• May look to dispose parts of MBM if acquisition successful

• Standing firm with offer price, opportunity to exit value-trap for MBM’s minorities

• Earnings accretive for UMW provided valuation gap between acquirer vs. acquiree remains

• Re-affirm BUY at unchanged TP of RM7.11

We attended UMW’s briefing yesterday. Below are the key takeaways:

May look to dispose parts of MBM. UMW does not rule out disposing parts of MBM’s businesses if its acquisition of the latter is successful. However, this is mainly to avoid conflict of interests particularly in the distribution/dealership units (vs. the current UMW stable), rather than engaging in a corporate raider-style buy-and-break up strategy, we think. In fact, we would not be surprised if an offer is made to sell back parts of MBM to members of MBM’s current major shareholder.

Perodua will remain equity-accounted. At this point, it is likely that UMW will not consolidate Perodua, even if it reaches 70.6% ownership. UMW and other shareholders are bound by the original Perodua shareholders agreement, which gives equal rights to the Japanese partners (i.e. Daihatsu Motor/Mitsui), which means Perodua will likely remain equity accounted in UMW’s books. Furthermore, the Japanese parties are in control of Perodua manufacturing while the Malaysian partners are in control of sales and distribution (See Exhibit 9). UMW will attempt to request for consolidation, but this requires undoing Perodua’s original shareholders agreement and coming out with a new one, which we suspect could be a lengthy and complex process as this would involve ownership of critical technologies and years of process improvements that have been put in place at Perodua.

Standing firm with offer price. UMW does not intend to budge on its offer price, even if a 3rd party comes in with a better offer, or at least this is what management is trying to sound out. UMW has an advantage given that: (1) It is an existing partner in Perodua, which would have the first right of refusal if a 3rd party offers to buy out a stake in Perodua from any of the existing shareholders (2) A 3rd party acquisition is not entirely a straightforward process as existing Japanese partners in Perodua also has to agree if a new shareholder is to come into Perodua given the eventual business partnership (3) There is actually a scarcity of buyers given that this involves a stake in the national carmaker which is of strategic importance to the nation; a potential buyer requires the necessary “political clout” and “financial clout”. Having said that, this is a business transaction and naturally UMW will not put out the highest offer the first round neither would it divulge its intention to raise offers.

• May look to dispose parts of MBM if acquisition successful

• Standing firm with offer price, opportunity to exit value-trap for MBM’s minorities

• Earnings accretive for UMW provided valuation gap between acquirer vs. acquiree remains

• Re-affirm BUY at unchanged TP of RM7.11

We attended UMW’s briefing yesterday. Below are the key takeaways:

May look to dispose parts of MBM. UMW does not rule out disposing parts of MBM’s businesses if its acquisition of the latter is successful. However, this is mainly to avoid conflict of interests particularly in the distribution/dealership units (vs. the current UMW stable), rather than engaging in a corporate raider-style buy-and-break up strategy, we think. In fact, we would not be surprised if an offer is made to sell back parts of MBM to members of MBM’s current major shareholder.

Perodua will remain equity-accounted. At this point, it is likely that UMW will not consolidate Perodua, even if it reaches 70.6% ownership. UMW and other shareholders are bound by the original Perodua shareholders agreement, which gives equal rights to the Japanese partners (i.e. Daihatsu Motor/Mitsui), which means Perodua will likely remain equity accounted in UMW’s books. Furthermore, the Japanese parties are in control of Perodua manufacturing while the Malaysian partners are in control of sales and distribution (See Exhibit 9). UMW will attempt to request for consolidation, but this requires undoing Perodua’s original shareholders agreement and coming out with a new one, which we suspect could be a lengthy and complex process as this would involve ownership of critical technologies and years of process improvements that have been put in place at Perodua.

Standing firm with offer price. UMW does not intend to budge on its offer price, even if a 3rd party comes in with a better offer, or at least this is what management is trying to sound out. UMW has an advantage given that: (1) It is an existing partner in Perodua, which would have the first right of refusal if a 3rd party offers to buy out a stake in Perodua from any of the existing shareholders (2) A 3rd party acquisition is not entirely a straightforward process as existing Japanese partners in Perodua also has to agree if a new shareholder is to come into Perodua given the eventual business partnership (3) There is actually a scarcity of buyers given that this involves a stake in the national carmaker which is of strategic importance to the nation; a potential buyer requires the necessary “political clout” and “financial clout”. Having said that, this is a business transaction and naturally UMW will not put out the highest offer the first round neither would it divulge its intention to raise offers.

