capacity

“ Energy Blueprint” - IPPs to supply at competitive prices to an Energy Exchange

Booming Demand

Supply shift to remote, unstable locations

Environmental impact, Fuel Mix

Demand shift in Asia

Middle East ‘cheap’ energy = diversification

Natural resources depleting fast

Massive capital required

Supply security

Interest in ‘Renewable’ energy

Demand reduction and Demand Management

Scarcity of Talent: Technical, Projects

Global labor market

New, low cost players

Niche companies in new technologies*

Alternative Energy – growth, fragmented*

Low R&D, demand for new technologies

Anti-Pollution Solutions**

Credit Crunch

Foreign entities

Reliability standards

Political instabilities

De-regularization, Unbundling

Global Warming, less Water, less Hydro power

Private Equity

Restructuring undervalued Conglomerates

Record profits, High Prices

Antitrust Regulations

Cross-border Regulations

Traditional utilities consolidation

Competition for Assets

Rise of NOCs

Biggest Trend

“ Earnings Per Share growth expectations are way above what companies can achieve in most territories from organic growth alone”

John McConomy, US Power and Utilities Transaction Services Leader, PricewaterhouseCoopers www.myCNI.com.my www.OOBEY.com

2. Rationale for M&As in the Energy Sector www.myCNI.com.my www.OOBEY.com

Rationale for M&As in the Energy Sector

“ Energy companies face a demanding future. They must start preparing for it now”

Ivo Bozon, Director, McKinsey’s Amsterdam Office www.myCNI.com.my www.OOBEY.com

Strategies for Growth “ Double-Digit Growth”, Michael Treacy www.myCNI.com.my www.OOBEY.com

Base Retention

Share Gain

Positioning

Adjacent Market

New Business

GROWTH

Rationale for M&As: Growth

Expansion

Consolidate

Geographic

Distribution

Compensate

Transformative

Portfolio refocus

Diversification

Easier Tougher www.myCNI.com.my www.OOBEY.com

Rationale for M&As: Expansion

Expansion

Consolidate

Geographic

Distribution

Compensate

Gain Scale to compete

Integrated Solutions

Financial Growth

Supply (security, mix)

Developing markets

High cost of Extra Capacity

Private Equity

Expanding NOCs

Rationale for M&As: Expansion

Expansion

Consolidate

Geographic

Distribution

Compensate

Remote, unstable locations

De-regularization

Demand outstrip supply

Fuel Mix – Carbon Tax

Talent

New, Low-cost Entrants

Undervalued Big Players

Newer Assets

Rationale for M&As: Transformative

Transformative

Portfolio refocus

Diversification

New Business Lines

Selling/Spin-off non-core

Increase product line

New customers

New technologies*

Complementary Business

Up-down Supply Chain

Patent

Convergence anticipation

Rationale for M&As: Energy Sectors New Delivery, New Sources, Existing Resources Oil, Gas, Electricity, Coal Biomass, Nuclear, Ethanol, Wind, Solar www.myCNI.com.my www.OOBEY.com Traditional Utility Alternative Energy Incremental Technology

Possible ‘Outside’ Acquirers or Investors

Institutional

Fund Managers Corporations Sovereign Funds VCs NGOs Non-Profit Org Financial (Loans) JV Partners M&A Social VCs Holding Co. Gov. VCs Supply Chain Gov. Partnership Competitors www.myCNI.com.my www.OOBEY.com

Why do ‘Outsiders’ Acquire or Invest?

Return/Profit

Risk Management/ Hedging

Tax-benefits

CSR/Image

Diversify revenue

Counter-cyclical balance

Support ‘Mission’

Exclusive rights

Contractual obligation

National Agenda

Control Supply Chain

R&D portfolio

Control Management

Alternative Cash Flow

M&A

3. Strategies, Structure, and Optimizing Value in M&As www.myCNI.com.my www.OOBEY.com

Strategies for Growth “ Double-Digit Growth”, Michael Treacy www.myCNI.com.my www.OOBEY.com

Base Retention

Share Gain

Positioning

Adjacent Market

New Business

GROWTH

How Markets determine Growth Strategies (1)

Growth Rate

Base Retention

Share Gain (Acquisitions)

Market Positioning

Share Gain

Base Retention

Strategy

Lose customers slower than competitors

Create scale economics, squeeze costs

Maintain market share in strategic segments

Prepare for market decline

Competitors focus too much on getting new customers

Why? Flat Fast Growth Rate

Churn Rate

How Markets determine Growth Strategies (2) www.myCNI.com.my www.OOBEY.com

Base Retention

Share Gain

Adjacent Market

Share Gain (Acquisitions)

Adjacent Markets

Strategy

Lose customers slower than competitors

Customers are always open to the best value and offer

Desperate to gain revenue

Buying customer base is cheaper than own efforts

New products, old customers strategy

Why? High Low Churn Rate

How Markets determine Growth Strategies (3)

