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Sunway Holdings (OSK Research) buy; target price RM2.60

Coming Under One Roof

Sunway’s 9MFY10 results of RM137m (+164% y-o-y) beat both our expectations and consensus. The proposed merger of Sunway and SunCity values the former at RM2.60, to be satisfied via cash, shares exchange and free warrants. We advise investors to accept the offer given the 15.5% upside and closeness to our previous RM2.72 TP. It would also provide investors an opportunity to participate in the growth of the stronger merged entity.

Strong set of results. Sunway posted revenue of RM489m (+18.8% y-o-y) and earnings of RM48.5m (+169.4% y-o-y) for 3QFY10. On a cumulative basis, 9M earnings totaled RM137m (+164% y-o-y), or RM121.3m if adjustments are made for derivative gains, the disposal of Hanoi Hotel and impairment losses of non-core assets. Margins were higher y-o-y, with EBIT and net figures at 7.8% and 9.1% respectively (vs 4.2% and 4.4% in FY09 comparatives). From a q-o-q perspective, earnings were flattish (-0.2%) as the impact of higher margins was offset by lower turnover and lower contributions from its JV and associates. In sum it up, the company’s annualized core earnings were 11.5% above our expectations and 12.5% higher than consensus.

Promising orderbook wins. Last week, Sunway won a smallish RM14.7m contract for pilling works in Port Dickson, bringing YTD job wins to RM686m. This compares to our FY10 assumption of RM1bn and management’s guidance for RM1.5bn. We expect more contracts to be announced by year-end to close in on our target. Sunway has some RM16bn worth of tenders in the pipeline, and boasts of a historical success rate of 10%-15%. The potential contracts are those from SunCity (NR) (RM1-1.5bn), Legoland Theme Park (RM700m), an airport extension (RM250m), Sarawak rural road networks, Phase 2 of Arzanah and precast concrete supplies in Singapore.

More launches on the way. Its HDB developments in Boon Keng and Toa Payoh have achieved sales of 95%-100% and construction is underway. Its recently launched Vacanza at Jln Senang this month has achieved strong take-up rates of 35%. Moving forward, it will be launching a low-rise condo in Yishun (SGD370m GDV with 30% stake). We are also positive on its maiden development in Colombo, Sri Lanka, which has a GDV of RM250m.

Accept the offer. In light of the better-than-expected results, we raise our FY10-12 earnings by 8%-10% mainly on account of the higher construction and property margins. We expect Sunway’s share price to rally close to its offer price of RM2.60 following the proposed Sunway-SunCity merger. Investors should accept the offer given the 15.5% upside. Our TP has been reduced from RM2.72 to RM2.60 to reflect the offer price.

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The Sunway merger. Yesterday Sunway and SunCity announced that they would be undertaking a merger exercise. The common shareholder of both companies is Tan Sri Jeffery Cheah, who holds a 44.7% stake in Sunway and 41.0% in SunCity. To facilitate the merger, a company known as Sunway SB (“Newco”) would acquire all the assets and liabilities of both Sunway and SunCity, which will be satisfied via a combination of share exchange and cash. Upon completion of the asset and liability acquisition, both Sunway and SunCity will embark on a capital reduction to return the cash proceeds to shareholders. Following that, both companies will be delisted and the Newco will be listed.

What’s on the table? The offer price values Sunway at RM2.60/ hare, which comprises: (i) an 80% in share exchange for Newco shares valued at RM2.80/ share, (ii) 20% in cash, and (iii) 1 free Newco “at the money” warrant with a 5-year expiry period for every Newco share. To put it simply, investors would receive the following for each Sunway share held:

RM0.52 in cash
0.74 Newco shares worth RM2.80 (i.e. you need 1.35 Sunway shares to get 1 Newco share)
0.2 Newco warrants (i.e. for every 6.75 Sunway shares, you get a free Newco warrant)

To illustrate further, we assume that an investor has 1000 Sunway shares and decides to accept the offer. He will receive (i) RM520 in cash, (ii) 740 Newco shares worth RM2.80 each, and (iii) 200 Newco warrants with an exercise price of RM2.80 and a 5-year expiry period.

Offer looks appealing. We believe investors should accept the RM2.60 per share offer as it provides a decent 15.5% upside from the stock’s last price. Furthermore, the offer price is only 4.4% below our previous TP of RM2.72, which we deem in line. By accepting the offer, investors will also have the opportunity to ride on the future growth prospects of the Newco. The free warrants, which are “at the money”, is another attraction.

Valuation of Newco. Based on the offer prices of both Sunway and SunCity shares, the total acquisition price for Newco would be RM4.5bn. If we were to simply consolidate the FY11-12 (Dec) profits of Sunway and SunCity, the Newco would be trading at 11.7x FY11 earnings and 10.5x FY12, which we believe is fair. In deriving the consolidated profits for the Newco, we have used our forecasts for Sunway and consensus estimates for SunCity (since we do not cover the latter). That said, we note 2 drawbacks in this simple method of adding up the profits of both entities, namely: (i) it does not account for company transactions between Sunway and SunCity, which would reduce the consolidated earnings, and (ii) it does not reflect any earnings enhancement that could be derived from merger synergies.

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Merger makes sense. Unlike the UEM Land-Sunrise and MRCB-IJM Land merger which involves a GLC and a private listed company, the Sunway-SunCity merger is a union of two companies from the private sector. Both Sunway and SunCity have long had a working relationships and share the same office premises as both are under the Cheah family. As such, concerns of cultural clashes post merger should be a non-issue. The union would also allow the group to consolidate the Sunway brand name under one roof. Management said that property will be the main earnings driver post merger at > 50% while the balance of earnings contribution will be from construction, quarries and other smaller divisions. The Newco will have a net gearing of 0.35x, which management is comfortable enough to bring up to 0.5x in view of further expansion plans. With a larger balance sheet, the Newco would be in a better position to undertake more property developments and bid for larger construction jobs.


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