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Further upside via merger entity for Sunway

Sunway Holdings Bhd (June 13, RM2.56)
Upgraded to trading buy at RM2.55 with revised fair value of RM3.27 (from RM2.60):
Last November, both Sunway and SunCity (not rated) announced that they would be undertaking a merger exercise. The merged entity will be known as Sunway Bhd, but to avoid confusion, we shall just call it "Newco" for now. The implied merger price for Sunway stands at RM2.60, which will be satisfied via 20% cash and 80% in Newco shares valued at RM2.80 each. For every five Newco shares held, the investor will also receive one "at the money" Newco warrant. To summarise, for every Sunway share, the investor gets: (i) 52 sen cash, (ii) 0.7429 Newco shares, and (iii) 0.1486 Newco warrants.

Any potential upside for the Newco implies an upside for Sunway owing to the fixed share swap ratio. As such, we are making a simple back-of-envelope calculation on what the Newco is potentially worth. The Newco would be listed at a price of RM2.80, which will give rise to a market cap of RM3.61 billion. It will have shareholders' funds of RM2.6 billion, which includes the negative merger reserve of RM1.18 billion. This implies a P/BV of 1.39 times upon listing (RM2.02 BV/ share).

Management estimates that 70% of Newco's profit before tax will come from property-related activities. As such, we have used property developers with market capitalisation of more than RM1.5 billion as a benchmark. Based on this sample set, the peer average historical P/BV will be 2.62 times.

But for prudence's sake, we are only valuing the Newco at 1.84 times BV, representing a steep 30% discount to its peer average. Its closest peers by market capitalisation, IJM Land (about RM3.9 billion) and UOA Development (about RM3 billion), are trading at P/BVs of 2.13 times and 3.73 times respectively, which are still at a premium to our valuation parameter for Newco.

At 1.84 times P/BV, the Newco would be valued at RM3.70, providing a 32.1% upside from its listing price of RM2.80. Should it trade up to RM3.70, then based on the swap ratio of 0.7429 Newco shares for every Sunway share, Sunway would be worth RM2.75 post-cash repayment. Adding in the 52 sen cash repayment (since it is a return to investors), Sunway is worth RM3.27 pre cash repayment. This gives rise to a 28.3% upside from the last close of RM2.55. — OSK Research, June 13

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