Timeline. Medbumikar has until 28th March to accept UMW’s offer. After that, the group will proceed with due diligence and an EGM for shareholders to approve the transaction. This is expected to take another 3 months to complete. Assuming all goes smoothly, the exercise is expected to essentially complete around mid-year.

How we think MBM’s shareholders will reason out. From Medbumikar’s perspective, there are actually not many suitors to takeout its stake in MBM lock-stock-and-barrel, which would be its only option out. As explained in above paragraphs there is actually a scarcity of buyers given that this involves a stake in the national carmaker which is of strategic importance to the nation; a potential buyer requires the necessary “political clout” and “financial clout”. Secondly, if there is unresolved disagreements within Medbumikar (considering sudden departures of management and board members in the past 12-16 months), this is the opportunity for the members to liquidate Medbumikar’s position in MBM and gives the opportunity for existing Medbumikar shareholders to buy directly into a listed vehicle. Moreover, Medbumikar was one of the original shareholders in Perodua; with Perodua having paid historical 50% payout as dividends in the past, these shareholders would have well broken even on their initial investment, we think. For UMW, the intention is to privatise MBM and the MGO (assuming Medbumikar accepts UMW’s offer) will only trigger a compulsory offer if acceptance crosses 90%. However if acceptance is less than 90% but free float is less than the minimum 25% under listing requirements, MBM will still be delisted.

Opportunity to exit a value trap - cash or shares? For MBM’s minorities, this is an opportunity to exit a value trap. For the MBM minorities which will get two options i.e. cash or share swap - a share swap deal will value UMW’s shares at RM6.09/share. If UMW’s market price is lower than this, it makes sense for MBM’s minorities to buy directly into UMW at a cheaper entry price and eventually accept the cash offer for their MBM shares (at a fixed offer of RM2.56/share). Even if MBM’s minorities accept the share swap deal, they will still be exposed to UMW’s rights issue to finance the acquisition of Medbumikar’s 50.07% stake in MBM.

Whichever way, its earnings accretive for UMW. Despite embarking on a fully new share-funded acquisition, earnings expansion from the acquisitions will more than offset any dilution from potential new share issuance to fund the acquisitions. Our sensitivity analysis suggests in a worst case, full cash payment scenario, UMW still attains earnings accretion of 4% (FY19F), whereas in a best case, full shares scenario, net earnings accretion rises to 6% (FY19F). This situation is possible given the large valuation gap between UMW (14x FY19F PE) vs. the offer for MBM

at just 8x FY19F PE. This situation is possible given the large deviation in valuation between UMW (14x FY19F PE) vs. the offer for MBM at just 8x FY19F PE. However, if UMW has to offer a significantly higher price for MBM, a fully new share-funded acquisition of MBM may not be earnings accretive anymore, in our opinion, given the narrower valuation gap between the acquirer vs acquiree. This is unless the discount given for its rights issue is also reduced in tandem, or otherwise, UMW would have to resort to part debt-funding for the acquisition. UMW’s bankers argue that it is actually valuing MBM’s non-Perodua businesses at RM57m equity value and EV of RM148m. This compares to our valuation of MBM’s non-Perodua businesses at RM115m. Regardless, even at UMW’s banker’s valuation, the implied valuation for UMW’s 22.6% stake in Perodua is around 8.5x forward FY19F PE, and gives UMW an effective 6% dividend yield (FY19F) assuming Perodua maintains a 50% payout.

Recommendation. Re-affirm BUY on UMW (TP: RM7.11/share) as this would be a good deal if it is successful given UMW’s potentially cheap entry into MBM at just 8x FY19F earnings and effective 6%-7% dividend yields attained from Perodua at the entry price. Our SOP and forecasts factor in strictly, only the 10% Perodua stake acquisition from PNB Equity Resource as this is the only firm deal at this point. There is further significant upside if Medbumikar accepts the offer and UMW proceeds with its takeover of MBM.

Source: MIDF Research - 20 Mar 2018