Pantech Group Holdings (95 sen) is on the final leg of a corporate exercise involving a bonus shares and rights issue of irredeemable convertible unsecured loan stock (ICULS) that also comes with free warrants. The entitlement date has been fixed on Nov 24.
We believe the exercise will offer shareholders positive investment returns over the next few years, underpinned by the company’s expansion plans and earnings growth prospects.
The bonus issue is on the basis of 1-for-5 shares. Shareholders will also be given the rights to buy two ICULS for every Pantech share held (before the bonus issue) priced at 10 sen per ICULS. The loan stock carries a 7% coupon rate with a conversion ratio of six to one, exercisable at anytime within a seven-year period.
As a sweetener, investors will be offered one free warrant for every 10 ICULS subscribed. The warrants have a maturity of 10 years and the exercise price is fixed at 60 sen. Post-bonus issue, Pantech’s shares will be adjusted to 79 sen based on its current price of 95 sen. This implies that the warrants will already be in-the-money upon completion of the exercise.
Decent 7% yield on ICULS
ICULS is somewhat similar to a warrant in that they give holders the right to convert their holdings into shares within the maturity period. However, holders will also earn fixed annual interest income until the loan stocks are converted into equity.
In Pantech’s case, its ICULS carries a coupon rate of 7%. That is a fairly decent yield, compared with current deposit rates. Of course, loan stocks are not risk free. But Pantech’s balance sheet is relatively strong with net debt of RM70.3 million at end-August 2010 or gearing of about 28%.
Plus, its business is expected to fare well over the next few years. We forecast steady double-digit earnings growth for Pantech going forward, following a slightly decline in FYFeb11 (excluding one-off items).
Both the ICULS and warrants will be listed on Bursa Malaysia on Dec 27. Their prices will likely track Pantech’s share price with reference to their conversion ratio/exercise price. For instance, based on current prices, the loan stock should trade at, at least, 13 sen (79 sen divided by conversion ratio of six).
Larger share base will enhance liquidity
Currently, Pantech has issued shares totalling 375 million. Assuming full subscription, the exercise will raise some RM75 million from the ICULS proceeds at the outset. The bulk of the proceeds will be used to fund the company’s expansion plans.
Future conversion of the warrants will raise a further sum of up to RM45 million. Upon full conversion of the ICULS and warrants, Pantech’s share base will be enlarged to about 650 million shares. The larger share capital — in step with its growing business — would improve liquidity and the stock’s attractiveness to investors over time.
Sales recovery, slowly but surely
We are sanguine on Pantech’s longer-term prospects. Sales are recovering, albeit at a gradual pace. Trading sales, in particular, dipped sharply in 2H09 on the back of a slowdown in contracts flow in the domestic oil & gas sector.
But calls for fresh tenders from the national oil company, Petroliam Nasional Bhd (Petronas), have been slowly picking up steam over the last few months. Pantech’s trading sales improved from a low of RM46.9 million in 4QFY10 to RM67.5 million and RM72.2 million in 1Q-2QFY11, respectively — and should continue to rise.
In addition to new deepwater and marginal oilfield projects, Petronas is also investing in enhanced oil recovery, where new technologies are expected to raise extraction rates in existing oilfields on upgraded facilities. Industry players are upbeat that the actual flow of contracts and jobs will gather momentum going into 2011-2012.
Meanwhile, its manufacturing arm is also doing better on the back of improving export orders. Crude oil prices have rebounded convincingly from the lows during the height of the financial crisis. At current levels, around US$85 (RM266) per barrel, prices are supportive of exploration and production activities.
Indeed, despite the weak US dollar, which translates into lower ringgit sales, Pantech’s manufacturing sales increased to RM25 million in the latest 2QFY11 from RM22.8 million in 1QFY11 and as low as RM10.3 million in the previous corresponding quarter.
Sales would gain a further boost from Pantech’s joint-venture deal with Saudi-based Al-Otaishan Trading Group, which paves the way for it to supply state-owned oil and petrochemical companies in the oil-rich country.
Manufacturing expansion to drive future growth
Pantech intends to focus on growing its manufacturing business over the next few years.
At the moment, its plant in Klang manufactures carbon steel pipes and fittings. Once the new manufacturing facility in Johor Bahru is completed — trial production is expected to begin sometime this month — its range will expand to include stainless steel pipes.
Under the next two phases, the product range will widen to encompass stainless steel fittings and eventually alloy-based pipes and fittings, targeted by 2013-2014. By then, Pantech plans to hit RM1 billion in sales, about 40% of which will be from the manufacturing arm, up from 16% in FY10.
In short, we believe Pantech has good upside potential given that prevailing valuations are still low. The stock is trading at just about 8.1 and 6.8 times our earnings estimate for FY11-FY12. Net tangible assets stood at 66 sen per share at end-August 2010.
