Will Swire’s repeat offer to privatize HAECO succeed this time?

11 June 2018, Hong Kong – Swire Pacific is attempting to privatize HAECO again after its unsuccessful attempt in June 2010. What works in Swire Pacific’s favour now is HAECO’s low free float of 25.01% and its trading liquidity is thin at only 43,760 shares per day in the past year.

However, the key resistance from investors would be valuations as the offer price is even lower than Swire’s offer price back in 2010 even though the MRO market is on the mend. The cash offer price is only at an 8% premium to HAECO’s historical average P/E valuation and a 19% valuation premium to the listed Asian MRO peers.

It also seems rather coincidental that HAECO reported its first net loss in history for the financial year 2017 which was mainly driven by one-offs. HAECO still generated positive free cash flows of HK$326 million in 2017 and has favourable long-term earnings prospects.

Therefore, some investors may want to hold out for a higher offer price from Swire Pacific.

Swire Pacific offers to privatize HAECO for the second time

Swire Pacific (19:HK and 87:HK) and Hong Kong Aircraft Engineering Company Limited HAECO (44:HK) have made a joint announcement on 9thJune 2018 to put forward a privatisation proposal to HAECO’s minority shareholders.

In summary, the offer of HK$72 per HAECO share will be paid in cash and the total cash consideration will amount to HK$2.995 Billion (or US$382 million) which will be funded by Swire Pacific’s existing cash resources. Upon the Scheme becoming effective with Swire Pacific holding 100% of the issued share capital of HAECO, HAECO will make an application to withdraw its listing from the Hong Kong Stock Exchange.

This is Swire Pacific’s second attempt to privatize HAECO. The first offer in June 2010 was unsuccessful as the low offer price was not attractive enough to investors.

This seems like an opportune time for Swire Pacific after HAECO reported its first net loss in history for 2017 and its shares trading liquidity has dwindled in recent years. The successful privatisation of HAECO would be positive for Swire Pacific’s shareholders, in our view, as HAECO is a free cash flow generating business with favourable long-term earnings growth prospects.

WHAT WORKS IN FAVOUR OF SWIRE PACIFIC’S PRIVATIZATION OFFER NOW

#1 HAECO’s current free float is low and its shares trading liquidity is thin

HAECO’s free float is low at 25.01%and its shares trading liquidity is thin, averaging only 43,760 shares traded per day in the past 1 year.

Investor interest has dwindled for this US$1.4 Billion market cap company. There are currently no research analysts covering this stock although we have been following HAECO’s developments for the past 17 years.

#2 HAECO just reported its first net loss in history for the financial year 2017

It appears rather coincidental that HAECO reported its first net loss in history (based on the 24-year profit history that we have on record) for the financial year 2017.

HAECO incurred a net loss of HK$541 million in 2017. However, note that this was largely due to the one-off impairment charge of HK$625 million and deferred tax asset write-off of HK$249 million by HAECO Americas in 2017.

Chart: HAECO Net Profit History (1994 to 2017)

HAECO Net Profit History (1994 to 2017)

# Implied valuation of the offer is at a significant premium to HAECO’s closing share price before the privatisation announcement

The offer price of HK$72 per Scheme Share (assuming no Dividend Adjustment), to be paid in cash, represents a 63.6% premium to HAECO’s closing share price of HK$44.0 prior to this privatization offer announcement.

HOWEVER, THERE ARE SOME STICKING POINTS FOR MINORITY SHAREHOLDERS

#1 HK$72 offer price is less attractive than Swire Pacific’s offer back in 2010 

The current HK$72 offer price is lower than the HK$105 cash per HAECO share offer back in June 2010. The HK$105 offer price represented a 25% premium to HAECO’s HK$84 closing share price prior to the privatization announcement. Back then, the implied valuations of the HK$105 offer price were 24.9x P/E and 3.14x Price/Book in 2010.

The implied valuations of the current HK$72 offer price are lower compared to Swire Pacific’s 2010 offer. Based on HAECO’s historical average earnings in the past 24 years, the implied P/E is 23.2x and the implied 2017 Price/Book is only 2.15x.

#1 Implied valuations are only at a slight premium to HAECO’s historical average valuation and the listed Asian MRO peers

Historically, HAECO’s P/E valuation has been 21.5x on average in the past 10 years so the current offer’s P/E valuation is only at an 8% premium to this.

Chart: HAECO P/E Valuation History (2008 to 2017)

HAECO P/E Valuation History (2008 to 2017)

Compared to the other listed Asian MRO companies ST Engineering and SIA Engineering (SIAEC), the current offer for HAECO is only at a 19% premium to ST Engineering and SIA Engineering’s P/E valuations respectively on average.

Chart: Asian MRO Companies P/E Valuation Comparison (2018)

Asian MRO Companies P/E Valuation Comparison (2018)

Chart: Asian MRO Companies Price/Book Valuation Comparison (2018)

Asian MRO Companies Price/Book Valuation Comparison (2018)

#3 If we look at HAECO’s adjusted profit analysis, the rest of its core businesses performed well in 2017 and HAECO generated positive free cash flows

Although HAECO reported a net loss in 2017, this was mainly driven by one-off charges, including a one-off impairment charge of HK$625 million and deferred tax asset write-off of HK$249 million by HAECO Americas in 2017. HAECO actually generated positive free cash flows of HK$326 million in 2017.

Drilling down specifically to its individual core businesses, HAECO Hong Kong’s adjusted profit rose 32% y/y while HAECO Xiamen’s adjusted profit rose 44% y/y in 2017. In addition, TEXL’s adjusted profit improved 7% y/y and HAECO’s share of profits from HAESL and SAESL rose 12% y/y. Overall, HAECO’s adjusted profit was HK$340 million, down 34% y/y as HAECO America’s losses widened 153% y/y.

Therefore, there could be some investors who would want to hold out for a higher offer price from Swire Pacific. Based on their filings, some of the major institutional investor shareholders of HAECO include First State Investments, Dimensional Fund Advisors, Schroders, WisdomTree Asset Management, SEI Investments, BSI Fund Management, Maple-Brown Abbott, Allianz and Manulife.

Chart: HAECO Adjusted Profit Analysis By Company (2017)

HAECO Adjusted Profit Analysis By Company (2017)

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Independent Research Declaration: Crucial Perspective does not own any position in the equities featured in this report nor have we received any compensation for writing this report. 

 

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