SMRT – CIMB

Deal revived for Shenzhen Zona investment

New sale & purchase agreement

Further to announcements made on 30 Sep 08 and 23 Jan 09, SMRT has unveiled a new sale and purchase agreement to acquire from Shenzhen Zoto Investment a 49% equity interest in Shenzhen Zona Transportation Group, a leading land transport company in Shenzhen. The purchase consideration of Rmb320m (S$68.4m) will be satisfied by wholly-owned subsidiary, SMRT Hong Kong Limited, in US$ cash equivalent. When completed, the purchase will count as a significant overseas investment for SMRT.

To recap, Zona owns 33.5% of one of only three bus operating companies in Shenzhen. Zona operates public buses, charter and tourist buses, long-haul coaches and taxi services. It also offers car rental & leasing services, and motor vehicle repairs. Its fleet comprises 803 buses, 142 charter and tourist buses, 78 long-haul coaches, 830 taxis, and 260 leased cars in the Shenzhen region. The group comprises 10 subsidiaries and three associated companies. Following the acquisition, Zona will become an associated company of SMRT.

Another Chinese company, the National Express Transportation Group, holds the remaining 51% of Zona. National Express was the first road passenger transportation company to provide extensive intercity bus services in 67 cities in China. Its other businesses include car leasing & rental, and charter & tourist bus services. It also develops and operates bus terminals.

Profit guarantee. Should Zona fail to meet certain profit targets for FY2010 and FY2011, SMRT will be entitled to additional amounts of distributable profits in Zona, in addition to distributable profits proportionate to SMRT’s stake in Zona.

Purchase consideration. Based on audited consolidated accounts for the financial year ended 31 Dec 08, Shenzhen Zona’s net asset value is Rmb376.7m (S$80.5m), represented by negative net tangible assets of Rmb48.0m (S$10.3m) and net intangible assets of Rmb424.7m (S$90.7m). Net intangible assets comprise mainly taxi operating licences acquired through open bids.

Comments

Details remain scant. The completion of the deal is subject to the satisfaction of certain conditions, including approval from the relevant Chinese authorities. No information has been given on funding or valuation. However, we again highlight that the intangible asset portion of the deal at Rmb424.7m appears excessive, probably due to a short supply of taxi licences in China and hence the premium pricing. We believe the situation in China is probably similar to Singapore, where taxi operators need to bid for certificates of entitlement (COEs). Notably, the new purchase consideration is 25.6% lower than the previous agreement, although it also corresponds to a 22% lower net asset value.

Impact based on assumptions. Despite the lack of information, we view this acquisition positively, given the growth potential of China’s public transportation sector. We understand from SMRT that Zona is profitable. If we take the average ROA of SMRT (FY09 ROA 10.8%) and ComfortDelgro (FY08 ROA 6.0%) (i.e. 8.4%) and apply that to Zona’s net asset value of S$80.5m, Zona’s pretax profit may be in the region of S$6.8m. Equity accounting SMRT’s 49% stake would result in associate income of S$3.4m, or a positive impact of 1.8% on SMRT’s FY10 pretax profit.

Valuation and recommendation

Maintain Neutral. We are keeping our forecasts unchanged as the deal appears to have a limited impact on the group’s business in the near term. We maintain our DCFderived target price of S$1.77 (WACC 9.6%). Dividend yield of 4.4% is mediocre and the stock is unlikely to outperform the market.

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