Proposal_Singapore Technologies Kinetics_Oct 31

Singapore Technologies KineticsJoint Venture Proposal withBeijing Heavy Duty Truck PlantUpdated on31 October 2002 Prepared by: Tee Song HuatTABLE OF CONTENTS Executive Summary1The Company2Terms and Conditions of Joint Venture3Product and Market Analysis4NEWCO Strategic Direction5Sales Forecast6Financial7Strategic fit to STK8Risk Analysis, Action Plan and Exit Strategy9Execution PlanAppendix1.Budget for various infrastructure projects in China2.Assembly plant and office layout3.List of fixed assets4.Call option calculation5.Calculation on market size of bulk cement trucks by 20066.NEWCO Financial AnalysisEXECUTIVE SUMMARYPreamble:China has budgeted to spend more than S$ 1063 billion on various infrastructure projects (see Appendix 1) over the next 10 years. Figure 1.0 shows The Six Key Pillars of China New Construction Industries.These multi-billion dollar projects provided a strong growth to the construction industry such as steel, woods and cements, as well as resulted in a strong demand of construction equipment, including heavy trucks, bulk cement tanker, concrete mixer, excavator and other construction specialty vehicles. These industries have enjoyed double-digit growth in the past few years. The trend is expected to continue for the next 10 years.The timing is right for STK to get into construction related vehicular industry. From here, STK can build a strong foothold in specialty vehicles like Oshkosh Truck Corporation in USA. STK will acquire some credential in truck manufacturing which is an important stepping stone to STK Truck of the Future (TOTF) vision.Figure 1.0 Sources of Strong Growth in Construction IndustryObjectives of the PaperThis paper seeks the approval for US$ 7.5 million to form 50%-50% equity JV with Beijing Heavy Duty Truck Plant (BHDTP). BHDTP has the right products and the necessary core competence to become a major player of specialty vehicle in the construction industry in China. Simultaneously, the Paper also sought approval for a further US$ 3.5 million called option to increase STK stake from 50% to 60% when Chinese government relaxes the <<Restrictive Rule for Automotive Joint Ventures>>, which is expected to happen by early late 2004 or early 2005.The IncumbentBHDTP is a State Own Enterprise (SOE) with business license to manufacture heavy truck. At the moment, BHDTP only produces one single platform -- 20-29 tons off- road dump truck.BHDTP has been losing money in the past five years. Like most SOE, the Company has too many employees and the management is inefficient. However, BHDTP is turning around in the last two years, thanks to the arrival of its current general manager, Mr. Liu Wen Tai, who has managed to narrow financial losses and reduced 42% of total number of employees.STK came across BHDTP early this year through Timoney connection (STK affiliate in Ireland). In September-2000, BHDTP contracted Timoney to design and develop a completely new articulated on-road truck. Currently, all Chinese articulated trucks are imported, no local company has technology and know-how yet.This year, BHDTP acquired two exclusive licensing agreements from Serviplem S.A, the 3rd largest bulk cement tanker and concrete mixer Truck Company in Europe. Serviplem bulk cement tanker and concrete mixer have distinctive technical advantages compared to those available in China today where they are 30% larger in capacity at a similar price compared with the smaller capacity counterparts. BHDTP has successfully prototyped three bulk cement trucks, which had been submitted for type approval. The prototype of the semi-trailer concrete mixer truck is expected to be complete by January 2003.Under Mr. Liu leadership, BHDTP expands from one single product to four product platforms: bulk cement tanker, concrete mixer truck, articulated trucks and conventional off-road dump truck. All will be ready for commercial in Year 2003.BHDTP Core CompetenceBHDTP core competence include:∙Design and manufacturing of specialty heavy vehicleBHDTP has designed and manufactured several types of heavy-duty trucks in the past 20 years. We have tested to drive the 32-ton trucks (total GVW 56 tons), and the drive-ability is good.∙Metal hand weldingMetal hand welding skills are critical for odd shape products such as bulk cement tanker & concrete mixer.