Highlights

Convertible to ordinary shares… Barakah-LA is a 5 years redeemable convertible unsecured loans stock (RCULS). Each RCULS holders shall have the right to convert RCULS into fully paid-up new ordinary shares in Barakah at par after the 1st anniversary of the issue date (which is on 25 October 2014) of the RCULS until maturity date (on 25 October 2018). The RCULS bear a 3.5% coupon rate per annum with semiannual payment. The RCULS also come with an option to redeem by the company at par-value of RM0.20 per share.

Mispricing from the market creates buying opportunity… 1) Zero cost conversion: Each Barakah-LA can be converted into Barakah shares after 25 Oct 2014 with zero cost by surrendering one RCULS of nominal value of RM0.20 each for every one new Barakah shares. This suggests Barakah-LA is currently trading at 18% discount to Barakah shares. We deemed the discount is too big to be justified as i) investors perceive that additional RM0.20 per share is required for conversion; and ii) short waiting period (around 10 months) to convert to Barakah shares (we used 10% discount instead). 2) Almost zero possibility to redeem at par value of RM0.20: We think it is almost zero possibility for the company to redeem Barakah-LA at RM0.20 per share due to: i) the main purpose for issuing RCULS is to refinancing debts for purchasing of pipe-laying barge; ii) major shareholders of company (lead by Nik Hamdan and Azman Shah have sizeable stake in Barakah-LA (>40% of total issued, very highly unlikely they will approve any redemption proposal); and iii) recent purchase of Barakah-LA by management on open market at RM1.16-1.20 reaffirms our thesis that Barakah-LA is a cheaper proxy to leverage on the company growth prospect.

Cheaper proxy and better leverage with upside potential of 23% to 58%... Given 10% discount (instead of 18% currently) and average consensus target price for Barakah at RM1.85, the fair value for Barakah-LA should be RM1.65 (23% upside). Recently, market is talking about the company is close to secure T&I jobs in Middle East. We understand that this 5 years contract could worth over US$1bn. If the company win the job, with assumption of net margin at 10% and 50% stake, we estimate that it will boost the consensus target price for Barakah to RM2.35. With 10% discount applied, fair value for Barakah-LA will hit RM2.11 (58% upside). For investors who are willing to hold until conversion date (on 25 Oct 2014), the discount should become zero and will boost fair value for Barakah-La to RM1.83-RM2.35 (37% to 75% upside).

How about downside risk? Assume Barakah fail to secure any new contract with only 10x target PER (fall from 14x due to disappointment) and 10% discount applied, Barakah-LA fair value will be RM1.18 (~12% downside, inline with management recent’s purchase at RM1.16-1.20).

Valuation

With upside potential of 23% to 58% and downside risk of 12%, the risk and reward for Barakah-LA at this level is attractive and favorable. It is also cheaper proxy for investors who are looking to build a long-term position in Barakah shares with better leverage on the upside potential.

Source: Hong Leong Investment Bank Research - 9 Jan 2014