Last Friday, Hyflux Ltd announced that the company will be amending its scheme of arrangement (“SOA”, or the “Hyflux Scheme”), in order to better achieve its objective to “balance the competing legal and commercial interests” of the scheme parties. The announcement came in response to a letter from the Securities Investors Association Singapore dated 27 Feb 19, which outlined an alternative proposal seeking for “a more equitable distribution” of Hyflux’s assets.
We have looked through the proposed changes and highlight here the key implications for stakeholders. Readers who are looking for more background information on the Hyflux Scheme may refer to our previous report (see “Hyflux to Hold Scheme Meeting for Creditors on 5 Apr 19”).
Amendments to the Hyflux Scheme terms
To recap, Hyflux will set aside the scheme consideration allocated to S$668.1m of contingent claims—~S$93m in cash and 10.87% of Hyflux’s shares post-restructuring—in an escrow account. The Scheme Manager (representatives from Ernst & Young Solutions LLP) will only distribute these amounts to the relevant parties if their contingent claims crystallize before the expiry date, which is two years after the restructuring effective date.
The existing plan stipulates that 80% of the cash allocated to contingent claims that are extinguished or expire will be distributed to the Unsecured Scheme Parties (“USP”) or senior unsecured creditors. The Scheme Manager will distribute the remaining 20% cash payouts to Hyflux (“Contingent Claim Management Payouts”), which will allocate the monies to its employees as incentives for project completions.
Under the amended scheme, the Contingent Claim Management Payouts will be halved to 10%. Hyflux also clarified that none of the company’s present board members or senior management will receive any part of the Contingent Claim Management Payouts.
In addition, the remaining 90% of cash payouts set aside for extinguished/expired contingent claims will be distributed pro rata between the USP and the Debt Securities Scheme Parties (i.e. junior creditors holding Hyflux’s perpetual securities and preference shares, or the “DSSP”). The split between the USP and DSSP will be in proportion of their respective scheme claims.
73 parties filed proofs of claims totaling S$3.51 billion
On the same day prior to its announcement of the amended scheme terms, Hyflux released the list of parties who file proofs of claim against its SOA. According to the exchange filing, 73 parties filed proofs of claims against Hyflux amounting to S$3.51 billion. This value includes ~S$106m of subordinated scheme claims, of which the claimants will receive only a nominal amount from the Hyflux Scheme.
The purported claims are significantly higher (~S$890m more) than the total of S$2.62 billion claims listed in Hyflux’s explanatory statement (dated 22 Feb 19) for its SOA. The large variance is likely due to overestimation of claims by some scheme parties. For instance, perpetual securities and preference shareholders have claimed for S$970m, which is higher than their principal amount of S$900m and have probably included accrued interest.
Nevertheless, the released figures introduce additional uncertainty to the cash recovery rates for the USP and DSSP. To reiterate one of the amended scheme terms, the cash allocations from extinguished contingent claims will be distributed according to the proportionate share of claims of each scheme party.
The Scheme Manager will provide a formal judgment on the claims and release more accurate claims figures by 15 Mar 19. In the meantime, we will estimate the recovery values for scheme parties using the assumptions in Hyflux’s explanatory statement.
Estimated recoveries under the amended scheme
As the proposed changes relate only to cash payouts set aside for contingent claims, the initial recovery rates for the DSSP and USP will remain unchanged at 10.7% and 24.9% respectively. Theoretically1, these amounts represent the minimum recoveries that the scheme parties can expect.
In the best-case scenario, where all of the contingent claims are extinguished or eventually expire, we estimate that Hyflux’s senior unsecured creditors may recover up to 36.8% of their principal amount, with 18.5% in cash (down from 21.7% under the current plan) and 18.3% in shares (unchanged). The amended scheme implies a maximum recovery rate of 15.2% for junior creditors, with 7.5% in cash (up from 3.0%) and 7.7% in shares (unchanged).
If we take the mid-point and assume 50% of extinguished contingent claims, the estimated recovery rates for the USP and DSSP will be 29.6% (15.9% in cash and 13.7% in shares) and 12.6% (4.9% in cash and 7.7% in shares) respectively. It is important to note that these numbers (see Figure 1 and 2) are indicative only, given that purported claims as mentioned above are significantly higher than the amounts provided in Hyflux’s explanatory statement. In any case, the adjudication results of submitted scheme claims should have little impact on the estimated initial recovery rate (10.7%) for the DSSP, as their principal amount (S$900m) is certain.
Overall, we see the amended scheme terms as a significant concession by Hyflux’s senior unsecured creditors, who have essentially offered to share all the potential upside from higher cash recoveries in exchange for higher acceptance of the Hyflux Scheme among junior creditors. Regardless of the eventual crystallization levels of contingent claims, Hyflux’s senior unsecured creditors will receive a cash recovery rate that is 2.3 percentage points (“ppt”) higher—over and above the estimated maximum recovery of 8.7% in a liquidation scenario—than that of junior creditors, instead of up to 10.0ppt higher under the existing plan. The improved scheme terms and the compromise by senior unsecured creditors should make it easier for the DSSP to vote for the Hyflux Scheme.
