On 9 May 2024, Xtep proposed a series of transactions related to the divestment of the athleisure business, which includes K-Swiss and Palladium. We believe the impact could be mixed: on one hand investors could get a special dividend of up to HK$0.447/share, and no more losses from the disposed business. On the other hand, the deal sacrifices medium-term growth potential. If the deal is completed, then Xtep will only operate the core brand, Saucony and Merrell, with running being the focus. Still, we remain positive on Xtep, as we view that it is hitting the sweet spot of the growing sportswear market.
Key Factors for Rating
Divesting K-Swiss and Palladium with a series of transactions. For Xtep, the relevant parts of the deal consists of: (1) the controlling shareholder Ding Family to acquire KP, the holding company of the brands, for US$151m; (2) Xtep to pay special dividends of US$151m to shareholders; (3) Xtep to issue CB of HK$500m to Hillhouse, and (4) Xtep to purchase the 3.5% 2032 CB issued by KP of US$154m. Hence, Xtep has the right to own 30% stake of KP upon the conversion of the 2032 CB, while Hillhouse may also become an investor of KP. The transactions are expected to be completed in Aug 2024.
Our take: short term positive but sacrificing medium-term growth. We believe the deal is a surprise to the market, given the seemingly improving performance of the two brands. KP had a net loss of US$31.8m in 2023 (approx.
RMB220m, or 21% of net profit), and is still loss making in 1Q24. So Xtep's stripping off the two brands could actually boost its 2024 and 2025 earnings, while shareholders could also enjoy special dividends of HK$0.447/share, likely in late 2024.
However, the deal has two drawbacks: (1) it sacrifices the long-term potential of the two brands, especially Palladium in China as its performance is good, and (2) the HK$500m CB issued by Xtep could dilute earnings by at least 3.3%, before the 3.5% interest cost is considered.
The deal could boost near-term valuation. We expect the market would still react positively to the deal, given the special dividend (equivalent to 8.2% dividend yield based on 10 May 2024 close), and less drag from the athleisure business. Xtep will focus the brands relevant to running, and we expect it would also spend more resources on Saucony and Merrell, which turn profitable in 2024. Assuming the deal completed, and 2Q24 YTD performance in-line, we believe Xtep could still achieve a >10% revenue growth for the remaining 3 brands, with NPM improving, which is stated as its previous guidance.
Key Risks for Rating
Downside risks: (1) unsuccessful multi-brand strategy; (2) deteriorated retail sell-through for core brand; (3) unexpected spike in spending, and (4) higher costs related to transactions.
Valuation
We assume the transactions could be completed in Aug 2024, and change our 24-26 EPS forecast by -1%/+3%/-0.3% to mainly reflect: (1) the divestment of K-Swiss and Palladium which mainly affects 2025-2026 revenue; (2) slight change in SG&A assumptions as we expect more cost will be dedicated to core brands, and (3) the shares dilution.
Maintain BUY and lift our TP to HK$6.2 as we lift our 2024 target multiple to 13x (previous: 12x) since we expect the now cleaner business structure should boost market's sentiment on the stock.