We are downgrading our call on Top Glove (TOPG) to HOLD from BUY, as we lower our TP to RM12.00, on the back of a 1.6%-7.7% earnings cut for FY18-20E. The cut is to reflect the weaker contribution from Aspion, as we now believe it would be challenging for Aspion to grow its net profit to RM108m organically by FY20E. TOPG has initiated the arbitration process against Adventa Capital (vendor of Aspion) for a claim of no less than RM715m, as TOPG believes that the fraudulent misrepresentations made by Adventa has caused them to overpay for the acquisition.

Overpaying for Aspion Due to Fraudulent Misrepresentations

Based on our understanding, the litigation was initiated by Top Glove believing that they had overpaid for Aspion by around RM715m (out of RM1.37b) due to fraudulent misrepresentations by the vendor, Adventa Capital. Limited details were provided as the case is undergoing arbitration. TOPG has reassured us that Aspion is still a sound business nevertheless. Aspion’s profit contribution (ex-finance cost) to TOPG was around RM7m in 3QFY18. TOPG could transfer Aspion surgical glove technology to its existing plant to improve its margin and recoup some of the cost.

The Deal Is Likely to be Dilutive But Not Significant

Based on the revised consideration and assumed that the valuation for Aspion remains unchanged, we estimated that the Aspion could achieve net profit of around RM39m and RM52m for FY18E and FY19E. Unless the claim is successful, the Aspion acquisition will be dilutive (~1%) to current shareholders in the near term. Although TOPG can fall back to the current profit guarantee, it is likely that TOPG would still need to impair some of the goodwill (RM1.1b) related to the acquisition.

Downgrade to HOLD With a Lower TP at RM12.00

We are downgrading Top Glove to HOLD, as we lower our TP to RM12.00 based on unchanged 27x CY19E PER (+2SD), as we cut our earnings by 1.6%-7.7% for FY18-20E to better reflect the profitability of Aspion. Despite the cut in earnings, we believe that the fundamentals of Top Glove remain unchanged, as bulk of its earnings is not dependent on Aspion. Risk to our call would be sharp movement of the Ringgit, and changes in investor perception on management execution capability.

Source: Affin Hwang Research - 9 Jul 2018