Private placement to help boost confidence and balance sheet
Largest shareholders to increase stakes to 34% While some in the market might view the RMB6bn private placement as a sign of confidence from the largest shareholders, we see the move as an inevitable step to prop up Dr. Peng’s balance sheet given its high leverage and significant future capex plans. We continue to think the capex spend of the business remains too high and will pose a significant headwind on the earnings growth and cash flow profile of the business in the medium term. Post the equity raising, we now expect only 5% EPS CAGR over the next 3 years and with the stock trading on 39x FY16 EPS, we maintain Sell.
Largest shareholders to increase stakes to 34%
Post 4 days of trading suspension, Dr. Peng has announced that it will issue new shares of up to 21% of its existing share base to the two largest shareholders. The private placement, priced at a 9% discount to the last close, will increase their stakes from 20% to 34%. Regulatory approval is still required and the newly-issued shares will be locked up for up to 3 years.
Raising necessary to sustain its capex plans
The company has indicated that the RMB6bn raised will be used to invest in the network infrastructure, build a cloud platform and improve its media offerings over the next 3 years. While some might take the raising as a sign of confidence by the two largest shareholders, we believe it is almost necessary given its high leverage ratio (3.3x vs. peer average of 2.1x) and the strain from ~RMB3.5bn p.a. in expected capex over the next 3 years.
We have incorporated the equity raising in our forecast, which reduced FY17E EPS by 4% and FY18E EPS by 9%. We have assumed that the money raised will be used to either reduce debt or be kept as cash in order to prop up the balance sheet (rather than to be spent on additional capex).
Valuation and risks
We value Dr. Peng based on the mid-point of our peer-based valuation and DCF. Risks relate to market share, tax rate, regulation, and margins.