PP/10551/10/2007 January 9, 2007 MALAYSIA EQUITY Investment Research Daily News Private Circulation Only Company Update MOTOR Wan Azhar Mustapha Trading BUY Maintained +60 (3) 2333 8373 PROTON HOLDINGS Price RM6.15 [email protected] Target RM7.30 Proton + VW = Skoda…? Stock Profile/Statistics In this report, we have synthesized the prospects for Proton in the event VW emerged Bloomberg Ticker PROH MK as the winner for this takeover saga. We have accredited VW success story on the re- KLCI 1113.02 birth of Škoda, a long suffering Eastern European marques before the entry of VW into Issued Share Capital (m) 549.21 Market Capitalisation (RMm) 3377.66 the fold. We have also highlighted the “before and after” of Škoda en-route to its 52 week H | L Price (RM) 6.75 4.48 eventual award winning models without losing its national identity. Hence, we are all for Average Volume (3m) ‘000 625.15 VW’s bid. Trading buy with immediate target price of RM7.30 vis-à-vis our sum of parts YTD Returns (%) -0.45 Net gearing (x) -0.02 value of RM9.19/share. Altman Z-Score 2.97 ROCE/WACC -0.07 Beta (x) 1.49 The Škoda Model. The success of Škoda is proven and well documented and hopefully some Book Value/share (RM) 10.64 of its magic does rub onto Proton. We traced the early days of Škoda before VW and try to get some insights of the impact after the acquisition by VW. Major Shareholders (%) Khazanah Nasional 38.3 EPF 10.5 From an ugly duckling. Škoda cars have come a long way under VW with multiple awards in Petronas 7.3 the bag as proof. Škoda nowadays is the best success story post communism and is the Share Performance (%) largest employer in the Czech Republic as well as the country’s main income generator, Month Absolute Relative contributing about 8% of the total GDP. 1m 3.33 -2.09 3m 25.51 9.05 6m 21.61 -1.65 Why VW is interested in Proton? We believed it has to do with (i) a ready hi-tech 1.0m 12m -2.14 -20.04 capacity manufacturing plant, and (ii) the potential of the Asean automobile market. It was speculated that VW may fork out RM2.0bn to control Proton’s manufacturing arm, which we 6-month Share Price Performance view as inexpensive compared to starting a greenfield project. Would Proton benefit? It is still too early to tell but judging from the positive impact VW had on Škoda, hopes are high. On the face of it, we could see benefits coming from technology 6.40 transfer, R&D, product development and marketing. 5.90 A new shareholder imminent. Khazanah is talking to various parties but the four main 5.40 contenders are all local prospects from the overriding desire that Proton to remain under 4.90 national control. However, none of the companies, DRB-Hicom, Sime Darby, Naza and Mofaz, 4.40 strike our fancy to take Proton up to the next level. Jul-06 Aug-06 Sep-06 Oct-06 Oct-06 Nov-06 Dec-06 Trading Buy with ample upside from valuation. Our valuation is based on 0.7x FY08 Price/Book ratio, translating into a target price of RM7.30/share. Furthermore, we do not expect Khazanah to let it go below the RM9.00 level given its costs to acquire the share was at between RM7.40 and RM9.10 per share. FYE Mar (RMm) FY04 FY05 FY06 FY07f FY08f Turnover 6,470.30 8,493.29 7,795.29 5,556.04 5,781.82 Net Profit 510.14 650.15 25.80 -14.30 -6.15 % chg y-o-y (53.94) 27.45 (96.03) (155.43) (56.99) Consensus Net Profit - - - EPS (sen) 92.88 147.50 4.70 -2.60 -1.12 DPS (sen) 6.94 34.70 40.28 30.00 30.00 Dividend Yield (%) 1.13 5.64 6.55 4.88 4.88 ROE (%) 9.56 11.41 0.44 -0.25 -0.11 ROA (%) 6.27 7.36 0.31 -0.18 -0.08 PER (x) 6.62 4.17 130.92 -236.20 -549.21 P/BV (x) 0.61 0.57 0.58 0.58 0.59 OSK Research See important disclosures at the end of this publication 1 OSK Research PP/10551/10/2007 January 9, 2007 KEY HIGHLIGHTS Mr. Right. Speculation is still rife that Proton is closing in on its strategic partner with the latest news that VW is making a u-turn and is in negotiation for the take over of Proton’s manufacturing arm. If so, we could see an arrangement similar to those of Perodua/Daihatsu structure whereby the Japanese principal is in control of Perodua’s manufacturing operations. We view it positively as there are benefits for Proton in terms of technology transfer and R&D, distribution network and access to more extensive product range. In this report, we will look at the various possibilities in the event VW does really come into the