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.

SMRT buys stake in Shenzhen transport firm

SMRT Corp is acquiring a 49 per cent stake in a Shenzhen transport company for 320 million yuan (S$68 million). And through its investment in Shenzhen Zona Transportation Group, SMRT hopes to gain a foothold in China.

Its subsidiary SMRT Hong Kong yesterday signed an agreement to acquire Shenzhen Zoto Investment Co’s 49 per cent equity interest in Zona.

SMRT operates Singapore’s biggest rail network, as well as a fleet of buses and taxis.

SMRT president and CEO Saw Phaik Hwa signed the agreement in Guangdong yesterday with Zoto chairman Wang Yongli. The ceremony was witnessed by Singapore’s Acting Minister for Information, Communications and the Arts Lui Tuck Yew and Guangdong province vice-governor Wan Qingliang.

This is SMRT’s first investment in a Chinese company. Ms Saw said that buying Zoto’s entire stake in Zona will be ‘a beachhead for our expansion into China’.

Zona is a limited liability company that provides taxi services in Shenzhen, car and bus repair services in Shenzhen and Huizhou, car leasing, scheduled coach services from Shenzhen to other cities, tour and chartered coach services within and beyond Shenzhen, and public bus services in Huizhou. Zona also has a 33.5 per cent equity interest in one of only three bus operating companies in Shenzhen.

Zona started with 300 buses in 2002 and has since grown its fleet to 803. It also has 142 chartered and tourist coaches, 78 long-haul coaches, 830 taxis and 260 leased cars in the Shenzhen region.

Based on its audited accounts for the financial year ended Dec 31, 2008, Zona has a net asset value of 376.7 million yuan, represented by negative net tangible assets of 48.0 million yuan and net intangible assets of 424.7 million yuan. The net intangible assets largely comprise taxi operating licences acquired through open bids.

The acquisition by SMRT is not expected to have a material impact on its consolidated net tangible assets or earnings per share for the current financial year.

SMRT announces new S&P for 49% stake in Shenzhen Zona

SMRT announced that it has signed a new Sale and Purchase Agreement (SPA) for a 49% stake in Shenzhen Zona for a total consideration of RMB320m (S$68.4m).

This is a new SPA which is slightly different from the previous one signed in Sep 08. The latter which has since lapsed earlier in 2009 as certain conditions precedent were not met. The new SPA is also subject to certain conditions precedent, including receipt of approval from the relevant PRC authorities. Given that this is a second time a SPA is signed, we think the chance of it coming to fruition is likely.

Upon completion of the acquisition, Shenzhen Zona will be an associate of the company. As completion will take several months, the impact on SMRT’s FY10F earnings will not be material. Assuming an acquisition PER of around 8x – 15x, which is similar to regional/global peers trading range, we estimate the profit contribution of this acquisition is around S$4.6m – S$8.6m (or 3%-5%) of SMRT’s Group profit.

As of Dec 08, Shenzhen Zona has a NAV of RMB376.7m, represented by a negative NTA of
RMB48m and Net Intangible Assets of RMB427.7m. The intangible assets largely comprise taxi operating licences acquired through open bids. The acquisition price works out to be around 1.7x P/NAV.

Shenzhen Zona is engaged in the following services:
• Taxi services in Shenzhen, car and bus repair services in Shenzhen and Huizhou,
• car leasing, scheduled coach services from Shenzhen to other cities, tour and chartered coach services within and beyond Shenzhen; and,
• public bus services in Huizhou.

Maintain Hold, TP of S$1.65

Still Worth Paying For

Still worth paying for. SMRT Corporation (SMRT) has, over the last 18 months, been trading at about 23.5% over and above the sector average, based on the PE metric. Even on a P/B basis, the stock is not cheap, trading at 3.6x P/B (though this is largely due to its low fixed asset base). However, the stock is still worth paying for, given its strong margins that outshine that of sector peers, outstanding return on assets (ROA), sustainable dividend payouts based on solid earnings, and its ability to leverage on the Singapore growth narrative.

Growth potential not yet exhausted. We view SMRT as a play on Singapore’s growth trajectory, and the rail system as the biggest beneficiary of the government’s push to nudge commuters and peak hour traffic towards public transport. The rail system is, by far, the best alternative transport method to avoid congestion on roads.

Stronger operating performance than peers’. We compare SMRT and sector comparables and find that the company commands the highest margins and ROAs among listed land transport operators. SMRT also has the added silver spoon advantage of lower capex due to strong government support.

Maintain BUY; target price raised to S$2.00. We have lowered our profit forecasts (by between -5.1% and -6.3%) and changed our valuation methodology from PE to discounted cash flow. We value SMRT using the firm’s discounted free cash flow to equity at S$2.00/share (6.9% COE, 1% terminal growth). Our revised target price (up from S$1.86) gives a return of 17% over the last closing price of S$1.71.

Circle Line operating performance may see upside

• Circle Line ridership could surprise on the upside: The Circle Line (CCL) attracted a daily ridership of about 30,000 – 35,000 during its first week of operations since the 5-station, phase 3 of the 29-station lines opened in May 2009. This is better than our estimate of 25,000. The remaining phases will be opened from 2010. With the CCL being a “transfer line” cutting across the other lines, it should be able to capture a good amount of ridership share.

• Might be net beneficiary of centralized bus planning: SMRT’s bus network currently spans the less densely populated areas of Singapore. The LTA is in the process of re-planning the whole bus network under its centralized bus planning exercise. SMRT could emerge a net beneficiary from this exercise, as routes get redistributed so that it could have a chance of securing the more lucrative bus services.

• Retail space rental earnings could see slower growth: Retail space rental experienced phenomenal growth in the past on the back of aggressive refurbishment of existing stations and the conversion of bigger underground stations into “Xchanges” housing more retail shops. Going forward, we believe that the growth from this segment could plateau as the CCL is fully underground and the stations are smaller, translating to less lettable retail space. This segment currently contributes about 23% of SMRT’s operating profits and is the second largest profit contributor after the core MRT business.

• Valuation, risks: At 15.4x FY10E P/E, we believe the stock is fairly valued, trading above its historical mean forward P/E of 13.5x. Upside risks could come from the CCL breaking even faster than the FY 2013E in our assumption.