∙Uses and applications of different steel metals∙Integration of complete vehicleWith the technology it acquires from Timoney and Serviplem, BHDTP has the basic "hardware" to excel in the specialty vehicle industry.The MarketsMarket analysis shows the market size for of bulk cement tanker and concrete mixer truck is expected to grow from S$ 592 million in Year 2001 to S$ 1.88 billion by Year 2006.Attractive factors for the JVThere are several important factors favoring the JV, as below:(i)The productsBHDTP products have ready markets and are growing rapidly. BHDTP new products have distinct competitive edge compared to other existing competitors.(ii)Favorable LawsLaws were passed to ban on-site concrete mixing and packing of cement in conventional paper bag. Beijing and Shanghai must comply with the law by 2003. All other cities (greater than 1.0 million people) must implement the laws by 2005.To ensure highest standard of concrete quality, new laws are been drafted to use only dry pre-mixed concrete for critical projects such as dam. Only the "vertical chute" or serviplem type of bulk cement tanker is suitable for dry pre-mixed concrete.(iii)Beijing FactorsBeijing is said to spend up to S$ 90.0 billion on basic infrastructure and Olympic projects within the next 5 years. Current tax system has resulted in a strong "local protectionism"or buys local first. There is an unwritten rule that the first priority for the Beijing City Fund will be used to buy local equipment, which will benefit BHDTP.At this time, Beijing represents 30% of total market shares for bulk cement tanker and concrete mixer. It is estimated the market size for bulk cement truck and concrete mixer truck in Beijing alone will exceed S$ 400 million/year by 2006.It is worth to mention that Mr. Lin FuSheng, the current BHDTP Group President (the former head of Ministry of Machinery, equivalent to Singapore Permanent Secretary), is influential in the construction industry in Beijing.Term and condition of the JVWe have agreed on the following terms and conditions:A.Liabilities∙BHDTP will responsible to settle all the debts and liabilities. In other words, NEWCO will be clean from debts, either from the bank or creditors.B.Employee∙NEWCO will take in a maximum of 350 existing employees from BHDTP. The new employee will sign yearly employment contract with NEWCO. The service will start from year one (1).∙NEWCO will not responsible for the employee housing, old pension etc (same terms as SEEV employees).C. Management Control∙Since STK has an option to increase total share to 60%, it is agreed STK will exercise the management control from the start. STK will position two senior staffs (the executive director and the finance director) at NEWCO. We will deploy STK engineers to work on production engineering and cost reduction issues separately.∙To ensure the continuity and initial stability, it is recommended the JV appoint Mr. Liu as the GM. Under the proposed structure, Mr. Liu will report to the executive director.∙NEWCO will implement STK policies, which includes financial reporting, very much like those we implemented in SEEV.D.Business license to manufacture heavy truck∙BHDTP will transfer the business license to NEWCOWhat BHDTP Need to move forwardMoving ahead, Mr. Liu considers the Company first priority is to clean up the SOE legal through a JV mechanism to ensure there is right sizing and right skills set. To this end, BHDTP has taken an initiative to retrench 400 employees in October 2002.Figure 2.0Why BHDTP wants to Partner with STKFigure 3.0 shows the reasons BHDTP considers STK as a good fit partner. Additionally, the senior management are comfortable working with a Singapore company because there will beFigure 3.0NEWCO Product Strategy∙NEWCO will concentrate on the bulk cement truck and semi-trailer concrete mixer truck as the immediate twin growth engines. It will also market the bulk tanker and concrete mixer to other modifiers and overseas markets (including re-export back to Serviplem).∙NEWCO will reduce total variants of dump truck from 5 to 2 - the 25 tons and 32 tons.The 25 and 32 tons are new standards in the dump trucks industry. It also has higher gross margin.∙NEWCO will position the articulated truck as the high profit margin niche products.The strategy is to replace import; today all articulated trucks are imported.