picture. Meanwhile, we have also look back on how Škoda has evolved with VW and the potential benefits. A brief history on Škoda. According to Škoda Auto, the company was founded in 1895 by Václav Laurin, a mechanic, and Václav Klement, a bookkeeper, both enthusiastic bikers, making their own bicycles, named Slavia. In early 1900, Laurin & Klement Co. (L&K) begun manufacturing motorcycles and 5 years on, the company made a major move setting itself to manufacture automobiles in 1905 with its first car called the Laurent & Klement A. In 1925, L&K merges with the country’s largest industrial enterprise, Škoda Pilsen that gave birth to Škoda as a brand name with the establishment of an assembly-line production for automobiles and made its name in Russia and Eastern European countries. In fact the Škoda brand was the top choice in the Eastern Europe with market share at about 35%. Škoda as a carmaker. Škoda has one plant in the city of Mlada Boleslav near Prague in the Czech Republic with a capacity of 180,000 units per annum. The production facility is labour intensive with only 1 product line for passenger cars. Privatisation of Škoda. This idea came about after the 1989 revolution that saw the end of Communism. The fall of the Soviet Union also resulted in the collapsed of Škoda’s main markets in Eastern Europe. Furthermore, the new government was in the rebuilding stage hence the need to push Czechoslovakia economy back to its health. According to an article by Jonathan Ledgard, there were about 24 bidders for Škoda with both Renault and VW down to the wire. Other conditions set forth were that VW would have to guarantee jobs and an injection of US$5.7bn to turn around the company. From having just one product line in small family car, the product expanded to include estate, 4WD, hatchbacks and saloons. Prior to VW take over, Škoda production was at about 180,000 units per annum of which 75% were for the domestic market while the remaining exported to the Eastern Bloc countries. It was reported that in 1990, Škoda was in the red. Being in a major Eastern Bloc country, Škoda enjoyed strong demand from it allies where the Eastern European countries accounting to about 35% of its sales. Domestically, Škoda cornered the market with a market share of about 45%, or 140,000 units of cars sold in Czechoslovakia (Prior to the split with Slovakia). Initial approach from Renault was thwarted when VW made a last minute successful bid. In December 1990, the government decides on for cooperation with the VW Group where on April 16, 1991, Škoda joins VW, Audi, and Seat as the fourth marques. Entry of VW. The acquisition by the Volkswagen Group is one of the major milestones for the company as it helped to transform the company from the brink of collapse to an economic powerhouse in the country. Controversial. The deal was deemed controversial as the acquisition of Škoda was the first major privatisation deal in Eastern Europe after the collapse of the Soviet Union. The deal between VW and Škoda was signed on 16 April 1991, where US$416.0m was transacted for a 31% stake in the company and a further US$260.0m each in 1993 and 1994 to raise the shareholding to 70%. VW acquired the final 30% from the Czech government (undisclosed amount) in 2000 Not all rosy. The acquisition has its ups and down as VW discovered early on. The “normal” setbacks were unmotivated workers, operations in disarray, overstaffed etc. Thus the real headache began when VW began to consolidate Škoda with production cuts, lay offs and crucially decided to cut its planned investment of US$5.7bn to US$2.5bn, prompting massive protest from the government and workers. Subsequently, the matter was resolved without further damage to the deal. OSK Research See important disclosures at the end of this publication 2 OSK Research PP/10551/10/2007 January 9, 2007 Life with VW. The impact from VW’s acquisition was immediately felt, as it promptly upgraded Škoda's manufacturing facilities (which is now regarded as one of the world's most modern plant) and reconstructed the value chain to streamline the vendors and increased employment from 24,000 to 26,000 of which 900 are its R&D staff. Strong capacity expansion. Since 1991, production capacity at Škoda increased to a whopping 500,000 cars per annum from 180,000 of which more than 80% are exported worldwide to 70 countries.