PUB’s default notice to Tuaspring adds to urgency of Hyflux’s restructuring
Last week was an eventful one for Hyflux, as the group received a notice from the Public Utilities Board (“PUB”) asserting certain defaults by Tuaspring Pte Ltd (Hyflux subsidiary and the owner of Tuaspring Integrated Water and Power Plant) under the water purchase agreement (“WPA”) between PUB and Tuaspring. The PUB notice provides a default cure period of 30 days from 6 Mar 19, the expiry of which coincides with the date of Hyflux’s scheme meetings, i.e. 5 Apr 19.
Importantly, the WPA also allows for “such longer period as may be reasonable” for Tuaspring to consult with PUB as to the steps needed for resolving any defaults that are alleged to have occurred. If Hyflux fails to resolve the breaches within the stipulated period, PUB has the rights to terminate the WPA and take control of the Tuaspring plant.
Recall that Hyflux’s restructuring agreement with SM Investments Pte Ltd (“SMI”) forms the bedrock of its SOA, with the capital injection by SMI funding the cash distribution to scheme parties, and completion being contingent upon the full and final settlement of all unsecured borrowings, trade debt, and contingent claims. The restructuring agreement allows SMI to terminate the deal if Hyflux loses control of Tuaspring.
We are unsure whether the timing of PUB’s default notice (and the default cure period) has any implicit connotations, or the national water agency is merely taking steps to protect its offtaker rights and ensure continuity of water provision, while waiting for the results of Hyflux’s SOA. In any case, it has become imperative, in our view, for Hyflux and its creditors to agree on a restructuring scheme as soon as possible.
As reported by the media2, PUB has issued the default notice because of various operational failures by Tuaspring and a lack of evidence that Tuaspring has the financial ability to keep the plant running for the next six months. Without implementing any form of capital restructuring, we are highly doubtful of Hyflux’s prospects in convincing PUB of its financial viability.
The worst-case scenario would be one in which Hyflux’s SOA is rejected by the scheme parties, Hyflux fails to convince PUB to extend the default cure period, SMI walks away from the restructuring agreement, Hyflux is unable to draw up another restructuring proposal before its debt moratorium expires, and the company is forced into liquidation. The likelihood of that last outcome has increased following the default notice by PUB. In short, for investors contemplating of holding out in hopes of a better deal, the chances of Hyflux being able to propose another scheme are now slimmer.
Some investors have also considered the possibility that PUB will offer a compensation amount to Hyflux—in the event of a takeover—that is high enough to provide better recoveries relative to the Hyflux Scheme. Although the terms of the WPA between Tuaspring and PUB are confidential, and we are thus unsure of the compensation involved (or whether there is any compensation) in a takeover event, we think the possibility of that scenario is remote. In the context of liquidation, for Hyflux to have any monies left for the junior creditors after satisfying its senior obligations (including the secured loans on Tuaspring owed to Maybank), the compensation by PUB has to be exceedingly higher than S$651m, which is the book value of the Tuaspring disposal group3 according to Hyflux’s court affidavit dated 1 Mar 19.
If we assume instead that PUB’s compensation to Hyflux is high enough for the company to stave off liquidation and propose a superior restructuring package, it would be a curious case for an implicit bailout to happen now, after months of negotiations between the various stakeholders. Last but not least, the Singapore government has said in parliament that the Hyflux situation is a “commercial matter”4, signaling that a government intervention is unlikely to happen.
Figure 1: Recovery analysis assuming different levels of crystallization of contingent claims
Figure 2: Graphical representation of the potential recovery rates for scheme parties
1 Our calculations have assumed an equity valuation of S$667m on Hyflux, based on the offer by SM Investments Pte Ltd to invest S$400m in exchange for 60% of Hyflux’s shares post-restructuring.
2 For instance, refer to Tang, See Kit. (2019, March 7). PUB’s default notice to Tuaspring complicates Hyflux’s restructuring: SIAS, analyst. Channel NewsAsia. Retrieved from https://www.channelnewsasia.com/news/business/pub-default-tuaspring-complicates-hyflux-restructuring-sias-11321656
3 The Tuaspring disposal group includes Tuaspring Pte Ltd and Hyflux Energy Pte Ltd, and is accounted as held for sale due to an agreement with Maybank.
4 Impact of Proposed Acquisition by Foreign Company of Hyflux Shareholding on Singapore’s "National Taps" Water Strategy [Transcript]. Retrieved from https://sprs.parl.gov.sg/search/sprs3topic?reportid=written-answer-na-4360
For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) has a principal position in HYFSP 8.000% Perpetual Pref (SGD) - Retail. The analyst who produced this report holds a NIL position in the abovementioned securities.