∙NEWCO will seek to introduce other medium volume specialty niche vehicles like fire engine, water tanker, airport tow-tug, refuse hauler, rubbish compactors etc within the next 24 months.Value add from STK to NEWCOAlthough BHDTP has the necessary "hardware", the Company management is very weak and the company was stagnated for past 10 years. Mr. Liu blames the SOE system where there is no incentive for employees to be motivated or the lack of "software".The "software" part is where STK can add critical value to NEWCO, such as:∙Modern general management∙Effective production engineering, in-process control improvement and cost reduction etc∙International networking in marketing and technologyAdditionally, STK relationship with Timoney and Silvertech will provide NEWCO a continuity of future technology, as suggested in Figure 4.0.Figure 4.0 Value Add RelationshipStrategic Fit with STKFigure 5.0 shows how the proposed JV fits into STK overall China Commercial Vehicle Road Map, with the final objective of having a substantial business presence in the heavy trucks sector. ∙Through this venture, STK will gain the essential credential in the heavy truck manufacturing.We would have built up an automotive organization, people and have the right connections in the automotive industry. These are important elements for STK to collaborate with other truck OEMs in the future.∙NEWCO would have contributed S$ 120-200 million revenue to STK Commercial sector by 2006. There is potential for more upside if we successfully introduce other specialty products and develop NEWCO as "Oshkosh of China". There is also good prospect to export the products, which is not considered in the sales projection.∙The JV compliments STK other investments such as Timoney and Silvertech where we can add value by applying their technologies into these specialty vehicles.∙NEWCO may offer STK, Timoney and Silvertech a low-cost manufacturing base for heavy truck components.Figure 5.0 Road Map to China Commercial Vehicle BusinessFinancialNEWCO will be break-even in Year one, and profitable from the second year. NEWCO is expected to have a sales turnover of between S$ 120-200 million by Year 2006. The project has an IRR of 16%.Risk factorsThe most risky element of this JV project is the current BHDTP management is rather weak (as any SOE). STK has management control from the start to provide the leadership to steer NEWCO. Additionally, we could now leverage on Shanghai Elite resources to provide additional assistance. Our experience in managing Shanghai Elite in the areas of cash flow management and corporate governance will help us to avoid the potential costly mistakes.1. The CompanyBeijing Heavy Duty Truck Plant (BHDTP or the Company) is a state own enterprise (SOE). Formerly, it comes under the Beijing Mechanical & Electrical Industry Holding Co., which has been renamed as Beijing Jingcheng Mechanical & Electrical Holding Co. Ltd (or Beijing Jingcheng). Beijing Jingcheng has more than 61 subsidiaries under its charge.The Company was established in 1954. The Company has been losing money in the past several years. Like a typical SOE, the Company has low productivity, high debts, too many people on the payroll and a very in-efficient management structure.Under Premier Zhu Rong Ji's 1998 plan, all unprofitable SOEs must be restructured, either be sold, ventured, Management Buy Out (MBO) or simply closed by 2003. Premier Zhu's strategy is to keep 20% of good (and big) enterprises alive and shut down or divest the remaining. To speed up the reform, the government has allowed selective liabilities to be written off completely. Current environment is favorable for foreign companies to acquire promising state own enterprises. For most SOE companies, JV with a foreign company is the most preferred option.Currently, BHDTP produces one single product platform, an "off-road dump truck" (Picture 1). The Company is vertically integrated. It produces special bolt and nut, transmission and does all the heat treatments. The Company has developed other specialty vehicle such as airport tug, water tankers etc in the past but did not proceed to production due to the lack of funding from the parent company.General Manager Liu Wen Tai was posted to this plant in Year 2000, with the mission to turnaround the company. Improvement made include Reduced total workforce from 2,400 to 1,374Reduced financial loses to S$ 1.0 million in 2001. Actually, the Company should achievebreak-even if total employee were 400 instead of 1374.Funded new strategic products♦ Contracted Timoney to design and prototype an articulated truck, this vehicle is designedto meet both the off-road and on-road requirement (Picture 2).♦ Bought the 28 m 3 bulk cement tanker licensing agreement from Spanish Serviplem S.A(Picture 3). Three prototypes were completed.