Karex  announced  last  Friday  that  it  has  entered  into  a  MOU  with Mr Davin Wedel to acquire a 55% equity stake in Global Protection Corp for USD6.6m to expand its OBM business. Management is confident the acquisition  would  have  minimal  cannibalisation.  Given  Karex’s solid balance  sheet,  we  think  the  funding  is  not  an  issue.  Upgrade  to  BUY (from Neutral), with a similar TP MYR3.41.

Proposed  acquisition.  Karex  announced  that  it  has  entered  into  a Memorandum  of  Understanding  (MOU)  with  Mr  Davin  Wedel,  the founder of Global Protection Corp (GP), a leading condom and lubricant distributor  that  owns  ONE®  brand  condom,  to  acquire  a  55%  equity stake  in  GP.  The  purchase  consideration  is  USD6.6m  with  options  to acquire 15% and 30% equity interest in 2017 and 2020 respectively via call  and  put  option  agreements.  The  acquisition  is  targeted  to  be completed  by  Oct  2014.  We  believe  there  should  not  be  any  funding issue given Karex’s strong balance sheet. 

Expanding  OBM.  Under  the  distribution  agreement,  Karex  will  be granted  the  exclusive  rights  as  a  sole  distributor  of  the  ONE®  brand condom and other condom brands to be mutually agreed in some Asian countries  (including  China),  North  Africa  and  some  countries  in  the Middle  East.  Karex  would  also  get  to  distribute  its  own  brands  through GP’s  extensive  network  of  approximately  30,000  stores  in  the  US  and Canada.  Management  believes  that  the  acquisition  would  have  minimal cannibalisation  impact  on  its  original  equipment  manufacturer  (OEM) business  as  ONE®  is  well-received  by  the  younger  generation.  It believes  this  should  pave  the  way  for  Karex  to  expand  its  own  brand manufacturing (OBM) division, especially in Asian countries.

Potential valuations. GP’s disclosed sales figures value the acquisition at  1.1x  price/sales  (P/S),  which  is  lower  than  Karex’s  P/S  of  2.8x. Assuming GP achieves only half of Karex’s margin due to its higher cost base,  this  would  value  the  acquisition  at  16-17x  P/E,  which  we  think  is fair.  Post-acquisition,  we  estimate  that  Karex’s  P/E  could  improve  to 17.7x CF15F (from 17.8x CY15F) after incorporating GP’s contribution.  

Upgrade  to  BUY.  We  make  no  changes  to  our  earnings  forecasts, pending  more  details  from  management,  as  discussions  are  still  at  the MOU  stage.  As  such,  we  maintain  our  MYR3.41  FV,  pegged  to  a  20x CY15F P/E, which is justified by the strong expected FY14/15F earnings growth of 51.6%/35.8%. As the recent selldown offers an opportunity to accumulate, we upgrade Karex to BUY (from Neutral.)

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Source: RHB