Hankore

UOBKayhian on 11 June 2014

VALUATION

• Downgrade to SELL with a target price of S$0.74. We derive our target price by scribing a 80% probability for the CEI deal to go through (eventual fair value of S$0.63) and a 20% probability that Hankore will remain as it is (fair value of S$1.18). We appraise the two scenarios by discounting the profits generated from its engineering, procurement and construction (EPC) and wastewater treatment businesses over the period of its concession (WACC: 8.3%).

WHAT’S NEW

• Hankore announced it has entered into a conditional sale and purchase agreement with China Everbright Water Holdings Ltd, a wholly-owned subsidiary of China Everbright International Ltd (CEI), to acquire the entire China Everbright Water Investments Ltd for approximately S$1.2b, which will be satisfied by way of an allotment and issue of 1.9b new shares. Upon completion, CEI will own 78% of the company, which will be re-named China Everbright Water Ltd.
• According to management, the transaction will significantly increase the scale of the company’s operations and make it one of the largest water treatment companies in China, enhance the financial strength of the company and allow the company to leverage on CEI’s access to a larger pool of debt capital at lower cost.

OUR VIEW

• While we do not doubt that the transaction will propel Hankore to be one of the top water players in the China, we are puzzled by the structure of the deal. As the new shares will be allotted at S$0.703 each (post 10-1 consolidation) to CEI, being the 90-day VWAP Price before the date of the first announcement, this will cause a significant dilution to current shareholders. Valuation of Hankore will thus become very demanding with the combined entity trading at 33x FY14F PE and 3.1x FY14F P/B, vs peers’ average of 25.6x and 2.7x respectively.
• We had expected the deal to be transacted at CEI’s book valuation of S$275m as the new shares is already priced at an 8% discount to Hankore’s book of S$0.76, but instead it was transacted at S$1.21b, slightly higher than the S$1.1b-1.2b appraised by American Appraisal and Grant Sherman.
• Even at the best-case scenario as the company gears itself up from 0.3x net gearing to 0.5x net gearing for acquisition, the eventual fair value of the combined entity will only increase from S$0.63 to about S$0.79, taking into account the larger share base.