♦ Bought the 12 m 3 semi-trailer concrete mixer truck (Picture 4) licensing agreement fromServiplem. Beijing Vice Mayor Mr. Zhang XiaoYu signed the agreement with Serviplem in Madrid this July.Serviplem has expressed an interest to JV with BHDTP in July. Because STK has started some discussions, Mr. Liu has not given an official response to Serviplem.Mr. Liu Wen Tai is a veteran in the heavy vehicle industry. He was the former Chairman and GM of Siemens Electric's China (a JV between Siemens and Ministry of Machinery). Mr. Liu was selected by the Beijing Government as a member of the 2-month study delegation to Singapore in 1988. Mr. Liu is the concurrent Chairman of JingCheng Heavy-duty Machinery Co. Ltd, the immediate parent of BHDTP. JingCheng Heavy-duty Machinery Co. Ltd controls three subsidiaries: BHDTP, Beijing Lifting Machinery Co. Ltd and Beijing Construction Machinery Co. Ltd. The lifting machinery co is negotiating a JV relationship with Tatano, Japan, which is likely to be formed before the end of the year.The Company sold a total of 98 units of 20-28 ton off-road dump trucks in 2001. The nearest competitor of the same range of dump truck is Northern Heavy Auto Ltd located in Baotou, Inner Mongolia, which produces a total of 86 trucks in 2001. Northern Heavy is JV with Terex, it is the largest off-road heavy truck manufacturer in China today.1.2 Unique Opportunity for the JVThere are several reasons favoring BHDTP's JV partners:i)China has budgeted to spend S$1063 billion on various infrastructure projects over thenext 10 years. As a result, there is very strong demand of heavy construction vehicles. ii)Beijing factors:∙Beijing desires to re-establish a strong vehicle industry, a good illustrating case is Beijing/Hyundai billion-dollar car joint venture project. Which means there will bemore automotive technical people, management personnel and suppliers.∙Beijing City announced it will spend S$ 90 billion on traffic related infrastructure and Olympic infrastructure from 2003-2007.∙There is an unwritten rule that Beijing City Funds will give priority to local companies.iii)Beijing Jingcheng just raised S$ 60.0 million of cash from land sales, which means it has money for restructuring, capital injection and other expenses for NEWCOiv)Most importantly, the Company is ready to commercialize three European designed trucks - bulk cement tanker, semi-trailer concrete mixer truck and on-road articulatedtruck; each has distinct competitive edge over current competitors.1.3 Other general informationI.FinancialTotal revenue for Year 2001 is S$ 13.0 million. Total loss for the financial year is S$ 1.0 million. The company has an outstanding debt amounting to S$ 31 million (bank loan:S$18.0 million, supplier: S$ 13 million)II. EmploymentThe company has an active workforce of 1,347.III. LocationThe Company was located in Beijing central (Shuangjinjiao), which also houses themachining workshop. Recently, the land was sold to a property developer.The Company has 80,000 square meter factory site for the final assembly, located about20-Km outside Beijing in the district of Tong Zhou. The Company plans to renovate thefactory and build a 2,000 square-meter office early next year (see Appendix 2). Therelocating process will be completed by March 2003.The paint shop is located about 5 km away from the main assembly plant.1.4 Restructuring Plans1.4.1Breaking-up of companyTo facilitate joint venture with a third party, Mr. Liu is in the process to break-up the company into four separate entities.i)Machining Workshop, a total of 150 people will be transferred to this entity, whichwill be sold to management staff (MBO).ii)Heat-treatment Workshop, a total of 50 staff eventually, to be sold to management staff (MBO). This facility already has steady business.iii)“ Third (miscellaneous) Business” includes clinic, school, canteen etc. It has 100 staff at the moment. All employees will be retrenched.iv)Main assembly plant, it has a total 1047 people today. JV Company will take a maximum of 350 and 747 will be retrenched. As shown in Figure 6.0 below.Figure 6.01.5 Core Competence AnalysisBHDTP core competence are summarized as below:(a)Design and manufacturing of specialty (heavy) vehicle,(b)Hand metal welding, this is critical for the manufacturing of odd-shape design such ascement tanker, concrete mixer, water tanker, rubbish compactor etc. which require extensive amount of hand welding,(c)Use and application of different kinds of steel metals,(d)Integration of a complete vehicleA comparison with STK shows there are some common core competencies between STK and BHDTP. There are many areas STK can contribute such as improving the engineering