Maintain  BUY,  with  a  higher  MYR3.52  FV  (from  MYR3.12).  Three  re rating  catalysts  driving  our  upgrade  are:  i)  greater  commitment  from management  after  the  recent  9.9%  acquisition  at  MYR2.90/share,  ii) acceleration of the  Penang State Government’s endorsement of STP2’s masterplan,  and  iii) transacted price for Eco Macalister land bumps up our RNAV, with our new land value assumption at MYR400 psf for STP2.

• FV  rises  to  MYR3.52.  Eastern  &  Oriental  (E&O)  has  charted  a  much greater  milestone  compared  with  17  months  ago,  when  we  initiated coverage on the stock  and its  share price was MYR1.57 on 3 Jan  2013. We now  raise  our  FV  to  MYR3.52  (from  MYR3.12),  largely  due  to  our new  land  value  assumption  for  the  760-acre  Seri  Tanjung  Pinang  2 (STP2) project. Maintain BUY.
• MYR2.90 is a floor  price.  Speculation has fuelled  the market, on top of scepticism  over  E&O  MD  Dato’  Terry  Tham  buying  110m  shares  at MYR2.90 each from Sime Darby  (SIME MK, NEUTRAL, FV: MYR10.40) on 28 May.  After our discussion with its deputy MD,  Eric Chan, we view the transaction positively. The 9.9% stake,  acquired at  a  22% premium to the closing price on 28 May by Dato’ Terry  Tham,  should indicate his greater  commitment  to  the  company  over  the  longer  term.  More importantly, this signals the minimum price that he is willing to pay for the company (as  buying 110m shares from the open market, although at a lower  price,  will  require  the  declaration  of  shareholding  interest),  and MYR2.90  plus  a  premium  will  be  the  price  that  he  and  other shareholders would accept if there is a future takeover offer.
• Imminent  state  endorsement  for  STP2.  The  acquisition  of  a  9.9% stake could also have  an  important implication for  the STP2 project, as the Penang State  Government may now draw greater  comfort  given the higher  shareholding  held  by  the  MD.  The  endorsement  by  the  state government  could  be  accelerated,  considering  also  that  the  two  by elections in Bukit Gelugor and Teluk Intan have just concluded recently.
• Eco Macalister  land price a new benchmark.  The transaction of Eco Macalister land by Eco World (ECW MK, NR) is a good benchmark for land valuations on Penang  Island. The 1.1-acre land in Georgetown  will be  injected  into  Eco World  at  MYR1,002  psf.  We,  therefore,  raise  our land value assumption for STP2 to MYR400 psf from MYR360 psf. Our new  assumption  is  still  conservative  –  at  a  60%  discount  to  the  latest transacted price.

Further Share Price Catalysts

Management buy-in a strong showing of commitment
After meeting  up with Mr Eric Chan, E&O’s deputy MD, we now view the 9.9% stake acquisition by Dato’ Terry Tham  from Sime  Darby in a positive light. The reason why the  market  has  been  fuelled  by  speculation  and  scepticism  over  the  transaction  is because Sime Darby previously acquired a collective stake of almost 30% in  E&O at MYR2.30/share  from  Dato’  Terry  Tham,  GK  Goh  and  Tan  Sri  Wan  Azmi  Wan Hamzah in Aug.  2011. With this latest transaction, Dato’ Terry  Tham’s shareholding in the company will increase to  15.07%, similar to the level before he sold his partial stake  to  the  conglomerate  three  years  ago.  Sime  Darby  remains  the  top  largest shareholder with almost a 22% stake in E&O.

According  to  management,  this  deal  came  about  as  Dato’  Terry  Tham’s  3-year management contract will expire  in August, and he now feels that he, at 61, would like to  continue driving the company over  a longer term –  considering that  the  STP2 project  is  on  the  horizon.  At  the  same  time,  Sime  Darby,  as  a  major  shareholder, would also like to maintain the key management team in the company, rather than bear  witness  to  another  scenario  like  SP  Setia  (SPSB  MK,  TRADING  BUY,  FV: MYR3.54),  which  saw  former  CEO  Tan  Sri  Liew  Kee  Sin  and  its  staff  leave  the company  in  an  exodus.  Sime  Darby  and  Dato’  Terry  Tham  have  entered  into  a private  share  sale  and  purchase  agreement.  The  transaction,  therefore,  ensures E&O’s continuity and  a  greater alignment of interests between the key management and the company.

The transacted price of MYR2.90 was arrived  on a “willing buyer-willing seller” basis. While some  may  question  the  possibility  of  buying  from  the  open  market  at  below MYR2.90/share,  as  the  purchase  price  is  at  a  22%  premium  to  E&O’s  MYR2.38 closing price on 28 May (being the day that the transaction was announced), we think buying back 110m shares over a period of 2-3 days is impossible, given the  stock’s average daily turnover of only MYR8m  (USD2.5m). Doing so would  also require the declaration  of  shareholding  interest.  In  addition,  buying  from  other  major shareholders, such as GK Goh and ECM Libra  –  which hold  7.25% and 6.13% (via Libra Strategic Opportunity Fund) respectively – would also be impossible, as it could possibly mean their complete exit from the company.

