United Chemical Industries (UCI) was set up by Malayan Flour Mills (MFM) to manufacture polypropylene woven bags. UCI later expanded into the manufacturing of polypropylene and polyethylene woven bags, geotextile fabrics and related products. Backed by its majority shareholder, UCI in 1992 controlled 30% of the local market while 40% of its products were exported overseas. However, its fortunes took a turn for the worse after 1996, which culminated in the group falling into the PN4 category in 2001. What events had taken place to such devastating effect?
Basically, the major shareholder decided to sell a business with poor economics for a handsome price. The new management and major shareholder then used UCI as a vehicle for corporate deals that went sour which consequently transformed its once relatively healthy balance sheet into a messy affair. We shall divide our analysis into 2 contrasting periods,  1990-1996 and  1996-2001, which were marked by a change in significant shareholder and management.
Core Business With Poor Economics
Although UCI was generating consistent earnings with increasing market share, a closer analysis of its financial performance paints a different picture. First, group sales were stagnant during the period of 1990-96 with a mere 6% growth, at a time when economic growth was robust. Secondly, its pretax profit margin crumbled from 12.4% in 1990 to an unattractive 4.8% in 1996 – see table 1. Thirdly, the trade debtors revealed that UCI had resorted to extending credit, even up to about 120 days in its bid to remain competitive.
Perhaps the transition from a business meant to complement MFM’s to one with ambitions of garnering market share proved too difficult. The economics of the business were poor – no product differentiation, no pricing power and low barriers to entry. Forced to confront with the influx of new entrants due to the low entry barriers, the management’s strategy to increase its capacity to possibly outspent and outlast the newer players backfired. Its capital expenditures, totalling RM11.8 mln during the period, only aggravated the overcapacity position in the industry. Further compounding the situation, efforts to expand its export markets to cushion the poor conditions locally were derailed as its reliance on high cost locally-sourced raw materials (i.e. resins) rendered its products uncompetitive in the export markets. Unable to compete with the intense competition, the group’s performance deteriorated. Essentially, the underlying business was a loser’s game – there was persistent oversupply, leading to price competition and yet faced with rising costs. Falling earnings and margins were the consequences.
Table 1 : Financial Highlights of UCI (RM mln)
Opportunity for A Handsome Profit
In April 1996, Trafalgar Links (M) S/B (Trafalgar) came in with an offer that was too good to refuse. UCI’s majority shareholder, MFM, sold its 24.81% stake or 4,590,000 shares at RM8.20 per share to Trafalgar for RM37.64 mln or equivalent to 125 years of UCI’s earnings attributable to MFM. MFM subsequently sold down its stake to 3.31% and recorded in total an extraordinary gain of RM38.4 mln from the above transactions - not a bad return for an unattractive business. Its Managing Director together with 6 other directors resigned in Aug 1996, marking the exit of MFM. So, why did Trafalgar pay such a high premium for the stake in UCI?
Change in Focus?
With a new significant shareholder, the new management sold its profit-making 45% associate, Muda Fibre Manufacturing S/B to MFM and Thye Nam Loong Holdings S/B, a major shareholder of MFM, for RM6.036 mln cash. Why did MFM sell its stake in UCI, only to buy back a smaller version of it? More worrying to shareholders of UCI was the Board’s decision to sell a synergistic company, possibly signalling a change in focus.
In Sep 1996, UCI proposed to buy from Sungei Wang Properties S/B (SWP) the entire capital of Hongkew Holdings (M) S/B (Hongkew) for RM450 mln cash. Hongkew was inactive except for 2 proposed projects; . Construction of an integrated cement plant and . A privatisation agreement with the Kelantan state government to develop a port in Tumpat. Hongkew would also be given state land, measuring 647 acres, for mixed development. SWP owned 100% of Trafalgar.
Subsequently in 1997, UCI proposed to sell to Sateras Resources (Sateras) the cement plant and quarry land for RM800 mln. UCI was to receive 320 mln new Sateras shares at an issue price of RM2.50 per share, resulting in UCI holding 41.3% of Sateras. This transaction would have meant a pretax capital gain of RM298 mln for UCI. Nevertheless, the proposal was rescinded in 1999. Then, in Mar 1999, UCI and SWP revised the purchase price of Hongkew from a massive RM450 mln to a mere RM78 mln (RM30 mln cash and 24 mln new UCI shares @ RM2 per share). Due to changes in local regulations, UCI and SWP terminated the deal in Jun 2000.
Questionable Motives Of New Management and Significant Shareholder
The above transactions not only left shareholders perplexed but also raised some far ranging questions on the motives of the management and significant shareholders. First, the purchase of Hongkew was dubious on 2 counts:  pricing and  viability. A price tag of RM450 mln for an inactive company on the premise of 2 proposed projects was worrying. These worries were justified when the purchase was subsequently reduced to RM78 mln. Hence, had Hongkew been fairly valued at RM450 mln, SWP would have made an extra massive profit of RM372 mln from the sale and yet, still retain control of the assets. The next question would be its viability. The proposed projects wee capital intensive and have long gestation periods. With shareholders’ funds of only RM27.1 mln, how would UCI have funded this acquisition, not to mention its subsequent operations?
Further clues to the puzzle emerged from the sale to Sateras. A staggering RM800 mln was offered for just the cement plant and quarry land that would have created a gain of RM298 mln for UCI. Had both deals gone through, SWP would have made hundreds of millions without raising a finger or conceding control of the assets. Guess who would be the losers ? No prizes for the right answers.
Core Operations Strangled by Debts
To pay for the deposit to acquire Hongkew, UCI borrowed RM30.0 mln in Jan 1997. Subsequently, the group’s debt soared to RM35.5 mln in 1997 from a net cash of almost RM2 mln in 1996. The annual interest due alone had erased all cash flows generated from its operations (CFO) – see table 2. Increasingly starved of cash with its core operations declining and led by a management with seemingly other agendas, the group’s performance suffered – see table 2. Notwithstanding the poor external business environment, the group’s performance was in stark contrast to its previous associate, Muda Fibre Manufacturing S/B, which was now managed by MFM – see table 2.
Table 2 : Financial highlights (RM mln) (click to view)
Aftermath of Deal Gone Sour
In 2000, UCI notified that the settlement agreement with SWP had ceased and seek full refund of its prior payments. However, due to the uncertainty of the recovery, UCI had to write off in full the RM48.2 mln investment incurred to date. This write-off resulted in UCI’s loss of RM53.2 mln for 2000. In addition, its term loan became due as the Securities Commission did not approve its conversion to equity. As company could not generate sufficient cash flow to service its interests and repay its loans, Trafalgar was taken over by Danaharta Nasional and its 24.81% equity interests in UCI were subsequently sold to KUB Malaysia. By Feb 2001, with a deficit shareholders’ of RM25.9 mln and doubts being raised on its ability to operate as a going concern, UCI became another PN4 candidate.