of articulation, as the technology is similar to STK's ATTC. Most importantly, STK can quickly introduce advanced production engineering, in-process improvement and cost reduction methodologies, these are the key differentiators compared to Chinese competitors.1.6STK value add to BHDTP (why BHDTP needs STK)Although BHDTP possesses the basic hardware to excel in the niche specialty heavy-duty vehicle (the core competence and technology it acquires from Timoney and Serviplem), the company is cleared it needs help from an overseas partner.Mr. Liu first objective is to clean up the company old SOE legacy and to implement modern management, which he thinks this can best be done through JV with a foreign company. Secondly, Mr. Liu wants to make a lean organization by reducing total workforce from 1074 to about 350. He has started the process by laying off 400 staff in October 2002. In other words, it has to lay off another 350 staff at the time it JV with STK. At the same time, Mr. Liu identifies production engineering, sales, HR and finance need immediate improvement.Mr. Liu considers STK as a well-fit partner, as Figure 3.0, because∙As a Singapore company, there will be less communication and cultural barrier∙STK can offer advanced general management, effective production engineering, in-process control improvement and cost reduction methodologies. These are critical for BHDTP to∙technical assistance to BHDTP∙STK has better international capabilities to provide export channel, BHDTP anticipate about 30% of its products could be exported eventually. South East Asia is the first market BHDTP would target.STK, Timoney and Silvertech can provide continuity in technology2.0 Terms and conditions of Joint VentureSTK and BHDTP have agreed on the following framework:2.1Type of JVUnder current Chinese law for Automotive JV, the minimum equity for the foreign company shall be 25% and the maximum is 50%. We expect China to relax this rule by 2004, as part of WTO accession commitment.The joint venture shall be an equity joint venture. For a start, both STK and BHDTP shall hold 50% equity each. STK has a call option to increase total equity to 60% when the government relaxes the rule.2.2Management controlBHDTP welcomes STK takes the management control including the appointment of GM. However, to ensure continuity and initial stability, it is suggested that the JV should appoint Mr. Liu as the GM for at least two years. STK will post two senior staff to the JV, an executive director and a deputy GM, either the CFO or the director of manufacturing.Under the proposed structure, the GM will report to the executive director, whose job will involve executive decisions and major activities as well as making strategic decisions with the GM. It is also agreed that the JV will use STK policy and guidelines like those adopted by Shanghai Elite.2.3Heavy Truck manufacturing license ("Catalog")At this time, BHDTP has Business License to Manufacturing and Modify: Heavy Vehicle, Underground Mining Vehicle, Airport tow-tug, Water Tanker, Engineering and Components.It means BHDTP is qualified to manufacture all kinds of Heavy Vehicle (greater than 8.0 ton payload), so long as it meets Type Approval criteria and has economic justifications.(China has very stringent rule on vehicular license. There are the manufacturer license and the modifier license. Off-road vehicle does not need license).BHDTP will transfer the Business License to NEWCO.2.4CapitalizationSTK will inject US$ 7.5 million of cash. BHDTP will inject US$ 6.14 million cash and US$ 1.36 million in-kind, as follow:i. Fixed asset About US$ 0.36 million (see Appendix 3)ii. IP US$ 1.0 million (see Section 2.9)iii. Cash About US$ 6.14 million2.4.1Call OptionAppendix 4 shows two methods of calculating call options:a.STK buy over BHDTP shares, additional investment will be US$ 1.5 millionb.NEWCO enlarge total shares, additional investment will be US$ 3.75 millionThe Parties will negotiate the actual transaction price at the point of buy-over. However, it is agreed in principle that the purchase price will base on the NEWCO actual "net asset" value at the time of transaction. Estimation of the projected net asset of NEWCO will be2.5Settlement of BHDTP debts and retrenched employeesIn the meeting with Mr. Lin Fu Sheng, the President of Beijing Jingcheng Holding Co. Ltd on September 12, 2002, Mr. Lin commits that Jingcheng will responsible for all the outstanding debts. In other words, NEWCO will not be required to shoulder any old baggage.NEWCO will take a maximum of 350 