• DRB-Hicom on Wednesday announced it had signed an agreement for China’s Geely Automobile Holdings Ltd to take up 49.9% of Proton Holdings Bhd. The main details are: (1) Geely will take up 49.9% of Proton Holdings. Proton has full ownership of the distribution and production & manufacturing sides.

Execution of a definitive agreement is targeted for mid-July. This will detail the final price for the stake in Proton.

The payment by Geely will comprise a cash injection of RM170mil and the injection of an SUV platform worth between RM550mil andRM1bil. DRB-Hicom is in the process of valuing the latter. Given the estimates provided for the “in-kind injection”, Proton would be valued at between RM1.4bil and RM2.3bil (for which Geely would pay between RM720mil and RM1.2bil for the 49.9% stake, respectively).

Geely made the shrewd choice to make this an auto-related acquisition only. DRB-Hicom will exclude non-auto assets and park them under the group. These consist of land bank (marked for development) worth RM400mil and holdings in associates and subsidiaries valued at RM140mil. (2) DRB-Hicom will sell its entire stake in Lotus for £100mil (51% to Geely, 49% to Tan Sri Syed Mokthar-linked Etika Automotive). DRB-Hicom said Lotus has suffered continuing losses and requires further capital towards being profitable, and that the group needs to focus on reforming Proton. Management noted that it had clearly put up Proton and Lotus as separate units in finding suitors for the two (they were not marketed as a single package)

• We understand the main goals from the tie-up to be:

(1) Raising the production volume in Proton by regaining market share in Malaysia and exporting to right hand-drive markets in Southeast Asia.

Proton will leverage Geely’s strength to produce cars that are more competitive in terms of technology and cost. Proton will also lean on Geely to find vendors who can offer the best prices, but it has given its own vendor network a grace period of 1 year during which things will remain status quo.

To establish Malaysia as a manufacturing base for Proton cars to be sold in right hand-drive markets in Southeast Asia. The group has set the target of becoming Malaysia’s dominant carmaker and one of the top three in ASEAN. It did not set a timeline for this.

(2) To share the cost of reforming Proton. DRB-Hicom said it had invested a total of RM4billion into Proton but sales had floundered as Proton failed to keep up with technology. Proton may require significant capital towards becoming profitable and towards this end, it was emphasised that Geely had invested US$11 bill towards turning around Volvo after acquiring it in 2010.

• We note that the above are in line with the key objectives that Proton had sought from joining forces with an FSP. Recall that these are: (1) A significant boost in production volume, Proton is currently utilising only 35% of the total capacity of its two production plants (total capacity: 355K units/year; Shah Alam: 195K, Tanjung Malim: 160K); (2) To close the technology gap with its rivals; (3) To share development costs.

• We believe a return to the black for Proton will still be years in the making. Its priority will be to produce cars that can sell in large numbers in both the domestic and regional markets. DRB-Hicom has hinted that the first development from the tie-up could be an SUV.

• This would see Proton using the platform for Geely’s top model, the Boyeu SUV (which was designed by former Volvo designer Peter Horbury, and comes in 1.8L and 2.4L variants). The Boyeu’s impressive technological features include compatibility with Apple Car Play and Android Auto systems, warnings for lane departure and adaptive cruise control (ACC), which aligns the Boyeu’s speed on highways to the vehicle in front of it.

• We believe the immediate goal for Proton, based on the information that has been articulated at this stage, would be to produce an SUV that can win on cost, looks and features. The SUV segment offers strong growth potential. Neither of the national carmakers (Proton and Perodua) has produced an SUV. However, we note that Proton is believed to have planned for a rebadged Suzuki Vitara (a compact SUV) for next year, while Perodua can similarly rely on its partner Toyota to fasttrack its way towards a locally-built SUV.

• We believe DRB-Hicom recognises that the recovery plan for Proton is a long-term one, and that it will need to set tangible milestones for this purpose. The group said it will formulate a 10-year plan with Geely for Proton, and this would cover future models, capex, and manufacturing and sales volumes. While the signing of an FSP ahead of the end-June deadline is positive, we await greater clarity on the first steps towards reforming Proton. We maintain a HOLD on DRB-Hicom with a higher fair value of RM1.60, after reducing the discount to our SOP value of RM3.10/share to 50% from 60%.

Source: AmInvest Research - 25 May 2017