Overall, we find the arrangement accretive (thus revising up FY24E-26E NP by 2% to 5%) for Xtep in the short run and turn more positive on its near-term outlook. With its rather undemanding valuation (10x FY24E P/E and 14% yield), we maintain BUY with a new TP of HK$7.63, based on 14x FY24E P/E.
What is new? Mr. Ding has proposed to buy K&P and reshuffle the deal with Hillhouse; special dividend will also be paid. Xtep has announced a series of actions: 1) Mr. Ding will buy K&P from Xtep, at a price of US$151mn (at around 0.7x FY23 P/S), 2) all the consideration will be paid as special dividend (at HK$ 0.447 per share, about 8% of current market cap), 3) Xtep will redeem Hillhouse's CB of K&P (issued back in Jun 2021) at full price, which was worth US$65mn (0% coupon rate, 10 years, strike price at US$4,333 for 20% of K&P ownership), 4) Xtep will issue a new CB of Xtep to Hillhouse, which was worth RMB500mn (3.5% coupon rate, 6 years, strike price at HK$ 5.5 for 4.07% of enlarged share capital of Xtep (fully diluted, including the interest income)), 5) Mr. Ding will also issue an option of K&P to Hillhouse, to buy back 20% of K&P ownership, at the same price of US$65mn, and 6) Mr. Ding will sell a CB of K&P of Xtep, for US$ 154mn (3.5% coupon rate, 8 years, strike price at US$5,988.95 for 30% of enlarged share capital of K&P).
Our view: Positive in short run as the risk of impairment has been removed. 1) It is positive for Xtep to dispose of K&P, because in the short run, K&P is likely to incur more losses (from opening more flagship stores and increased marketing) and there is also risk of impairment (as real result is slower than the projected growth) and in the long run, the industry landscape may become tougher for the high-end fashion brand in China. Also, the original losses in FY24E/ 25E/ 26E (CMBI est. were at HK$ - 171mn/ -47mn/ -7mn) could be reduced (will consolidate only 8 months in FY24E) but will partly be offset by the CB dilution (around 4% of Xtep share capital). So all in all, we revise up FY24E-26E by 2%- 5%.
2) It is also positive because Xtep's cash flow will be improved and it will focus more resources on its mass-market and running products and expansion of Saucony could be accelerated afterwards (both Saucony and Merrell are already breakeven and shall make positive contribution onwards).
3) Some investors are concerned about the selling prices of K&P (0.7x FY23 P/S) vs the buying price of (1.2x FY18 P/S), the dilution of ownership (can only buyback 30% of K&P shares if it turns out to be successful) and the strike price implied valuation (priced at US$513mn in FY32E). However, we have to consider the overall risk-reward as Mr. Ding is taking a bigger risk and bearing all the short-term losses here for the long-term story of K&P.