employees. STK will work with BHDTP selection criteria for these employees as shown in figure 7.0 below. BHDTP will responsible for the retrenchedFigure 7.0 Preliminary Organization Structure2.6Rental of factory and officeTo preserve valuable cash, NEWCO will rent the factory and office space from Beijing JingCheng instead of acquiring it. Beijing Jingcheng has started the construction of the additional 4,000 square meters of floor space and 2,000 square meter new office. Beijing Jingcheng is expected to spend up to US$ 1.5 million on building construction and renovation. Final rental is expected to be as follow:-2003-2006 -- 5% of the assessed value,∙Year 2007 onwards -- not to exceed 8% of the assessed value2.7Valuation of fixed assetsBHDTP has a total of Rmb7.9 million of fixed assets in the final assembly plant. They mainly comprise of overhead hoists, welding machines, metal cutting equipment, workbenches etc. As of September 30 2002, these fixed assets have after-depreciated net value of Rmb3.05 million or S$ 650,000 (see Appendix 3).The assets will become part of in-kind investment by BHDTP. An authorized valuator will be appointed to value these fixed assets. STK will participate during the valuation. We might be able to negotiate a discount factor after the evaluation.2.8Valuation of inventoriesThe inventory consists of finished vehicles, components and raw materials.As of September 2002, the Company has 30 finished vehicles in the inventory. BHDTP has built more finished vehicles as inventory in an anticipation of the disruption caused by relocation. There is an estimated Rmb10 million of other inventories.NEWCO will buy over these inventories from BHDTP. First all inventories will be segregated into "Useable" and "non-usable". A "discount factor" will apply on these inventories.2.9Intellectual PropertiesOnly the new products (ie. the articulated vehicle, bulk cement truck and concrete mixer truck) have IP value. It is agreed that the BHDTP will charge US$ 1.0 million as IP, and the sellable prototype as inventory. Total value will not exceed the following amount paid to Timoney and Serviplem:∙Design and development fee to Timoney US$ 800,000∙One time technology transfer fee to Serviplem Euro 310,000 for bulk cement truckand Euro 300,000 for concrete mixertruck.Timoney will receive a 3% royalty fee for all vehicles sold by BHDTP. At the same time, Timoney has an exclusive worldwide right for all BHDTP articulated trucks.For Serviplem Agreements, BHDTP does not need to pay any royalty to Serviplem. There is no restriction for BHDTP selling its cement bulk tankers and concrete mixer to other countries.STK will responsible for all overseas markets except those already given to Timoney.2.9 Board structure and managementBoth STK and BHDTP will have the same number of directorship. Tentatively NEWCO will have a 6 or 8 member board. If and when STK takes up more equity, STK will have board control. STK will hold the Chairmanship of the board.STK will send two expatriate managers (including an executive director) to the company. Under the proposed structure, the GM reports to the executive director. NEWCO will share the expatriate manager expenses in China.3.0Products and market analysisAccording to the data published in 2001 China Auto Yearbook, total number of specialty vehicles in Year 2000 is 130,000 units1. At an average price of S$ 30,000, total market size in Year 2000 was S$3.6 billion. It is estimated total specialty vehicles will be growth at a rate of 15% per annum or 300,000 units by Year 2006, or a market size of S$ 9.0 billion.3.1Product StrategyIn the short term, NEWCO will adopt the following product strategyi.Concentrate on bulk cement tanker and semi-trailer concrete mixer truck as theimmediate twin growth engine.ii.In the first 1-2 years, use conventional dump truck to provide the base load.iii.Position Timoney articulated truck as high margin nicheIn the mid-term (Year 2004/5), NEWCO should plan to introduce other medium volume, good margin specialty trucks. As depicted in Figure 8.0, liquid tanker2, garbage compactor, fire engine, airplane tow-tug are some of the products NEWCO can seek to introduce. For an example, we could discuss with Timoney to transfer its airport fire engine design to NEWCO.Figure 8.0 Relative volume/margin matrix for specialty vehicle1 On-road dump truck 72,000; boxed vehicle 21,718; semi-trailer 3,200; tankers 10,000; Hoisting vehicle 5,600; special construction 3,000; other 12,0002 semi-trailer multi-function liquid tanker with high carrying capacity。