Investment Highlights

• UMW Holdings (UMW) on Friday said it had proposed the following:
  • To acquire the 50.07% stake in MBM Resources (MBM) owned by Med-Bumikar Mara Sdn Bhd and Central Shore Sdn Bhd (CSSB). Med-Bumikar is the single largest shareholder in MBM with a 49.5% stake and CSSB (its wholly-owned unit) holds another 0.57%. UMW intends to privatise MBM with the mandatory take-over triggered. UMW is offering RM501mil or RM2.56/share, which is a 13% premium to the 5-day VWAP to March 6 for MBM shares, valuing MBM at RM1bil. UMW intends to pay for the RM501mil or 50.07% stake with cash, and it has not disclosed how it would pay for the remaining RM499.3mil or 49.93%.
  • To acquire the 10% in Perodua owned by PNB Equity Resource Corp Sdn Bhd (PERC). UMW is offering RM417.5mil or RM29.80/share, valuing Perodua at RM4.2bil. UMW will pay with the RM300mil raised from issuing 49.3mil new shares (at RM6.09: the 5-day VWAP for UMW up to March 6) and RM117.5mil in cash.

• Other salient details:
  • What is the timeline? The offers to Med-Bumikar and PERC are open till the market close on Wednesday, March 28 and UMW can decide to extend it beyond this date. Both parties have 3 months from the date of acceptance to complete the deal, by meeting certain conditions such as the due diligence on the relevant units, getting approval from the required shareholders, and approval from authorities for UMW to list new shares. All parties can mutually agree to extend this to another date.
  • Who gets to vote? In the deal for MBM, we believe: UMW shareholders excluding the EPF, which has a major stake in both UMW (9.19%) and MBM (15.81%); its other major shareholders include PNB and KWAP. MBM shareholders excluding Med-Bumikar and the EPF, its other major shareholders include AIA. MBM will also need approval from key principals (these are the car brands it distributes for and includes Volvo, Volkswagen and Mitsubishi) and the lenders to certain subsidiaries (which have earnings or assets excluding RM0.5mil; and this includes OMI, Federal Auto Holdings and Hirotako). 
    
    In the deal with PERC, we believe: UMW shareholders excluding PNB, which is its largest shareholder.
    
    PERC will also need to get consent from other Perodua shareholders, excluding UMW. These consist of Daihatsu Motor Co (20%), MBM (20%), Daihatsu (Malaysia) Sdn Bhd (5%), Mitsui & Co (4.2%) and Mitsui & Co (APAC) (2.8%).
  • Can UMW afford this? It was last in a net debt position of RM1.6bil with RM1.2bil in cash. It has committed to pay RM619mil in cash for the deal, and acquiring the remaining stake in MBM may necessitate debt, which will raise its gearing from the present 0.52x.
• Why is UMW doing this?
  The ultimate aim is to raise ownership in Perodua from 38% to 70.6%. This will be done by acquiring an additional 22.58% of effective interest in Perodua held by MBM (MBM has a direct stake of 20%, and an additional 2.58% held by its 51.5%-owned Daihatsu (Malaysia) Sdn Bhd, which has a direct stake of 5% in Perodua) and the 10% held by PERC.
  
  Perodua is only one of two home-bred auto manufacturers and the market leader with a 36% share of TIV. Based on its last audited results (2016): Perodua made a revenue of RM9bil and net profit of RM464mil, resulting in a fair net margin of 5%. It sold 205K cars last year on a lean line-up of 4 models, and it is set to release a game-changing SUV by early 2019.
  
