Get a 9% Compound Return with Minimal Risk

Few weeks ago, Burren Buffett investment in Goldman Sachs had got the attentions of Wall Street. Despite the bad economic outlook, the purchase of $5 billion preferred stocks with a juicy 10% dividend is said to be a great investment. It's said that only Warren Buffett can have the power to secure such a good deal.

But here, in KLSE, I had found a similar opportunity which can generate a 9% compound return in the next few years. And the best part is, the risk of this investment is very low.

What we had to do is just buying the Redeemable Convertible Preference Shares (RCPS) of Malaysia Airlines System at its current market prices. This RCPS is a product of MAS' debt-restructuring processes during year 2007.

Here's a short summary about this RCPS:

• Issued at RM1.00.
• preferred dividend: 3.0 sen per RCPS.
• convertible to common share of MAS at RM4.05 by surrendering the RCPS. (period of conversion: four years starting from 1-Nov-2008)
• at maturity date (31-Oct-2012), all un-converted RCPS will be redeemed at RM1.00.

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The Potential Return

the RCPS is currently trading at around 70 sen. Assume that we bought it now and hold it until maturity, the average compound return will be at least 9% p.a. in the next four years.

If MAS decided to declare any dividend during the coming years, the holder of RCPS is entitled to received a preferred dividend of 3.0 sen per share. Then the return on investment will become higher, (up to 13%, if the preferred dividend is received in each the four years).

Furthermore, the RCPS is convertible to MAS common shares. As a result, while enjoying the above benefits, the holders of RCPS will not miss the opportunity to ride on the share market performance. If, by whatever reasons, the share price of MAS shoot up during the next four years, the price of RCPS should enjoy the same increase as well.

(the converible feature of RCPS may be the main reason why it's trading at such an attractive price now. People simply tie up its price to the share price of MAS. So, when the share price of MAS drop, the price of RCPS simply follow. By right, a preferred stock should be traded at a premium to its common shares).

For anybody who is interested to buy the stocks of MAS (and the share-holders of MAS), I strongly recommend buying RCPS (or replacing their common stocks of MAS with RCPS). Because the RCPS is currently traded without premium to the common share price of MAS. That means we are paying nothing for the above benefits of preferred shares if we buy the RCPS instead of MAS common shares.

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Risk Analysis

If we are ready to hold the RCPS to maturity, there's only one risk risk that will cause us earning a return less than 9% p.a. -- MAS may be unable to redeem the RCPS at the maturity date. We have to examine the probability of this event.

According to its latest financial report, MAS is currently holding more than RM 5-billion of cash. The total number of RCPS issued was 417.7 million. Thus, MAS will have to pay out RM 417.7 million to redeem the RCPS if all of them are being held to maturity. That means, the cash currently held by MAS is actually more than 10 times higher than the amount needed to redeem the RCPS.

However, the huge amount of cash in MAS may reduce significantly in the coming years if the operating performance of MAS is very bad. But I have little worry about that.

One of the reasons is our government's policy that always protect the GLC's. Thus, despite the economic downturn and the increasing competitive environment, I think that the chance of MAS going into bankruptcy is very low. The second reasons is merely my confidence on the management team leaded by Idris Jala. I believe that with his Business Transformation Plan, Idris will turn MAS into a continuous profitable company.

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Conclusion:

With a purchase price around 70 sen, the compound return rate on RCPS of MAS will be:

• minimum 9% in the next four years,
• between 9% ~ 13%, if MAS declare dividend,
• even higher return if the share price of MAS go up.

While there's a risk that MAS may not be able to redeem the RCPS at maturity, I believe that the probability is very low.

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