Although Empire is unlikely to be liquidated, GENM is paying a hefty price for the RPT acquisition which saw its market cap plunging RM3.2b as the proposal raised corporate governance issue due to the financial difficulty faced by the loss-making Empire. In addition, the proposed acquisition is not merely on equity stake but involves capital injection for debt restructuring. As such, this RPT will suppress stock sentiment further. Thus, we cut the stock to MP with revised TP of RM3.20.

Empire unlikely to be liquidated. Yesterday, responding to a query on Bursa Malaysia, GENM believed with (i) its proposed Empire Resorts Inc (Empire) shares acquisition from Kien Huat Reality III Ltd (KH) and (ii) a proposed 51:49 JV between KH and GENM to privatise Empire, the loss-making Empire should be able to resolve its present liquidity challenges. To recap, Empire announced to the United States Securities and Exchange Commission last Friday that if such measures, including the KH-GENM’s bid to take it private, are unsuccessful, it may pursue a voluntary Chapter 11 bankruptcy proceeding on the Catskills casino.

A costly acquisition. Share price of GENM has contracted 15% or RM3.2b in market cap since the announcement of this proposed acquisition ten days ago. Under the deal, GENM will pay KH USD128.6m or c.RM538.8m for 13.2m Empire shares at USD9.74/share. And, eventually, the KH-GENM JV will need to pay c.USD53.6m to take Empire private. In all, this deal is viewed as vital to Empire which needs fresh capital injection to restructure its borrowings given its poor cash flow generating ability being loss-making for the past 20 years. The latest 1H19 results showed a net loss of USD73.7m against FY18 net loss of USD155.4m and it has a total payment commitment of USD112.0m over the next 12 months or USD827.0m over the next five years. Therefore, GENM’s commitment is not capped at only cRM538.8m.

RM1.69b to own 49% stake in Empire eventually? In the filling, Empire’s biggest outstanding debt is the USD520 Building Term Loans for the development of Resort World Catskills which commenced operations in Feb 2018. As of 2Q19, the Term Loans have outstanding of USD504.7m or USD688.5m payment commitment including interest payments over the next five years. Assuming GENM has to bear 49% of this term loans, it may need to inject USD247m or RM1.04b for the debt restructuring. Together with USD128.6m initial acquisition cost, USD26.3m or RM110.3m (49% of USD53.6m) privatisation cost, total capital outlay for this acquisition could eventually hit RM1.69b. We see it has no problem of financing this acquisition given its cash position of RM5.56b as at 1Q19. However, the negative earnings impact in the near term could be significant as the 49% stake in USD155.4m net loss, which accounts to RM320m is 17% of GENM’s FY18 core earnings.

Negative in the near term; cut to MP. Although its share price has plunged 15% since the acquisition, valuation of GENM is still not attractive enough. In fact, the retracement has fairly reflected the earnings risk coupled with corporate governance issue. For now, we keep our estimates unchanged. But, we decided to remove the RM1.69b potential cost of this acquisition from our valuation matrix and tag a 20% discount for earnings and corporate governance risks. This reduced our target price to RM3.20 from RM4.30. Correspondingly, we downgrade the stock to MARKET PERFORM from OUTPERFORM. Risks to our downgrading include extreme good luck factor and business volume.

Source: Kenanga Research - 16 Aug 2019