  UMW would also be more involved in Perodua's manufacturing and distribution. Oriental Metal Industries (OMI), a whollyowned unit of MBM, supplies alloy wheels for certain variants of the Perodua Axia, Myvi, Bezza and the upcoming SUV. MBM's 51.5%-owned Daihatsu (Malaysia) Sdn Bhd is also a prominent Perodua dealer: it has a total of 17 Perodua sales outlets and 13 service outlets, and last year accounted for 11% of Perodua sales.
• Is this a fair deal?
  • The valuation for Perodua is on the low side. UMW is valuing Perodua at RM4.2bil or RM29.80/share. This would have an implied a PE of 9x on its FY16 EPS (of RM3.31) and 9.2x on our estimated FY17 EPS (of RM3.23). We believe a PE of 12-13x would be more suited given Perodua's calibre and prominent market share. The offer price is a 12% premium to Perodua's last book value of RM26.66.
  • The offer price for MBM is an 11% premium to our FV of RM2.30. We note that UMW is valuing MBM at RM1bil and the 22.58% stake in Perodua at RM942mil. However, it would be incorrect to equate MBM to its stake in Perodua. The focus should be on MBM's core operations: auto distribution and auto parts manufacturing. Its distribution business has seen slow car sales (its sales volume for Volvo, Volkswagen and Mitsubishi has seen double-digit YoY declines for the past 3 years) and miniscule returns (a pre-tax margin of 0.7%), while its auto parts segment is working to halt losses by building the production volume for its alloy wheel unit.
• What are the gains?
  
  UMW would have Perodua as a subsidiary. It would be entitled to a bigger stake in the earnings of Perodua and have some ownership in the key parts of its operations: the supply of certain car parts (made by MBM), the production of Perodua cars and its distribution to customers (by DMSB).
  
  We are moderate on the prospects for Perodua. The company worked hard to sell a monumental 205K units last year (a 1% YoY drop, similar to TIV) but margins have come off slightly. Volume growth is increasingly difficult to sustain and we believe Perodua is cognizant of this. It expects to sell 2% more cars this year after factoring in the new Myvi, and early indications show that the upcoming SUV will serve to defend margins rather than boost volume.
  
  The bigger question is what UMW can do with more control of Perodua. The blue-sky scenario would be for Perodua to allocate most of its orders for wheels to MBM, for the latter to find sufficient volume to make a profit in its alloy wheel unit.
  
  We caution that the execution would not be so simple. MBM has resolved to build its alloy wheel production volume on a slow-and-steady basis. This is to avoid its past mistake of ramping up volume without having addressed the operational issues that led to sub-optimal product quality. We also note that there could be a limit in the orders from Perodua considering its shift to a dual-sourcing policy for big volume models. This is done to minimize the impact from a disruption in one supplier.
  
  There is little synergy to be found elsewhere. We believe UMW does not have much to offer to improve MBM's auto distribution. UMW had resolved to exit the distribution side for Toyota entirely from January this year, choosing to focus on manufacturing instead. In terms of the benefit to Toyota, it could start sourcing parts that MBM manufactures (OMI makes wheels, and Hirotako makes safety, noise and heat products) if there is a distinct price or quality advantage.
  
  There would be more concern for cannibalisation between Toyota and Perodua. The key distinction today is price: Perodua trades at a cheaper range (the Axia, Myvi and Bezza sell from RM24K to RM75K) than Toyota (the Vios, Hilux and Innova — which together accounted for 70% of Toyota sales here in 2017 — sell from RM75K to RM110K). We believe it would be a challenge for Perodua to build value if it is constrained to selling cars within a lower price range.
• We deem the deal to be positive for UMW as it is taking up a bigger stake in Perodua at a low price. The flipside to this is taking on the task of turning around MBM's loss-making alloy wheel unit and finding more synergy within the core operations of the two groups.
• The deal should be similarly positive for MBM given that it will be owned by Perodua's largest stakeholder, but we caution that the alloy wheel unit would still take time to build volume towards becoming profitable.

• We retain our FV projections for UMW (FV: RM5.50) and MBM (FV: RM2.30) given the gestation period to completion, and pending more details on funding and where the two can find synergy beyond Perodua.

Source: AmInvest Research - 12 Mar 2018