Acquiring a 21.5% Stake in Eco World International

In a surprise development, Paramount Corporation Bhd (PCB) has acquired a 21.54% equity stake in Eco World International Bhd (EWI) at a price of RM0.33/share from GLL EWI (HK) Ltd, amounting to RM170.6mn, in order to expedite its overseas expansion strategy. The acquisition, conducted through PCB’s subsidiary Flexsis Sdn Bhd, entailed the direct purchase of 517mn shares from GLL EWI (HK) Ltd, owned by billionaire Tan Sri Quek Leng Chan. According to Bursa filling, the purchase consideration will be payable in full on 14 May 2024. PCB intends to fund the transaction via a combination of bank borrowings and internally generated funds.

Upon completion of the acquisition, PCB will emerge as the second largest shareholder in EWI, after Eco World Capital (International) Sdn Bhd, with a 27% stake.

More About EWI and Its Recent Developments

EWI focuses on real estate development primarily in the UK (centred in London) and Australia (projects in Melbourne and Sydney). Given the challenging conditions that persist in the UK real estate landscape, marked by high interest rates and elevated living costs, EWI management has deemed the current market conditions unfavourable for initiating new launches or acquisitions in the near term. Consequently, they have suspended new launches across remaining sites pending feasibility reviews. Currently, EWI has an inventory and unlaunched projects with a GDV of about RM9bn – see Appendix 1.

As of 29 Feb, 2024, EWI possesses completed and nearly-completed stocks valued at approximately RM650mn, with EWI’s effective share amounting to approximately RM500mn. It was reported that EWI targets selling out all these stocks in FY24 and returning the excess cash to shareholders.

Over the past three years, EWI has undertaken cost rationalisation efforts to improve its operating cost structure, resulting in lower working capital requirements. As of January 31, 2024, EWI has no borrowings and maintains a net cash balance of RM211mn, as reported in their latest quarterly report.

In Aug-23, EWI completed a reduction of its issued share capital by RM1.5bn, eliminating accumulated losses and enabling dividend payouts totalling RM936mn to shareholders in Aug-23 and Dec-23.

EWI is currently undergoing another proposed capital reduction of RM500mn to bolster retained earnings, potentially facilitating future dividend distributions.

As set out in the EWI circular, EWI aims to distribute dividends of up to RM504mn, or RM0.21/share, from 2024 to 2025, subject to meeting internal sales targets and regulatory requirements, while ensuring adequate funds for working capital and funding needs.

The Rationale for Buying Into EWI

Since divesting its education businesses in 2018, PCB has actively sought opportunities to diversify its earnings base both domestically and internationally, which is in line with its strategic plan spanning 2020-2025. It has invested in various digital start-ups and expanded its property development activities overseas through a partnership in Bangkok, Thailand.

The acquisition now represents a strategic opportunity for PCB to expedite its overseas expansion and diversification efforts. It allows PCB to gain a significant 21.54% stake in a reputable international property development company operating within the familiar Malaysian legal and regulatory framework.

Moreover, the acquisition opens avenues for potential collaborations with EWI and its management, aiming to capitalise on synergies by leveraging the expertise and experience of both parties in property development.

Low Entry Cost After Adjusting for Dividend From EWI

The acquisition price of RM0.33/share represents an 8.3% discount to EWI’s last traded price of RM0.36/share prior to the announcement. Based on 1QFY24 results, the price tag translates to a FY24 P/NAV multiple of 0.51x (NAV of RM0.65/share as of 31 Jan 2024). In comparison, the average P/NAV multiple for property stocks under our coverage is 0.8x.

Appendix 2 illustrates that M&A deals in the property sector over the past 10 years have typically concluded at an average P/NAV ratio of 1.0x. Excluding privatisation offers from major shareholders, which often value the company below its book, the average P/NAV ratio of these acquisitions stands at 1.3x.

Compared to the 0.5x P/NAV ratio that Datuk Tee Eng Ho and his brother Tee Eng Seng, via Amazing Parade Sdn Bhd, paid to acquire Sime Darby Bhd’s last block of a 10.89% stake in Eastern & Oriental Bhd for RM93.5mn or 60sen per share in Mar-21, the 0.51x P/NAV multiple to acquire EWI also seems justifiable.

From a pure landbanking acquisition standpoint, the entry cost of RM170mn for access to RM1.1bn worth of effective GDV appears reasonable, given the land cost-to-GDV ratio of 16%. Adjusting for the expected RM108.6mn dividend distribution from EWI over the next twelve months, the net entry cost would be reduced to RM61.4mn. This adjustment results in a more attractive land costto-GDV ratio of only 5.8%.

Positive on the Deal

We view the deal positively as it accelerates the realisation of PCB's overseas expansion and diversification strategy. This opportunity stands out among other options for overseas expansion, particularly given the complexities involved in direct investments in foreign property development projects. This is especially relevant in light of Bank Negara Malaysia's (BNM) encouragement for businesses to prioritize domestic investments and adopt a "Malaysia first" approach to help prop up the Ringgit. Such prioritisation may result in a more rigorous approval process for overseas investments, potentially lengthening the timeline for executing international business deals.

What Are the Risks?

Risk factors associated with the acquisition include: 1) potential further deterioration of the property markets in the UK and Australia, 2) limited control over EWI’s operation due to its non-controlling stake, although PCB intends to nominate representatives to safeguard its interests, and 3) uncertainty regarding the realisation of expected benefits or the generation of adequate returns.

Additionally, we acknowledge a potential for fresh capital injection into EWI from shareholders upon the resumption of new property launches in FY25/FY26, possibly to address increased working capital requirements. Depending on the size of the new launches, we believe the working capital could also be funded through borrowings, considering EWI’s current healthy balance sheet with zero borrowings. In the event of a cash call, PCB can utilise dividends received from EWI to reinvest back into the company.

However, we consider the low entry cost to access overseas markets, coupled with the potential for additional profits beyond those generated from domestic property development business in the future, to justify the associated risks.

Impact

We maintain our FY24-26 earnings forecasts at this juncture. EWI will become an associate company of PCB upon the completion of the acquisition. We expect minimal earnings contribution from EWI in FY24-FY26, as the sale of unsold stock is expected to yield thin margins. Additionally, any new launches potentially in FY25/26 will likely only begin contributing to earnings in FY27, as revenue recognition is contingent upon project completion according to both UK and Australia Accounting Standards.

In terms of balance sheet impact, we anticipate PCB's net gearing to rise to 50% from 44% as of Dec-23, assuming the acquisition is entirely financed through borrowings. However, we expect the forthcoming dividend distribution from EWI to alleviate PCB's financial strain.

Valuation & Recommendation

We value PCB at RM1.71/share (previously RM1.47/share), based on a higher CY25 P/Bk target multiple of 0.7x from the previous 0.6x, reflecting potential value enhancement from its investment in EWI. We anticipate a positive reaction in PCB's share price to the acquisition and maintain a Buy recommendation on the stock.

Source: TA Research - 13 May 2024