We understand that, besides Dato’ Terry  Tham, other senior management  members may also be roped in to participate in the .9% stake acquisition. We now see the MYR2.90 level as a floor,  being the price that he  is willing to pay for the company, and  MYR2.90  plus  a  premium  as  the  price  that  he  and  other  shareholders  would accept  if  there  was  a  future  takeover  offer.  Going  forward,  apart  from  the  beacon STP2 project, investors should expect E&O to penetrate the London property market further  as well as  other parts of Europe  potentially, given that Dato’ Terry  Tham  has been spending a large amount of time in the UK. This is in line with E&O’s strategy of growing  its  brand  internationally,  enabling  the  cross-selling  of  products  with  a stronger client base.

Endorsement for STP2 may come soon
In  our  view,  given  Dato’  Terry  Tham’s  higher  shareholding  in  the  company,  the Penang  State  Government  would  now  draw  greater  reassurance  given  the  full commitment  of  E&O’s  management  team.  As  such,  the  State  Government’s endorsement for STP2’s masterplan could be accelerated, since the two by-elections in Bukit Gelugor, Penang, and Teluk Intan, Perak, have just concluded recently.E&O  received  the  conditional  approval  letter  from  the  Department  of  Environment (DOE) on 11 April for the detailed environment  impact assessment (DEIA) study and conceptual masterplan relating to the proposed reclamation of STP2. Currently, the company  is  awaiting  an  endorsement  of  the  masterplan  from  the  Penang  State Government. Upon obtaining the commencement of work notice, it  should  be able to kick-start reclamation works. According to the plan, the final green light is expected to be granted by June/July. We view this as the next share price catalyst.

Assuming everything is on track, we believe the tender for the reclamation job will be called  in  3Q,  and  works  can  kick  off  by  end-2014.  E&O  will  start  with  Stage  A reclamation, which  involves  384  acres  that comprise  131 acres along Gurney Drive and  253  acres  at  STP2.  The  131  acres  will  then  be  turned  into  a  public  park  (81 acres)  and  government  reserve  land  (50  acres).  Financing  structure  for  Stage  A reclamation will likely be similar to that of STP1, whereby the latter was previously funded via 85% debt and 15% equity.

Given the equity requirement, the interest rate for the credit facility from banks (which was a completion guarantee) for STP1 was rather low, at only 0.5-1.0%. Based  on  our  assumption  of  a  blended  average  reclamation  cost  of  MYR132  psf (reclamation cost was MYR90 psf for STP1 on a net basis), we estimate that Stage A reclamation  should  cost about MYR1.8bn (MYR150 psf for 253 acres at STP2 and MYR30 psf for 131 acres at Gurney Drive). Assuming the same funding structure and credit  facility  are  used  for  STP2,  the  impact  on  E&O’s  balance  sheet  should  be manageable. Net gearing  should  likely be kept below 0.5-0.6x (currently 0.31x), as the  impact  from  the  completion  guarantee  amount  will  only  kick  in  once  the reclamation  works  are  done,  ie  in  2.5-3  years.  Meanwhile,  the  equity  financing requirement  could amount to MYR270m-300m, which is about 10% of E&O’s current market cap. As the type of equity calls (if any) is still unknown, and given that the fundraising exercise is expected to come only in late 2014, it is still early to assess the potential impact on RNAV.

Eco Macalister land valuation sets new pricing benchmark
We raise our land value assumption for STP2 to MYR400 psf from MYR360 psf. In end-2013,  Eco  World  Holdings  SB  acquired  1.1  acres  of  land  in  Penang’s Georgetown (at the  corner of Jalan Macalister and Jalan  Anson) at MYR1,252 psf. The land is now in the process of being injected into Eco World Development (ECW MK, NR) at MYR1,002 psf based on the appointed valuer’s appraisal. We understand that  Eco World  intends  to  set  up  its  own  sales  office  and  subsequently  develop  ahigh-rise project on the site, named Eco Macalister. These two prices, despite a 20% discrepancy that is largely attributed to the valuations given for the heritage building erected on the land, are high enough to set a new benchmark in Penang island, and should lift land prices in the northern Penang island area. Therefore, given the prime seafront  location  of  STP2,  our  revised  land  price  assumption  of  MYR400  psf  is reasonable  and  still  conservative  –  at  a  60%  discount  –  to  take  into  account  the typical  premium  ascribed  to  smaller  land  parcels.  Further  upside  is  possible  in  a longer run, as the reclamation works progress along.

Valuation
Based on an unchanged 25% discount to RNAV, we raise our  FV to MYR3.52 (from MYR3.12), as our RNAV/share is lifted to MYR4.70, after we revise up our land value assumption for STP2. To summarise, the greater alignment of management’s interest resulting  from  the  9.9%  stake  acquisition  by  Dato’  Terry  Tham,  the  imminent endorsement of STP2’s masterplan by the Penang state government, and rising land values in Penang island are the key re-rating catalysts for E&O. Maintain BUY.

Source: RHB