After finding out more about how RAM fits into its overall business plan, we are now convinced with the strategic acquisition. Furthermore, it will be accretive in nature. Our forecasts were unchanged, pending completion of the deal. We still like CTOS for its market leadership, strong economic moat, and highly scalable business model. Thus, we view the recent price pullback as a good opportunity to accumulate the stock. Maintain BUY call but with a lower FCFF-TP of RM1.70 (from RM1.95), based on an implied 45x FY23 P/E.

CTOS Held a Briefing to Share More on the Acquisition Plans for RAM Holdings.

Acquisition rationale. RAM is a bond ratings leader with a c.65% market share. With this, CTOS looks to leverage on RAM’s leadership to penetrate into new addressable markets, particularly in the space of smaller bond issuances and high yields, targeting the under-tapped SME segment. CTOS has identified there are 8.5k local companies with yearly revenue of RM50-500m p.a., which it could potentially serve through RAM. Also, there is opportunity to tap into RAM’s large corporate customer pool to cross sell data and digital solutions. Besides, management finds that RAM still has a lot of room to grow in the area of non-credit rating offerings, like market intelligence and analytics. Lastly, RAM enhances CTOS’ positioning as an expert in credit assessment.

Deal structure. To-date, CTOS has purchased a 19.2% stake in RAM for RM49.6m, implying a blended equity valuation of RM258.2m. Going forward, management plans to make a general offer to the remaining shareholders of RAM, with it being valued at RM280-300m (20.0-21.5x FY22 P/E; based on RM14m average earnings guidance); preliminary feedback suggests that CTOS may end up with 55-60% stake. In addition, Creador has committed to divest its 19.9% shareholding in RAM at a 10% discount vs final general offer price, in order to maintain investors’ confidence, since it is a related party transaction. Besides, there is no intention to raise new equity capital and this will be funded via RM100-120m borrowings (for 36-41% stake). In turn, gearing level may only nudge up by 4ppt to 39%, according to CTOS. With the above information along with a 4% debt cost assumption, we calculated RAM will be an accretive acquisition. On top of that, we understand RAM has capacity to dish out special dividends since it could monetize investment properties worth RM67m and has cash equivalent coffers of RM131m. If materialize, it will help CTOS to offset some of its acquisition cost.

New management targets. For FY23, CTOS is now looking at revenue to come in at RM275-290m, EBITDA at RM124-131m, and core PATAMI of RM95-100m (includes RAM’s contribution). For FY22, there were no changes with revenue target of RM185- 195m, EBITDA of RM85-92m, and core PATAMI of RM75-80m.

Forecasts. Unchanged, pending completion of the deal.

Maintain BUY call but with a lower FCFF-TP of RM1.70 (from RM1.95), based on an implied 45x FY23 P/E (from 52x) with the assumptions of 7.9% WACC (from 7.6% to reflect higher risk free rate) and 5.0% TG. This is above the global peers’ average (GPA) of 20x and their 5-year mean of 28x. The premium is warranted given its bright outlook and more robust earnings growth profile (4ppt higher vs GPA), backed by the under penetrated ASEAN market. After finding out more about how RAM fits into its overall business plan, we are now convinced with the strategic acquisition. Moreover, CTOS shared that they will hold off further business purchases for the next 1-2 years and will instead focus on assimilating recent acquisitions. Thus, we still like CTOS for its market leadership, strong economic moat, and highly scalable business model. We view the recent share price pullback as a good opportunity to accumulate the stock.

Source: Hong Leong Investment Bank Research - 22 Jun 2022