HSS has proposed a 1-for-10 rights issue of new shares to raise up to RM31.9m with issuance of bonus issue shares at 1-for-2 rights shares and free warrants at 3-for-2 rights shares subscribed. HSS has also proposed a private placement of new shares to raise up to RM52.3m. The equity issuance is to part finance the acquisition of SMHB Engineering for RM270m, which was highlighted in our previous report (2 October 2017: Attractive Acquisition). We recommend subscribing for the rights issue as EPS will be enhanced by 53% (based on the maximum case scenario) post-acquisition and existing shareholders will be entitled the issuance of bonus shares and free warrants. BUY with TP of RM1.34.

SMHB Purchase Settlement Structure

The SMHB purchase consideration (RM270m) will be funded by bank borrowings at 6% interest rate (RM81m), a private placement and a rights issue (RM81m) and the issuance of new HSS ordinary shares at RM1.14/share (RM108m) to the vendors of SMHB. For the RM81m cash settlement, effectively, every 20 existing shares held by shareholders are entitled to 2 rights issue shares with 1 bonus shares and 3 free warrants. The rights issue is sweetened with free bonus and warrants where only existing shareholders are entitled, and not for private placement subscribers.

Maximum Enlarged Share Capital Increase

Based on maximum scenario, the total enlarged share capital will increase to 514m shares (+61%) pre-warrants conversions, mainly from the additional new shares issued to vendor (95m), private placement (52m), rights issue (32m) and bonus issue (16m) representing 30%, 16%, 10% and 5% of HSS’ existing share capital of 319m shares respectively. With warrants conversion, the enlarged capital will grow to 562m.

Post-acquisition Profit and Order Book Expansion

On a proforma basis, HSS’ FY16 net profit increases by 71% to RM38m, after excluding investment income for SMHB (RM4m) and interest expense (RM5m) on RM85m of new bank borrowings to part finance the acquisition. This also excludes the corporate exercise expenses of RM7m. Its combined order book would increase by 85% to RM738m post-acquisition. HSS’ net profit margin will likely to be enhanced, given SMHB’s higher net profit margin of 28% compared to HSS’ 10% in the latest audited financial figures.

Earnings-accretive Acquisition

We believe the acquisition will be earnings-accretive. Based on the maximumcase share issuance scenario and indicative prices of RM1.00 for the rights issue and private placement and RM1.63 exercise price for warrants, HSS’ EPS would be enhanced by 53% post-acquisition. Net gearing will increase to 0.16x from an existing net cash position. We maintain our BUY call.

Source: Affin Hwang Research - 30 Oct 2017