Value Investing

Understanding StarHub’s True Equity

We have covered this before, but this is a simpler and much clearer explanation of how merging accounting can distort equity values. As a backdrop, StarHub’s Group equity is about one-tenth of its Company equity. This gives rise to its >200% return on equity figure which does not allow for meaningful analysis.

Effects of Merger Accounting

Consider the following scenario (pay attention to the equity figures):

There are 2 entities prior to acquisition:

Starhub 1

StarHub acquires SCV for 100 cash. After acquisition, the balance sheet for the respective entities will be:

Starhub 2

If you need a detailed breakdown, the above is attributable to the following entries:

Starhub 3

Starhub 4

It is important to note that the equity of StarHub Group is not the sum of StarHub Company’s and SCV’s equity. There is also  significant goodwill booked due to the negative equity of SCV.

After the goodwill write-off, the revised balance sheets will be as such:

Starhub 5

StarHub Group’s equity has been significantly reduced below that of StarHub Company’s. However, logic dictates that the amount of equity contributed by the shareholders of StarHub Company should remain unchanged (at 100), regardless of the equity level of the acquired company. The equity level of the acquired company determines the goodwill incurred which leads to the write-off, deflating StarHub Group equity. Therefore, one should look at the StarHub Company equity as a true representation of equity contribution by shareholders.

Finding the True Equity Value

We have established that the equity contribution by shareholders should remain the same prior-to and after an acquisition. However, equity holders are entitled to the profits/losses of the acquired company after the acquisition. On a rolling basis, the true equity can be determined by taking the initial StarHub Company equity and accounting for StarHub Group profits and dividends paid.

In StarHub’s case, we start with the company equity at 2003 and arrive at an equity of SGD1,250.6mn in 2014. This corresponds to a c.30% return on equity which is in line with M1’s.

Starhub 6