Stock price decline leaves John Keells (JKH) vulnerable to a takeover by Sri Lanka’s oligarchs

October 15, 2018 (LBO) - 2018 has been a tough year for emerging market equities, and Sri Lankan stocks are no exception.  The major stock indices of the Colombo Stock Exchange (CSE), the All Share Price Index (ASPI) and the S&P SL 20 are down near 10% and 20% respectively so far for the year.  The market in aggregate looks inexpensive, trading at a PE of less than 10 and nearing book value. The most important stock by far at the CSE is John Keells Holdings (JKH). JKH is a diversified conglomerate whose reach touches almost every aspect of the Sri Lankan economy. It is normally the company with the highest market capitalisation on the CSE, although the recent downturn has put it at second to Ceylon Tobacco (CTC), a local monopoly cigarette player owned by giant British American Tobacco. Although second in terms of market cap, JKH dwarfs Ceylon Tobacco or any other company in terms of importance to Colombo's floundering stock market. Aside from the banks (which are protected by legislation prohibiting a controlling shareholder), JKH is the only major listed company in Sri Lanka that does not have a controlling or even dominant shareholder. JKH is the last of the old British founded corporates that remains uninfluenced by any of Sri Lanka's emerging oligarchs. One family (headed by Solhi Captain) has a stake which is approaching 20%. However, at this juncture, the Captains exert no control over the company. Although Rusi Captain was once on the Board, at this time his family do not even have a board seat.  The Captains have owned a large stake for some time, and previous attempts by them to increase their stake have been met with pushback in the form of rights issues. These cash calls required existing shareholders to come up with large amounts of funds to avoid dilution of their holdings. JKH has always been controlled by its Board of Directors, currently made up of 9 of the top personalities in corporate Sri Lanka. Today the board members are as follows: Susantha Ratnayake (Chairman), Krishan Balendra (Deputy Chairman), Gihan Cooray (Finance Director), Ashroff Omar, Hans Wijayasuriya, Amal Cabraal, Nihal Fonseka, Premila Perera, and Radhika Coomaraswamy. Susantha Ratnayaka (59), longtime Chairman and CEO of JKH, is due to retire at the end of the year.  After his retirement the company will be stewarded by Krishan Balendra (45). Balendra is the scion of JKH's most famous Chairman Ken Balendra. It had long been speculated that the young Balendra would eventually reach the helm of Sri Lanka's most important company, and that long telegraphed transition is less than 3 months away. The next Chairman of JKH is taking over at a precarious time. JKH's market capitalisation, once well above US$2bn, is now very close to dipping under a billion dollars. Almost 60% of the shares of the company are owned by foreign institutions, and there have been rumours circulating that many would like to sell. With the global correction in emerging market stocks, there are many stocks in Asia whose valuations have come down significantly. Portfolio managers are almost certainly evaluating their JKH positions in comparison to other opportunities that have presented themselves after the global emerging market stock selloff. It has long been speculated that the Malaysian soverign fund Khazanah, which owns 10% of JKH bought at much higher prices, is keen to sell. Schroder International Selection Fund which owns over 6% of JKH is down sharply in 2018. The poor performance of emerging market funds in 2018 may lead to redemption pressures, forcing portfolio managers to liquidate some positions to meet cash calls. Shares of JKH, like the rest of the stocks at the CSE, have become relatively illiquid during this stock market downturn.  With emerging market funds looking for liquidity, a large bid for a block of JKH from a local investor would be hard to pass up. The most likely local investors to make such a move are Sri Lanka's quasi oligarchs. A recent 'fireside chat' event put many of these quasi oligarchs on stage together in an event that ended up sparking media outrage. Sri Lanka's wealthiest businessmen, many who have benefited directly from significant state patronage, took to the stage to complain about the current government.  One even outrageously suggested that Sri Lanka needed a dictator in order to get things done. The business magnates on that stage control many of the listed conglomerates in Sri Lanka. It would not be a stretch to imagine that they would covet the crown jewel of Sri Lanka's corporates, JKH. The most liquid, and possibly most feared, of these Sri Lankan business magnates in Harry Jayawardena. Through his holding company Melstacorp, Jayawardena already owns a 3.5% stake in JKH.  If he is able to take the block from Kazanah, he will have close to 14%.  With that shareholding (14%), he together with the Captains would control in excess of 30%, and together could block any rights issue or other major dilutive capital raise. The deal for the Khazanah block is likely just a price negotiation, and could happen in a matter of days if there was interest and both parties came to terms. This deal (if Khazanah sold the whole block to a Sri Lankan) would likely be the start of a group of Sri Lanka's richest people, colluding to control Sri Lanka's most important company. Krishan Balendra would then find himself at the head of a company much different than the one he thought he would steward. One veteran market watcher said this: "If one of Sri Lanka's billionaires wrestle control JKH, you may as well close down the Colombo Stock Exchange. There would be no meaningful company with a sizeable market cap and free float to invest in." JKH stands as the only non-financial company with a sizeable free float. It has been shareholder friendly and exhibited a high standard of corporate governance, characteristics that are hard to come by in Sri Lanka. One needs only to ask any of the country's many oppressed minority shareholders about the standards of corporate governance or shareholder value ethos that exists in the country to realise how rare JKH is. JKH is the only company in Sri Lanka that can raise a billion dollars in financing for a large project. It is the only company which is controlled by a diverse aggregate of shareholders as opposed to a dominant shareholder. It symbolises the best of corporate Sri Lanka. And here she lies... open and vulnerable to Sri Lanka's most aggressive corporate predators. John Keells Holdings has done stock buybacks in the past when its stock was floundering.  With the shares now trading below book value, it would be wise for management to get the company to start buying its own stock soon. If they don't, they may find it in the hands of someone less palatable.