CHONGANG (FV HKD1.31 - NEUTRAL) Company Update: Sealing The RMB19bn Deal

- We  are generally neutral  on Chongqing Iron & Steel’s (Chongang) agreement to acquire from its parent, steel assets valued at RMB19bn, to be satisfied via the issuance of new shares, cash, assumption of liabilities and government compensation for its relocation.

- We are positive  that  Chongang  will  emerge  as a fully integrated steel company. However,  we believe:  i)  its  minority shareholders  will  only benefit in the long run since the challenging outlook is expected to dampen its medium-term profitability,  ii) the deal fails to  seriously address  Chongang's  high gearing, and iii)  the  government's compensation is less than the actual costs incurred in relocating its plant.

- We reiterate our NEUTRAL stance on Chongang, with a FV of HKD1.31.

Injecting RMB19bn in assets. After a 3-month share trading suspension, Chongang finally entered into the agreement  with its parent company  to acquire steel  assets amounting to RMB19bn as well as  finalized the environmental loss compensation. The acquisition consideration will be satisfied by issuing 2bn new shares at RMB3.14 per share,  a  cash consideration of RMB538m, and assuming its  parent company‟s RMB10.7bn in liabilities.  Meanwhile,  Chongang‟s parent company has  also undertaken to obtain government compensation of not less than RMB1.5bn  as the operating loss arising from relocating its plant, which we think may be used as part of the settlement  amount. Chongang  has  also proposed  to raise  RMB2.2bn via  the placement of new A-shares.

Largely NEUTRAL. We are positive on Chongang potentially transforming into a fullfledged integrated steel player  on  completion of the deal. We  are  pleased  that  its parent company  will accept  a  major part of the settlement  by  issuing  new shares priced at 1.33x of its FY11 P/BV, which is at a significant 189% premium to the price of its H-shares. Nonetheless, we are  not  overly  excited about the proposal from an investment  standpoint as we fail to see any major improvement in its bottom-line in the near term, especially  in view of the medium-term structural challenges confronting  the steel industry. Furthermore, the exercise  does not address Chongang‟s  high gearing, which is  expected to remain at 2.5x  even after the completion of the new share placement to  investors.  That said,  the RMB1.5bn compensation from the government falls short of the allocated impairment incurred in relocating  its plant.  As we are generally  neutral  on the deal, we are  NEUTRAL on Chongang. Our Fair Value of HKD1.31 is derived from 0.5x FY12 BV.

Source: OSK