Energy Sector

Market Positioning

Share Gain (M&A)

Base Retention

Adjacent Markets (M&A)

Fast Growth, Low Churn

Neutralize Competitor Advantages

Deliver far better value

Buy Market Share outright

Price Premium

Operating Model

Integration

Strategy 2: Share Gain www.myCNI.com.my www.OOBEY.com

Buying Market Share: Acquisition strategy No evidence of previous company One Kingdom Pre-integration Blueprint Slow Trigger, Fast Bullet www.myCNI.com.my www.OOBEY.com Integration Operating Model Price Premium Buying Market Share Net Cost per Customer < Direct Acquire

Buying Market Share: Side notes on Funding www.myCNI.com.my www.OOBEY.com *Adapted from Warren Buffet’s acquisition strategies

Cash from Stock sale

Issue more stock

Cash from Earnings

Cash from Borrowings

OK, but not preferred Preferable

Strategy 4: Invade Adjacent Markets

Adjacent Market = Important Similarities and Large Differences in:

Cost Structure

Competitors

Customers

Critical Capabilities

Strategy 4: Invade Adjacent Markets www.myCNI.com.my www.OOBEY.com Traditional Utility Alternative Energy Incremental Technology

Strategy 4: Invade Adjacent Markets Upstream Midstream Downstream Distribution Generation Extraction Vendors/Services www.myCNI.com.my www.OOBEY.com

Is it a promising market?

Best when market is new and not stable

You must time your entry carefully

Entrenched companies usually delay embracing new technology or process

Can you win in this market?

Must be built on advantages that are tangible, practical and easily implemented

Strategy 4: Invade Adjacent Markets www.myCNI.com.my www.OOBEY.com

Can you match the Standards of Competition in this Market?

You do have to meet the quality level that is common in the market

Three Standards:- Technology , Relationships , Business-model

You must have 80 percent of the capabilities you need to match competitor’s Standards

Make or Buy?

It is easier to meet the standards of competition if you buy an existing player

Adjacent acquisitions must remain as a separate enterprise

Integrate Management Control (systems, technology)

Inter-transfer of management talent, knowledge and capability are important

Strategy 5: Acquire new Business

No core advantage to bring in

Investors mind-set vs. Managers mind-set

Value unlocking via operational improvements

Invest in Management/Leadership

Premium = Combined value > stand alone

Linking BSC to M&A Strategy Revenue Growth Base Retention Share Gain Positioning Adjacent Market New Business Operational Excellence Product Leadership Customer Intimacy Competencies Information Systems Motivation, empowerment, alignment Financial Learning & Growth Internal Process Customers Investment Strategy Productivity Market Value www.myCNI.com.my www.OOBEY.com

Optimizing M&A: 4-Wheels Model Culture Business Objective M&A Strategy www.myCNI.com.my www.OOBEY.com Structure Resources Leadership Person

Optimizing M&A : Framework

Org Structure

Job Design

C&B

Policies & procedures

Decision making

Job fit

Management Systems

BSC and KPIs

Decentralized & Empower

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Role modeling

Vision/Mission/Philosophy

Leadership Style

Delegation & Empowerment

C&B, Promotions

Sense of Urgency

Customer focused

Best practices

Bottom line management

Tradeoff between Cost vs. Value

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Identification and Recruitment

Incentives

Training

Values

Motivation

Competency Analysis

Education/Curriculum

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Enablers

Projects

Technology

Equipment

Materials

Intellectual Property

Partners

Property

Funding (Capital Access)

Public

Private

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4. Considerations, Risks and Pitfalls www.myCNI.com.my www.OOBEY.com

Global footprint vs. Local Presence

Anti-trust and Regulatory permissions

Environmental (e.g. Europe’s ban on Biofuels)

M&A Accounting Standards

‘ Fair Value’ definition in financial reporting = ‘Exit’ price

Acquirer and Target having different Risk Tolerances

Public (or Public-hopeful) companies need to consider EPS after acquisition

Synergies and Improvements need to realized as quickly and efficiently as possible

Combined Management capability to deliver improved performance

First 100 days post-acquisition blueprint

Culture management

Consideration: Alternative Deals to M&A

“ When companies are unwilling to sell or acquisition premiums are too high, alliances are the next best thing to a merger. In other cases, they are actually preferable to M&A”

David Hernst, Principal, McKinsey’s Washington, DC www.myCNI.com.my www.OOBEY.com

Consideration: Alternative Deals to M&A Joint Venture Unite business units Problem with shared ownership New Product Lines Cost Reductions Share risk, Share Cost in new markets, R&D Buy-out clause Alliances Reduce non-core or commoditizing parts Outsourcing, Offshoring Help supplier gain Scale Enter Complementary business www.myCNI.com.my www.OOBEY.com

5. Investment Opportunities www.myCNI.com.my www.OOBEY.com

Examples