Management held a briefing to address the legal proceedings against the vendors of Aspion. Of the RM715m, (i) RM74m pertains to overstatement of assets; whilst (ii) RM641m relates to the “overpaid price” arising from an adjusted expected PAT pegged to 16.93x (acquisition multiple). We adjust our FY19-20 earnings downwards by 7.5%-9.5% as we factor in lower profit expectations from Aspion. Our TP decreases to RM9.92 (from RM10.81). We maintain our HOLD call.

We attended the analyst briefing post the acrimonious announcement regarding the legal suit against the vendors of Aspion. The following are the key takeaways:

The claims breakdown. Upon further clarification it was established that during the acquisition process, the due diligence was carried out via a virtual data room (VDR). It was later discovered by Top Glove that the information revealed by the vendors pertaining to inventories (non-existent, obsolete stocks and over-valuation) and PPE (non-operational, decommissioned or non-existent) left much to be desired upon assuming control of the entity. As such, the acquisition price was overvalued based on the incorrect information given. Of the RM715m, (i) RM74m pertains to overstatement of assets; whilst (ii) RM641m relates to the “overpaid price” arising from an adjusted expected PAT pegged to 16.93x (acquisition multiple).

Impairments. We understand that should the need for impairment on the acquisition arise, it would be decided after the purchase price allocation of goodwill and intangibles, which is expected to take place within the next FYE.

Continuity. Management gave the assurance that the technology (Finessis) and existing business are still intact. Top Glove has since dismissed Mr Low Chin Guan and has taken the onus to manage Aspion moving forward. We understand that subsequently, the profit guarantee is void moving forward. The group is confident that there will be no disruptions in the day to day operations of Aspion.

Impact to earnings. Management are of the view that Aspion will take 3-4 years under Top Glove to reach the profit guarantee levels (RM80-110m). Assuming we strip out the profit guarantee amount from our FY19-20 earnings, our forecast would decrease by 14-18%. It is imperative to note that Aspion is a profitable entity and based on guidance, Aspion’s realistic PAT is c.RM40-55m for FY19-20.

Impact to gearing. All in all, this has been a costly exercise for the group. Top Glove’s net gearing increased to 0.72x (9MFY18) from net cash (pre-acquisition) position. Assuming that the group can claw back the RM715m (although we do expect this to be a lengthy legal process), we can expect net gearing to decrease to 0.4x.

Forecast. We adjust our FY19-20 earnings downwards by 7.5%-9.5% as we factor in lower profit expectations from Aspion into our model.

Maintain HOLD, TP: RM9.92. Our TP which is pegged to PE multiple to 25x of CY19 earnings decreases to RM9.92 (from RM10.81). We maintain our HOLD call.

Source: Hong Leong Investment Bank Research - 10 Jul 2018